Last month Dan and I discussed getting to know the developer. This month we’ll discuss an overview of the development process.
The path from start to finish for a commercial development can be like a roller coaster. While it appears to be linear, in reality, there are many ups and downs, and several points when your car can feel like it’s going to jump off the rails! This is one of the key reasons why you want to partner with an experienced developer, who can direct the process, and who knows how to apply the roller coaster brakes if needed. While a typical roller coaster ride takes just minutes to complete, a development can take years from start to finish.
What are the typical stages of development?
- Due diligence/feasibility
Due Diligence: Determining the viability of a site means answering the question “What does this site want to be someday?” You may already know the answer to this for your property, or a developer may have done enough research before calling, but a quick analysis of location, zoning and market conditions is the starting point.
If your property looks viable as a development site, the next level of due diligence research needed is when money has to be spent. The types of reports and analysis (such as an architectural massing study, a survey, an environmental report, and a geotech report) need to be done by consultants and depending on the size of the property, they could cost $20,000 – $30,000 in total. The key however is that the developer on the other end of the phone should be the one willing to pay these costs!
So when a developer is asking you to step into that roller coaster car, they should be able to show that they have done these studies and/or have the cash available to do them. You should expect to see a summary of their analysis, including a high level financial pro forma, and they should provide an estimate for how much pre-development cash they are investing to get through the design and permitting stages.
Design: The design process has multiple stages and multiple team members involved, with each stage eliciting greater detail and more specialty consultants involved. Typically the design team is led by the architect, but the structural and civil engineers and landscape architects are equally key partners. The first round of design is called “Schematic Design”; the second round is called “Design Development”, and the third round is called “Construction Documents” – again, each round is meant to advance the design of the project with greater and greater levels of details.
Entitlements and Permits: The permitting process for a project can vary slightly depending on which city the site is in, and it runs in parallel to the design process. Typically there is an approval for Land Use (what and how much you can build), Platting (if needed) (breaking the property into more lots), and then the Building Permit (permission to build). Any impacts that reach beyond the property line, such as sidewalks, utility connections and street restoration, are governed by additional permits and approvals. Land Use permitting aligns most closely with the Schematic and early Design Development Design phases, then the Building Permit aligns with the later Design Development and early Construction Document phases. Likewise with all the offsite and utility permits and approvals.
Does it matter who gets hired on the design team?
Yes – it matters a great deal! A common mistake made in development is hiring the design firms with the lowest cost proposals. This is a short-sighted approach since “lowest cost” often means less experience, skipped steps, or missed details which inevitably create problems when discovered, and have to be paid for later. Having an experienced team to guide the project through the design and permitting process is essential, as they need to be able to present a project successfully to the public, negotiate with permitting officials, coordinate myriad design details, and produce complete documentation for construction.
Financing: The developer who wants to partner with you is responsible for lining up financing for the project. Not only should they have the working capital to fund all the costs of pre-development (which can often be hundreds of thousands of dollars), but they should have contacts in the lending world to tap into when it comes time to start a construction loan.
Both Dan and I have worked in lending and in development – so we can attest to how much work and how many design and development decisions are made before a banker gets involved. The banker expects to receive a nice tidy package with all of the costs identified, and in particular, the name of the person who will provide a guarantee for the loan. While you may be contributing your property as part of the equity for the deal, it is important to clarify with the developer who they expect to sign on the dotted line with the bank – because in most cases, the bank won’t move forward without it.
Since financing is a large component in the development process, we’ll be devoting a full article to this later.
Now it’s time to turn the plans into reality!
Construction: The roller coaster brakes are off, the seatbelts have been tightened a few times, and now the shovels are ready to go in the ground! The start of construction is a major milestone for any project. The selection of a contractor has already happened during the design and permitting stages, and by the time construction has started all contracts are in place and permits have been issued. Construction can be a very dynamic process which requires constant attention and communication with the construction team. In a perfect world where no project has ever existed, the drawings and plans provide perfect guidance for all of the different trades to be able to build the building. In reality, there are many questions about details or design conflicts which get asked and answered, plus a constant monitoring of how well the construction expenses are matching with the budget. Personally I love the construction phase, since there is great satisfaction in seeing the physical reality of something that has only been on paper for a long time.
Leasing: Now your roller coaster ride has come down the final hill, and is in that final flat stretch where you catch your breath, your heartbeat slows down, and you can laugh at how silly your hair looks from the ride. It’s time for leasing up the building! This is the stage when at long last, the money flows in vs. out as end users sign leases, move in, and rent payments start flowing. Within the final months of construction the property managers or leasing brokers have been at work lining up the property’s public presence and branding position, generating interest in leasing. Depending on the size of the building, it can take 6-12 months to complete the lease-up process, but there does come a point where the revenue generated by leases exceeds operating expenses and turns cashflow positive and you can achieve a return on your investment.
Next month we’ll discuss the basic structure and risks of joint ventures, as those set the parameters for how your return on investment will play out.
Laura Bachman is a long time real estate professional in the Greater Seattle Area. Her work centers on taking properties through the design, permitting and construction phases of development on behalf of both private property owners and for commercial developers. Laura brings both an attention to detail as well as a background in finance to each building she brings to life. The extensive list of projects she has worked on can be found at: www.bachman-group.com.
Dan Whitaker provides real estate and finance guidance for families, business and government. His 35+ year career in real estate has spanned all facets of commercial real estate. He focuses on helping families with real estate work through transitions, manage portfolios, and keep the finances in order. He brings both an investor’s high-level perspective as well as an accountant’s level of detail. You can find out more about Dan on his website, here or email him at email@example.com.