Chapter 16: Financing Project Development

1. Chapter 16: Financing Project Development

2. 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

3. 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

4. Financing Project Development Developer Phases Land acquisition Construction Completion and occupancy Management Sale Economic success and value creation

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

6. 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

7. Develop land and buildings in a master-planned 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 Developer Business Strategies

8. 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?

9. 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

10. 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

11. 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 Project Development Financing

12. 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.

13. 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

14. 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

15. 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 Lender Requirements

16. 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

17. 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

18. Lender Requirements Permanent Loan Closing Lender confirms that contingencies are met Nonrecourse Clause Restrict lender’s claim in default Increase emphasis on property quality Credit enhancements

19. 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

20. Profitability Before-Tax Cash Flows and After-Tax Cash Flows Net Present Value Internal Rate of Return Sensitivity Analysis Feasibility Analysis