Foundations of CRE Development: From Concept to Completion

Construction site with workers and blueprints, depicting the development phase in commercial real estate

Table of Contents

  1. Introduction
  2. Types of Development
  3. Development Process
  4. Development Budget
  5. Timing & Distribution
  6. Construction Financing
  7. 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:

  1. Land Acquisition: Assess feasibility, secure financing, and purchase land.
  2. Pre-Development: Design and plan site, secure entitlements and permits, and finalize financing for the project.
  3. Site Work: Prepare land, infrastructure, and ensure compliance.
  4. Vertical Construction: Build the structure as per the approved design.
  5. Lease Up: Market, negotiate leases, and fill commercial spaces.

Development Budget

Hard Costs

CategoryDescription
Building ShellThe essential structural framework of a construction project.
Site CostsExpenses related to land preparation and site development.
Offsite / Infrastructure CostsExpenses for external utilities, roads, and services required for the project.
General ConditionsOverhead costs, such as project management and temporary facilities.
Other Hard CostsMiscellaneous tangible expenses in the project's construction phase.
Hard Cost ContingencyReserved funds for unforeseen construction expenses.

Soft Costs

CategoryDescription
Design CostsExpenses incurred during the architectural and engineering phases.
Permits & FeesCosts associated with obtaining necessary permits and approvals.
Testings and InspectionsExpenses for quality control and safety assessments.
LegalLegal fees and expenses related to the project's development.
Taxes & InsuranceProperty taxes during construction and insurance coverage costs.
AdministrativeGeneral administrative and office-related project expenses.
Other Soft CostsMiscellaneous non-tangible project expenditures.
Soft Cost ContingencyReserve 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 AspectDetails
Loan TermsUsually shorter than traditional loans (1-3 years).
InterestRates are typically higher than traditional loans (interest is capitalized).
RepaymentLoans are often interest-only during construction.
Permanent FinancingSought 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.

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