Developers are promoters. Like concerto conductors, they have to manage the varied forces within the development scenario, perpetually inside a private conception of a way to bring those forces along to create a development that upon completion, is the value quite the price of making it.
It is probably that developers and their organizations have some depth of information within the areas of construction, leasing, management and sales. Depending on the dimensions of a specific organization, if possible, there ought to be in-house designing, legal and funding skills in addition. However, unless there’s a continuing high volume of developments, it’s most likely cheaper for developers to contract with professionals within the marketplace to handle web site designing and design, legal problems and mortgage funding.
Determining a need
In one sense, real estate is like any other product: unless it fills a need, there can be no assurance of its success. Development potential can be researched through professional market surveys. However, it is more likely that developers will sense, based on in-depth local knowledge, where the opportunities are and then engage a market analyst to verify their guesses. In most markets, unmet needs are quickly filled by competitors.
Three scenarios by which needs are determined include the following:
1. A dynamic economy, with continual growth in jobs and population, can spur new development of a speculative nature, such as speculative nature, such as rental and condominium apartments, ware house and distribution facilities, retail centers, office building and lodging facilities.
2. A tenant wanting to expand asks for proposals.
3. A combination of speculative development and specific tenant expansion.
The assumptions and challenges of financing these three scenarios are quite different and mortgage bankers can work with developers to establish the likely financing available for each of these situations.
Testing Economic Feasibility
Once a development need has been determined, the developers work on many fronts simultaneously to create a series of models for testing the economic feasibility of the proposed response to the need. Various sites are identified and analyzed for
2. Cost, and
3. Ability to accommodate the proposed improvements
In this process, the developers solicit, manager and ultimately rely on input from planners, architects, lawyers, tenant representatives, contractors and mortgage bankers. The project is outlined on paper in sufficient detail to develop capital and income budgets, as well as to assess risk.
Mortgage bankers help estimate how much of the costs can be financed through term debt, providing developers with estimates of the terms of such debt. This enables developers to determine how much equity will be required and what the economic return on that equity will be. At this point, a decision must be made about investing the equity money and seeking partners for all or part of it. Each developer’s own experience, liquidity and knowledge of equity investors’ expectations are critical in deciding whether to risk more money in the project. Frequently, mortgage bankers can determine projections to help developers attract equity funds.
During this process, leasing and money markets can change for the worse and major tenants can disappear. For example, the approval process for one shopping center in Connecticut took nine years. Generally, developers who are able to work effectively – either personally or through professionals – with municipal, state, and federal planning professionals will be more successful than those who try to push the envelope too far.
It is possible that the secured approvals do not permit the scope of the development that was initially planned. When this happens, the developers must update their economic models and conduct nee feasibility studies before making another decision. Again, mortgage bankers can help by supplying current data in terms of lender guidelines, rates and terms. Once the necessary approvals are received, the developers need a loan commitment to provide the funds for land acquisition and development.
Developers should know local construction cost and competent contractors. Timely completion of cost-efficient construction is always a priority after the long approval process. Tenants will be anxious to take occupancy, and, once the land is purchased and a construction loan closed, the interest is running without any income being generated. Nothing happens until the property is completed: No tenants can move in, the permanent loan cannot close, and some approvals may even lapse. Experienced contractors in commercial construction, with solid records of on-time completion, can save hundreds of thousands of dollars in last-minute problem.
Depending on the property type and nature of the leasing challenge, developers may choose to handle the losing in-house. For properties other than apartments (retail leasing in particular), leasing can be a specialized skill. It is important for developers to consider engaging experienced brokers to complete the leasing issues. Most lenders want to approve major leases.
Economic rent is one factor in the leasing equation. The cost of the landlord’s work to build out the tenant spaces, the length of the lease and go-dark, and cancellation provisions are also critical points that must be negotiated. Tenants want their leases recognized in the event of a foreclosure. Lenders want estoppel agreements for all major leases. Mortgage bankers can help developers identify lease provisions that are critical to the lender.
Real estate development is a difficult profession at best. The risks are ever present, and many projects are never completed, resulting in substantial sums of money lost. Developers who listen carefully and understand the requirements of approval authorities, tenants and lenders – and who can bring forth developments that satisfy all requirements – will enjoy great success.