There is a critical component that runs through each of the major areas of developing a new commercial real estate project, from purchasing the land, to building construction, to attracting tenants, to managing the space as an owner, and even to refinancing or sale of the project. This only component is money. All development projects need money, one must acquire the land, pay certain initial costs, pay to build the project and pay to maintain the building while enough tenants are found to fill it.
Since development projects can be expensive, most developers turn to third parties, such as commercial banks and investors, to raise the money needed to “finance” the project. If a developer can finance a project, they can build it. Obtaining financing, money, therefore, becomes the biggest hurdle in moving from developer vision to construction, completion, and ultimately a successful, operational, open development project. Almost all commercial real estate construction projects are mostly debt financed. The debt usually takes the form of a construction loan from a commercial bank and typically represents between 60% and 80% of the cost of the project. The great 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 financed by the bank’s construction loan, is often referred to as equity. Equity can come from many sources, equity can come from the developer, the land the project will be built on, or from third party investors. Remember that the bank only lends a part of the money needed to complete the project (60-80%). The capital investment finances the difference. Together, the construction loan and the equity investment make up the money or value needed and are often referred to as a development project, equity stack.
Most developers realize early in the process that closing the construction loan is the most important step in bringing a new development project to fruition. With the closing of the construction loan, a project moves from the stage of waiting to be built to a high probability that it will be built. Therefore, meeting the needs and demands of the construction lender and equity investors becomes the most important factor in moving a development project forward.
That said, financing for a development project is not always easy to come by. It can take many months, if not years, to close acceptable project financing. Although obtaining construction financing and equity investment may once again seem complicated, there is a single critical component that attracts almost all construction lenders and equity investors to a real estate development project. We will explore this critical component in detail with Part 2 of “How to Successfully Buy the Land, Construct the Building, Attract Tenants, Own, and Own or Sell a Commercial Real Estate Development Project.”