Foundations of CRE Development: From Concept to Completion
Table of Contents
- Introduction
- Types of Development
- Development Process
- Development Budget
- Timing & Distribution
- Construction Financing
- Conclusion
Introduction
Commercial real estate development is a complex and nuanced process that encompasses everything from land acquisition to the construction and leasing of the property. There are several types of development, each with its own risks and rewards, as well as a detailed process that includes numerous steps and budget considerations.
Types of Development
Speculative (Spec):
- High risk
- Building is developed to attract tenants who will lease the space after construction is complete
- Less predictable cash flows than build-to-suit development, since there is lease-up risk
- 15%+ expected annual returns**
Build to Suit:
- Low to moderate risk
- Building is designed and developed to the custom specifications of one tenant who is committed to fully lease the space after construction is complete
- Predictable cash flows from the long-term credit tenant
- Returns based on the terms of the specific agreement with the tenant
Development Process
The development process for commercial real estate involves several key stages:
- Land Acquisition: Assess feasibility, secure financing, and purchase land.
- Pre-Development: Design and plan site, secure entitlements and permits, and finalize financing for the project.
- Site Work: Prepare land, infrastructure, and ensure compliance.
- Vertical Construction: Build the structure as per the approved design.
- Lease Up: Market, negotiate leases, and fill commercial spaces.
Development Budget
Hard Costs
| Category | Description |
|---|---|
| Building Shell | The essential structural framework of a construction project. |
| Site Costs | Expenses related to land preparation and site development. |
| Offsite / Infrastructure Costs | Expenses for external utilities, roads, and services required for the project. |
| General Conditions | Overhead costs, such as project management and temporary facilities. |
| Other Hard Costs | Miscellaneous tangible expenses in the project's construction phase. |
| Hard Cost Contingency | Reserved funds for unforeseen construction expenses. |
Soft Costs
| Category | Description |
|---|---|
| Design Costs | Expenses incurred during the architectural and engineering phases. |
| Permits & Fees | Costs associated with obtaining necessary permits and approvals. |
| Testings and Inspections | Expenses for quality control and safety assessments. |
| Legal | Legal fees and expenses related to the project's development. |
| Taxes & Insurance | Property taxes during construction and insurance coverage costs. |
| Administrative | General administrative and office-related project expenses. |
| Other Soft Costs | Miscellaneous non-tangible project expenditures. |
| Soft Cost Contingency | Reserve funds for unforeseen non-construction expenses. |
Timing & Distribution
Timing
Relates to the period in which the respective development costs are incurred. Common Timing Periods include site costs and offsite costs typically starting when site work begins, and building shell, general conditions, and other hard costs typically starting when vertical construction begins. Soft costs typically start when the land is purchased.
Distribution
Relates to how the development costs are spread over the timing period. Distribution Methods include Straight-Line, where costs are spread evenly over time, and S-Curve, where costs are spread according to a normal distribution curve, with the steepness determined by the standard deviation input.
Construction Financing
| Financing Aspect | Details |
|---|---|
| Loan Terms | Usually shorter than traditional loans (1-3 years). |
| Interest | Rates are typically higher than traditional loans (interest is capitalized). |
| Repayment | Loans are often interest-only during construction. |
| Permanent Financing | Sought after construction, with longer terms and lower interest rates. |
Conclusion
In conclusion, commercial real estate development is an elaborate and dynamic field that demands a deep understanding of market trends, risk management, and financial acumen. Whether opting for speculative developments or build-to-suit projects, the goal remains the same: to create valuable, revenue-generating properties that meet the needs of tenants and investors alike.
