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Chapter 16:

Financing Project
Development
McGraw-Hill/Irwin

Copyright 2011 by the McGraw-Hill Companies, Inc. All rights reserved.

Financing Project Development


Developer Challenges
National and local economies
Competition among developers
Changes in tenant preferences

Project Development
Finance land acquisition with intent of
developing it and selling it
Development is impacted by the regulatory
environment
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Financing Project Development


Permitting
Application
Site
Location
Preliminary Design

Zoning
If in compliance, then permitted
If not in compliance, then appeals process
City planning department input

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Financing Project Development


Developer Phases
Land acquisition
Construction
Completion and occupancy
Management
Sale

Economic success and value creation

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Exhibit 16-1
Phases of Real Estate Project Development and Risk

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Developer Business Strategies


Develop, own, manage, and lease projects
for many years
Leasing and management are major
components of the business model

Develop, own, lease-up to normal


occupancy, then sell
Buyers could be insurance companies,
syndicates, etc.
Sometimes continue to manage the property
after sale
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Developer Business Strategies


Develop land and buildings in a masterplanned development
Business parks and industrial parks
Some build to suit for a single tenant

Some developers specialize in specific


development phases
Most developers will consider a serious
offer to purchase at any time
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Risks & Feasibility

Risk begins with acquisition


Seasoned Property
Leasing Prior to Completion
Demand Factors
Vacancy rates, rent levels, predevelopment
leasing commitments
Post-development competition
What do end users want?
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Risks & Feasibility


Project Risks
Site Location
Value increases with tenant perception
More valuable sites result in higher-quality developments
Density increases with value perception

Specific Component Risk


How design features and amenities are valued by
potential tenants
Uncertainty about how quantity and quality of services
should be packaged
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Project Development Financing


Equity investment
Developer
Partnership

Construction (Interim) loan


Appraised value of completed development
Hard costs
Materials and labor

Soft costs
Planning, leasing and management costs
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Project Development Financing


Loan Structures
Short-term financing if the intent is to sell the
property after completion and lease-up
Permanent loan and construction loan if the
developer retains ownership as part of their
business model
Construction financing followed by extended
financing (a mini-perm) if the developer
might own the property for a short while
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Project Development Financing


Complications
In multi-loan financing, a permanent loan
must be in place first.
If a sale is planned, market conditions may
require a committed buyer in place.
Excess speculative and open-ended
construction lending may lead to overbuilding.

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Lender Requirements
Loan submission information
Detailed description of development and
market analysis

Requirements become complicated when


multiple lenders are needed
Permanent commitment
Binding agreement between developer and
permanent lender

Permanent lender or take out commitment


takes out the construction lender
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Lender Requirements
Standby commitments
Binding agreement, but low expectation of
being used
Used when:
Developer does not want to pay fees for a
permanent loan
Expectation of securing a better permanent loan
later
Plans to sell the project and permanent loan is not
needed
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Lender Requirements
Permanent lender common contingencies
Time limit to acquire a construction loan
Completion date for construction
Minimum leasing requirements and approval
of main leases
Gap financing provision
Expiration date
Approval of design and material changes
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Lender Requirements
Construction or Interim Loan
Usually local lenders who
Know the local market
Monitor construction progress
Disburse funds as phases are completed

Mini-perm loan
Monthly draw method
Work is verified by architect or engineer

Floating interest rate


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Lender Requirements
Closing the Interim Loan
Assignment of commitment letter
Create obligation between interim and permanent
lenders

Triparty buy-sell agreement


Used in lieu of assigning the commitment letter
Create obligation between all three parties
Permanent lender will buy the construction loan directly
from the construction lender
Two lenders agree about their duties and responsibilities
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Lender Requirements
Permanent Loan Closing
Lender confirms that contingencies are met
Nonrecourse Clause
Restrict lenders claim in default
Increase emphasis on property quality
Credit enhancements

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Project Costs
Cost per square foot of gross building area
Compare with comparable property

Loans to cover improvement costs only


Generally, there is some level of equity
investment made by the developer. 20% is used
in the book and is reasonable.
Holdbacks
Lender holdbacks prevent developers from drawing
down funds at a faster rate than they pay to
contractors
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Profitability
Before-Tax Cash Flows and After-Tax
Cash Flows
Net Present Value
Internal Rate of Return
Sensitivity Analysis
Feasibility Analysis

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