Topic 1

What is real estate development?

  • Real estate development is the continual reconfiguration of the built environment to meet society’s needs

    • It is the creation and re-creation of housing, office buildings, shopping centers, warehouses, roads, sewer systems, landscapes, etc.

  • It is a multi-faceted business that encompasses a wide range of activities

    • Acquisitions, renovations, construction, leasing, purchase of raw land, etc.

  • It is complex and, as much intuitive as logical and as much creative as mathematical

    • No two developments are exactly alike

  • It involves many players with congruent or divergent goals and objectives

  • Big difference between re-development and renovation


Real Estate Development is considered a highest risk and highest return area of real estate investing


Sources of risk to a developer include

  • Market risk

    • Ability to lease up/sell units

  • Government approval and permitting (entitlement) risk

  • Legislative risk

  • Site risk

    • Physical condition, environmental risk, infrastructure

  • Financial risk

    • Access to credit risk, cost of financing , interest rate risk

  • Construction risk

    • On time and on budget


Risk factors not only impact the bottom-line financial returns but also the reputation and credit worthiness of the developer


Real estate cycles

  • Real estate market are affected by the economy and interest rates

    • Demand for space is related to broad economy as well as specific industries and employment trends

    • Feasibility of a project depends on ability to access capital at low cost

    • Demand from households for single family homes and condos are related to market mortgage rates

  • Development has a long lead time

    • Projects approved in boom times, but when they are delivered several years later, economic conditions may have changed

  • Cycles are exacerbated by overbuilding

    • Many developers choose the same, favorable moment to start projects


Demand Drivers


For residential single family and condos (owner occupied):

  • Population

  • Household formation (child rearing ages)

  • Interest rates (Bank of Canada)

  • Employment growth (business and professional occupations)

  • Consumer confidence (how individuals view the economy, their jobs….)

    • If worries, less likely to spend money on down payment on house


For Multi-family residential (renters):

  • Population

  • Household formation (non-child rearing ages)

  • Local housing affordability

  • Employment growth (blue collar occupations)


Retail:

  • Disposable income

  • Household wealth

  • Traffic wealth (specific sites)


Office:

  • Economic growth

  • Employment in office occupations (Finance, Insurance, Real Estate, Business and Professional Services, Legal Services)


Industrial:

  • Mfg. employment

  • Transportation employment

  • Airfreight, rail and truck volume

  • Online sales


The development team

  • The developer must compose a team having the skill set for the unique requirements of each project

  • The developer should have enough knowledge of a wide range of subject areas to effectively communicate his vision and manage the development team.

    • The level of knowledge should be sufficient to evaluate the work and identify potential problems and conflicts.


Major team players

  • Developer

  • Investors

  • Architects

  • Engineers

  • Landscape architects

  • Building contractors

  • Land planners

  • Urban designers

  • Environmental consultants

  • Traffic and transportation consultants

  • Biology consultants

  • Geotechnical and soils consultants

  • Hazardous substance consultants

  • Greenhouse gas consultants

  • Noise consultants

  • Market research analysts

  • Construction lenders

  • Permanent lenders

  • Appraisers

  • Attorneys/Notaries

  • Accountants

  • Real estate leasing agents and/or sales brokers

  • Marketing and public relations consultants

  • Property managers

  • Regulators

  • End users

  • Others


The developer

  • Developers range from straight fee to speculative developers

    • Fee developer is hired by a client and does not usually own equity in the project

      • Little downside risk

  • Speculative developers own all or part of the equity in the project

    • Downside risk for upside potential

    • Risks include the cost of pre-development work for projects that may not go forward

      • Due diligence

      • Feasibility studies

      • Market analysis


  • Developers are usually compensated by one or more of the following

    • Development fees: payment for services

    • Profits on sale of the project

    • Promote fee: when a developer earns a disproportionate share of the profits

      • Often given to the developer as a form of bonus for achieving a higher IRR

      • Generally applies to profits after the financial partner has achieved his targeted IRR

  • Ownership of entities that sell services related to the development process

    • Leasing

    • Property management

    • General contractors


Characteristics of a good developer

  • Clarity of vision

  • Creative

  • Promoter

  • Leader

  • Risk taker

  • Manager

  • Flexible

  • Logical

  • Negotiator

  • Good listener

  • Planner

  • Entrepreneurial

  • Problem solver


Architects

  • Participate in the development of the concept

    • Site selection advice

    • Alternative concepts

    • Feasibility

  • Participate in communicating the vision

    • Illustrations

    • Models

    • Integration into the neighborhood

    • Videos

  • Creation of the detailed plans

    • Used for construction, public authority review and approval, costing and contractor bids

  • Use other professional firms in developing the plans

    • Structural engineers

    • Mechanical engineers

  • Monitor the construction work

    • Construction work phases completed satisfactorily

    • Approval for construction loan draws

    • Attestation of compliance with plans

  • Landscape architects plan, design all landscaping including walkways, outdoor lighting and outdoor living spaces


Building contractors

  • Building contractors turn designs into physical form.

  • The general contractor is responsible for the overall construction project and hires subcontractors to perform specialized work

    • Excavation

    • HVAC installation

    • Electrical wiring

    • Plumbing

  • The general contractor schedules subcontractors’ work and monitors its quality to ensure that it satisfies the general contractor’s obligations to the developer.

  • General contractors are often chosen through a bidding process

  • Cost, experience, keys employees, financial strength are all considered in the selection process

  • In some cases the developer serves as his own general contractor

  • Contractor fees are dependent on size, complexity and risks of the project


Geotechnical and soil consultants

  • Geotechnical and soil engineers determine the ability of the ground to support the proposed development. Their surveys identify major structural features such as

    • Earthquake faults

    • Landslides

    • Bearing capacity of the soil

  • This information becomes part of the design requirements, in the specifications of the required depth and type of foundations, compaction, and setbacks

  • Geotechnical reports are also part of the information that excavation and grading contractors need for determining their scope of work


Appraisers

  • Appraisers produce an estimate of a property’s value

  • They are involved before, during, and after project completion and often take part in the financing process.

  • They can also provide a broad range of services, from investment analysis to litigation support.

  • Future looking but they don’t have a crystal ball


Other consultants

  • Traffic and noise are highly important issues during the approval process

  • Most projects require environmental site studies.  Environmental impact studies may also be required as part of the approval process.

  • Biological studies may be necessary to ensure that all regulations regarding wildlife, wetlands and endangered species are met. 


End user

  • Ultimately end users determine the success of a project

  • Project concepts must be designed and adjusted to meet the end users’ needs


Market analysts

  • The key component of feasibility is market potential

  • The market study will measure the supply and demand conditions for the project, determine potential pricing, and estimate the sales or leasing period

  • The developer uses the market researchers’ work to determine the revenue assumptions for the economic analysis of the proposed project. 

  • Will I be able to lease or sell when I am building, at what price and how fast?

  • The fundamental principle of supply and demand also applies to real estate

    • In commercial real estate tenants demand space for offices, stores, manufacturing, etc. and landlords create space to satisfy these demands

  • The Market Analysis must consider all factors that affect both the supply and demand for space.



Markets

  • Seller’s market: there are more buyers then sellers so the price of homes go up.

  • Buyer’s market: There are many homes for sale and less buyers so prices drop and the homes don’t sell quickly

  • Balanced market: the amount of buyer and sellers in the market are equal. the houses are selling for fair value


National Economic factors

  • Global and national economy

    • GDP

    • Inflation

  • Consumer confidence

  • Employment levels

  • Inflation

  • Interest rates

  • Changes in technology or manufacturing processes (productivity)


Area Demographics

  • Population growth and density

  • Age distribution and trends

  • Income levels

  • Education levels


Competitive factors

  • Local supply and competing space

  • Vacancies

  • Rental rate trends

  • Current rental rates and trends

  • Competing projects currently under development

  • City plans


Infrastructure

  • Roads

  • Transportation nodes

  • Schools

  • Services


The first deal

  • Most difficult project is the first project

  • Lack of funds 

  • Lack of knowledge

  • No track record

    • Difficult to attract investors and lenders


You must control one of these to get started

  • Land

    • Supply: a site looking for a use.  If you have or control land, a development strategy can be created once the developer has acquired information about the market, engineering, public approvals required, environmental issues, etc.  The market analysis will be a key tool.

  • Capital

    • Supply or demand.  Obtaining capital is the biggest hurdle for a new developer.  With capital in hand a developer can attempt to match a site with the best possible tenant.  A starting developer can use capital to gain knowledge, secure a site and attract tenants.

  • Knowledge

    • Demand: a use looking for a site.  In depth knowledge of the local market can give a starting developer a competitive edge by knowing where space is in short supply and which tenants are looking for space.  The ability to convince potential lenders and investors of these opportunities through the use of market studies or letters of intent from prospective tenants can start to make up for the lack of track record in development.

  • Tenants

    • Demand: a use looking for a site.  Having a tenant ready and committed to leasing a property can make it easier for the beginning developer to access capital.  It also eliminates or reduces the lease-up risk.  


The first deal will:

  • Establish your track record

  • Establish your image in the marketplace

  • Create contacts within the municipalities

  • Create a network of consultants and other players

  • Build a relationship with investors and lenders


When starting out:

  • Develop what you know best in the market you know best

  • Keep it to a size and complexity that you can easily manage


Key Success Factors for a Developer

  • Ability to access capital from equity partners and lenders

  • Ability to identify high-potential sites for development

  • Knowledge of needs/preferences in local market

  • Ability to close a deal with a tenant/buyer

  • Ability to thrive in high risk environment

  • Ability to persevere through frustration

  • Great analysis, negotiation and management skills

  • Drive to succeed/strong work ethic