How to Successfully Develop Commercial Real Estate – Part 1

How to Successfully Develop Commercial Real Estate – Part 1

There is one fundamental component that stretches across each of the major areas of developing a new commercial real estate project, from buying the land, to building the building, to attracting tenants, managing the space as Landlord and even refinancing or selling the project. This single component is money. All development projects need money, one must acquire the land, pay for certain up-front costs, pay to get the project built, and pay to support the building while finding enough tenants to fill it.

Since development projects can be expensive most developers look to third parties such as commercial banks and investors to supply the money needed to “finance” the project. If a developer can finance a project they can get it built. Getting financing, the money, therefore becomes the single biggest obstacle to moving from the developer’s vision, to construction, completion and finally, an open, operating, and successful development project. Almost all commercial real estate construction projects are financed by a majority of debt. The debt is usually in the form of a construction loan from a commercial bank and will typically constitute somewhere between 60-80% of the project cost. The neat thing about construction loans is that the developer/borrower pays only interest during construction and for a short period thereafter and then must refinance the loan.

The remaining portion of the project cost, the portion not funded by the bank construction loan is often referred to as equity. Equity, can come from many sources, equity can come from the developer, the land the project is to be built on or from third party investors. Remember the bank only lends a portion of the money needed to complete the project (60-80%). The equity investment funds the difference. Together the construction loan and the equity investment make up the money or value needed and are often referred to as the development project, capital stack.

Most developers realize early on in the process that closing the construction loan is the most important step in a new development project becoming a reality. With the closing of the construction loan a project moves from the stage of hoping to be built to a high likelihood it will be built. Therefore, meeting the needs and demands of the construction lender and the equity investors becomes the single most important factor in moving a development project forward.

That being said, financing for a development project is not always easy to obtain. It can take many months, if not years to close acceptable project financing. Although obtaining construction financing and equity investment may sound complicated once again there is a single fundamental component that attracts almost every construction lender and equity investor to a real estate development project. We will explore this fundamental component in detail with Part 2 of, “How to Successfully, Buy the Land, Build the Building, Attract Tenants, be a Landlord and Own or Sell a Commercial Real Estate Development Project.