Real estate development is a multi-step process that can be complicated, lengthy and risky. It can take years to bring a project from the initial planning stage through construction to final completion, and there are plenty of obstacles that can pop up along the way. Yet development projects also can be highly profitable investment opportunities. By definition, development projects provide the opportunity to deliver a product that does not currently exist into a market, often providing the fresh new supply to satisfy pent up market demand. When executed well, this aspect of a development project can translate into a runaway success story, something that simply isn’t nearly as possible with an existing asset. Investors can more confidently assess some of the risks associated with construction by better understanding the “life cycle” of a development project.
Risk across project type and stage
Two factors can play a big role in the risk of a given project: the project type and stage. As shown in the graph above, the project type can determine the steepness of the risk curve across the project life cycle.
An example of a project type with relatively low risk across all stages of the life cycle is a retail “build-to-suit” project. In a retail build-to-suit, a developer secures a long-term credit tenant, such as a McDonald’s or Walgreens, and develops a property to suit that tenant. For these types of projects, construction risk is low because the buildings are fairly uniform, and leasing risk is almost non-existent because the tenant is already identified and under lease with limited ability to terminate. There may be some pre-development risk depending upon the regulatory hurdles, as described in the Pre-Development section below.
At the opposite end of the spectrum, an example project type with relatively high risk across all stages is called a “speculative” or “spec” project. In a spec industrial or office project, a developer may have few or no leasing commitments before commencing construction. The developer justifies the project by pointing to existing or projected demand for the property after completion. For speculative projects, the leasing risk is high because there are no identified tenants at the outset, the construction risk can be high if the project design is unique, and the pre-development risk can be high if financing is difficult to obtain or regulatory hurdles abound.
As each step in a development project is completed, overall project risk incrementally abates. Early in the cycle, there are more potential obstacles and unknowns. As a project nears the “shovel-ready” construction stage, many of those potential obstacles have been addressed and resolved and there is more certainty related to execution, costs, and schedule.
Below, we discuss items that are consistent across project types.
Early stage: Pre-Development
The early stage of a project focuses on due diligence, research and permitting. It is often the most variable in duration. Investing at this stage carries the greatest and most varied risks because there are many unknowns. Some of the common steps in this phase include:
Market analysis and feasibility studies
Land acquisition or securing option rights to purchase land
Site plans, development plans, and building plans
Some infrastructure improvements
Arranging construction financing
Because this stage is the riskiest, pre-development work is usually financed by the project sponsorIn commercial real estate, the sponsor is an individual or company in charge of finding, acquiring and managing the real estate property on behalf of the partnership. The sponsor is usually expected to invest anywhere from 5-20% of the total required equity capital. They are then responsible for raising the remaining funds and acquiring and managing the investment property’s day-to-day... More or a source of seed equity that might get taken out by the construction loan. Investments made during this stage, therefore, provide for higher returns than those made during the later stages. One important note for equity investors is that obtaining construction financing from a bank or other lender is a very rigorous process, and if a developer already has a construction loan arranged, it usually means that a number of major hurdles have been cleared.
Perhaps the greatest impediment to capital formation at this stage is the local jurisdiction permitting. There are usually two distinct approvals required to begin construction: land use approval and building approval.
A land use permit is a governing jurisdiction’s approval of the project on a conceptual level. Almost every jurisdiction in the country, with the notable exception of Houston, Texas, has some form of land use regulation, which provides a subject system of sorting and qualifying not only the proposed use of land (retail, industrial, residential, etc.) but also the physical characteristics of the improvements (height, density, setbacks, etc.).
The land use application process can delay a project for months or even years. For this reason, the land use permit, while not the final approval for construction purposes, is often the greatest hurdle to achieve project financing. Some items that might delay land use approval are:
Appeals from neighbors or other interested parties
Disputes between the developer and the jurisdiction
An involved design process that requires multiple site plan iterations
By granting a building permit, a jurisdiction is approving a project on a technical level. A jurisdiction, through its engineers, will review building plans to determine whether they meet certain safety standards and conform to current building codes. The building permit application process is relatively speedy compared to the land use process because is supposed to be based on objective criteria. For this reason, it is less likely to delay fundraising. The building permit is generally the last milestone in the pre-development stage.
Middle Stage: Construction
The middle stage involves constructing the improvements. Since the pre-development tasks have been completed, the project risks at this stage are greatly reduced but certainly not eliminated. Some of the common steps in this stage include:
Drawing on construction financing
Arranging permanent financing (if not done during pre-development)
Arranging for the property manager (if not done during pre-development)
The project typically is financed at this stage by the sponsor, outside investors, and a short-term construction loan. Often, the debt is distributed to the developer in increments called “draws” upon the achievement of construction milestones. Investments and loans made during this stage generally provide lower returns than pre-development investments but higher returns than those made for fully-constructed or stabilized buildings.
The certificate of occupancy generally marks the end of the construction phase and allows for the commencement of property operations. Like the building permit, it is based upon objective criteria regarding construction quality and is a fairly administrative process.
Final Stage: Operation
The final stage of the development process, operation, is the first stage of the building’s life. While the pre-development and construction risks may be removed by this point, obtaining tenants is still at risk. Some activities during the final stage include:
Ongoing marketing and leasing
Finding a buyer, if not done earlier
Determining a hold strategy, if not selling
Ramping up property management
The project is typically financed at this stage with construction financing or another round of short-term “bridge” financing until the project reaches a threshold called “stabilization,” which is typically defined as a certain occupancy level (perhaps 90% or better) for a certain duration (perhaps three consecutive months). Upon stabilization, so-called “permanent” or long-term financing can be placed and used to take out construction financing. Depending upon the amount of pre-leasing that was accomplished during construction, this can be the least risky stage. For this reason, permanent loans and equity investments will provide the lowest returns.
This snapshot view highlights the risk profile of development projects over time; however, many of the same risks apply to the purchase or refinancing of an existing building, such as sponsor solvency and expertise, economic conditions, and market factors also apply.
Pre-qualification and Selection of Contractors
Bentley Builders knows that finding the right contractors is essential to the success of any construction project. Once your drawings are finalized, we carefully examine the scope of your project, including unique requirements, budgetary issues, required manpower and completion deadlines. Based on these criteria, we recommend a select group of contractors whose experience, proven track records and qualifications are the best fit for your particular project.
Bid Solicitation and Contract Negotiations
Bentley Builders solicits clear, detailed contractor bids that cover the anticipated scope of work. Every bid is closely evaluated to ensure that it is complete, competitive and accurate. We establish criteria for evaluating these bids, and make measured and thoughtful recommendations. We then meet with the successful bidders, and negotiates business terms that are favorable to our clients. The results facilitate an accurate and well-informed bidding process, and reduce any time and cost-consuming surprises once the project is underway.
Once your drawings are finalized, Bentley Builders acts on your behalf to expedite the plans through all appropriate public agencies. We work to make the approval process seamless and as favorable to your interests as possible.
Every misused day on a project site represents lost time and money. That is why we make sure your project advances in a realistic, logical and aggressive manner-from start to finish. We closely examine the overall scope of work, and then assemble a schedule that maximizes the time and resources of every team member. Sometimes the schedule may move in a singular fashion, at other times it may incorporate multiple tasks being worked on simultaneously. We continually look for opportunities to accelerate progress, pushing your project that much closer to completion.
During construction, Bentley Builders is regularly on-site to monitor progress, talk to contractors and offer suggestions to make sure that your project is moving forward according to plan. We help facilitate communication among every project team member, anticipate potential problems and take decisive action when necessary. Our hands-on approach means we pay close attention to the day-to-day issues that will ultimately dictate the project's success.
Cost and Quality Control
Bentley Builders institutes strict cost and quality control measures during the construction phase of every project we manage. By serving as a "checks and balances," we not only make sure that your project is completed on time, but also that the final product meets your standards and budgetary criteria. We carefully review every invoice to confirm that what is being paid reflects the work that was agreed upon, as well as the work that has actually been completed. Change orders are checked for their accuracy and necessity, and our "schedule of values" approach dictates that payments are made only when costs are actually incurred.
Our design-build teams strive to provide design and construction services to stay ahead of any and all issues. We are able to provide the services to effectively budget, design and build projects for our clients. Our fast delivery from design to construction ensures a successful project.
From the first meeting with you to the last drop of paint, we effectively manage all components of your process while staying in ongoing communication with you. Our design-build services are well suited for clients who want a “soup to nuts” approach. Key benefits include:
Accountability & quality control: Because we manage your entire project, you have a single point of contact who is accountable to you. Our team is working together cooperatively from the first meeting with you. This eliminates communication failures and conflicts of interest.
Proven, established processes: Unplanned changes and unforeseen conditions can be a project coordination nightmare when multiple parties are involved, leading to mistakes, higher costs, and extended time lines. A well-planned project using our streamlined internal processes for addressing change allows efficient change orders and tight cost control.
Speed, efficiency, and cost control: By working together as a single entity, we are able to create more detailed and accurate budgets and construction plans. This means we save you time, money, and stress. We carefully manage your project so that we can deliver it as promised.