Chapter_24_-_Development_and_Creating_Value.doc

Jennifer Bishop December 11, 2009 RE Book Notes Chapter 24: Development ? Dynamics of Creating Value Introduction Development: continual reconfiguration of the built environment to meet society?s needs (a necessity) What developers must know: RE property interests Land use regulations Market potential for projects Cash flow analysis to determine profitability Financing/investment RE transactions Property management Process of Development 3 ways development projects arise: 1) a site in search of a use 2) a use in search of a site 3) capital in search of an opportunity 8 Stages: 1) Establishing Site Control Best: developer owns site outright (no debt) Happens when developer part of family/org whose land has suddenly become valuable 4 ways for developer to finance site control: Purchasing an option: lets developer choose by certain date whether to go through with the purchase Gives time for financing, zoning, testing, permits Contract for deed (disguised) ? can purchase land w/ this, w/ small down pmt, then abandon project if infeasible Joint venture w/ future tenant/owner Lets new developers enter industry Allows tenant a facility ? BUT uncertainty as to availability date Risk reduced if tenant knows he/she will occupy larger part of facility Build-to-suit: developer leases to strong tenant to build to tenant?s specifications (restaurant, fast food chain, etc.) Ground lease: only land rent paid before development starts Gives land owner LT, inflation-protected income Gives owner all improvements 2) Feasibility Analysis, Refinement, Testing Financial feasibility analysis compares project PV to cost Developer decides if NPV positive enough to do project Must analyze land even if NPV positive (consult experts) Wetlands, toxic substances, ruins, wildlife habitat, etc. Environmental Impact Statement (EIS) or Environmental Impact Report (EIR) required before permits given 3) Obtaining Permits Site plan review required of all development projects even if zoning change not needed Reviews may be expensive and 1+ years for big projects Time and legal expenses may require months or years Political resistance possible if building near neighborhoods Lawsuits, delays- most serious threat to developers!!! Developer may have to provide ?gifts? ? parks, improvements 4) Design Selecting an architect Provides design services/schematics Details plumbing, electrical, HVAC, etc. Can represent development in public meetings ? expertise, positive image compared to developers/attorneys Compensation: Hourly basis during permitting stage % construction cost or fixed fee + expenses during design stage (depends on design complexity) Problem w/ %: rewards for costlier designs Architect chosen by reputation, compatibility of values/goals, competence, communication aptitude Land planner: uses input from specialists to ?solve? aesthetic, use, preservation, traffic, utility and drainage issues ?macro? perspective ? concerned w/ relationships of project with the land Landscape architect: focuses on topography, soil, vegetation context to enhance setting for structure May also address energy efficiency/drainage Soils engineer: addresses safety/stability of structure foundation Structural engineer: determines structure skeleton Mechanical engineer: addresses HVAC/building systems Electrical engineer: designs power sources/distribution system Civil engineer: designs utilities (sewers, water, streets, parking, grading) 5) Financing Land Acquisition Financing Developers have limited capital ? high opportunity cost ? liquidity value for other projects Institutional lenders won?t lend on land generating little cash flow ? usually no more than 50% of land worth Deed/money purchase mortgage common funding solutions Soft costs: incurred by developer before reaching construction financing stage Title examination, evaluations, legal costs, architect/engineer fees Developer gets funding from outside investors ? usually LLCs or limited partnerships Developer ability to raise funds depends on track record Construction Financing Bank most common source of construction funding Finances land costs, soft costs, hard costs: direct cost of materials, labor, subcontractor Loan dispersed to developer in stages Risks already resolved when bank grants construction loan: Environmental, ecological, title, permitting Remaining risks: completion, delays, strike/accident risks Take-out commitment: required by banks from LT lender when they don?t want to bear post-construction rent-up risks ? LT lender pays off construction loan Mezzanine Financing: ownership shares in development shared w/ mezzanine lenders as security Construction loans fund 70-80% of projects, more capital needed Default means lenders get a portion of the development More expensive than construction financing Cheaper than equity capital, avoids equal returns Post-construction Financing Certificate of occupancy: from gov, certifies safety of building Construction lenders expect loan payback in 2-3 years, through financing or a permanent loan (funded when certificate issued) Lenders start with floor loan: smaller starting loan, since payback depends on level of occupancy Subordination agreement: construction lender makes construction loan lien inferior to lien securing take-out loan If take-out loan doesn?t pay off construction loan, developer may convince construction lender to subordinate rest of loan to take-out loan Lets take-out lender have first lien position Miniperm loan: permanent construction loan for a few years after property built Good for developer if interest rates go down with time Developer gets better LT financing after project leased After project completed/leased, most risk has passed Makes project more valuable, allowing lower financing IRs 6) Construction General contractor: central authority who controls/coordinates construction ? subcontracts excavation, concrete, building systems Can have fixed-price pay or negotiated pay Usually paid at maximum cost plus fee Cost higher/lower = developer/contractor split overrun/savings Communication between contractor/developer important Subcontractors: selected by general contractor, reviewed by developer or architect Construction manager: developer?s liaison/rep on project site; may observe contractor/architect discussions for developer Design-build: architect/general contractor are one ? reduces design/cost conflicts Fast-track construction: design broken into phases, beginning before last phases of design complete ? accelerates construction, but known to fail when later design elements incompatible with already-built elements Coordination of contracting General contractor must give input into design ? must be hired before construction loan closed Construction lender needs cost estimates from general contractor ? depend on design Developer may not be able to purchase land funded by construction loans until preleasing obtained that will satisfy take-out lender 7) Marketing and Leasing Marketing/leasing usually done by external brokers Broker must be familiar with local business so he/she knows about tenants who may want to occupy facility being built Broker shouldn?t be marketing similar projects Broker should be enthusiastic about property Broker must have organizational/personal capabilities Broker must know what market wants in this property Developer should include broker in design process ? increases likelihood RE is marketable ? gives broker more enthusiasm Increase community awareness ?position? events in development (ex: announce new tenants) Sponsor charities Provide press with ?copy? ? improves work relationship Build good relationships with regulatory officials Present problems openly and with recommended solution ? no surprise policy Show flexibility/goodwill Marketing depends on property type Advertise well in advance for offices/retail ? before project completed construction funding only available once tenants secured businesses plan moves over longer time periods, so must be sold on building beforehand lender usually keys loan terms to occupancy level Advertise apartments only shortly before units available Presell for condominium units Presell for construction financing (usually required) 8) Operation Project in ?operating phase? once mostly rented Management important for maintaining property value Numbers of Development Developer should not go through with a project unless values exceed costs In feasibility stage developer creates construction budget Projects income/operating expenses for 1+ years to compute NPV of project Determine NOI for Year 1 and capitalize it to find NPV 6 components of construction budget: 1) land costs (12%) Acquisition costs Site development Interest costs Property taxes 2) hard costs (66.3%) ? mostly actual building construction Landscaping, hardscaping Contingency reserve (for change orders) 3) construction soft costs (9.4%) Mostly utility use Architect fee Engineering fees 4) marketing soft costs (1.6%) 5) developer?s fee (1.7%) 6) total construction financing costs (10.2%) Being a Developer Good projects have positive impact on community Development is competitive, complex and uncertain ? BUT involves LOTS of risk Good job for risk managers Need to be detail-oriented, prepared, respected, able to negotiate 4 phases of the real estate cycle: 1) trough 2) expansion ? most desirable phase, unlikely to enter it when project done 3) peak 4) decline Entering Development Drive, flexibility, creativity, handle stress well, degree in a related area Credibility/respect ? knowing about money, land, tenants Gain knowledge: brokerage, property management, appraisal, construction lending, etc.