Financing Project Development CHAPTER 16 Financing Project Development

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

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

Financing Project Development Developer Phases Land acquisition Development and construction Completion and occupancy Management after completion Eventual Sale Economic success and value creation

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: insurance companies, syndicates Sometimes continue to manage the property after sale

Developer Business Strategies Develop land and buildings in a master-planned development Business parks and industrial parks Some build to suit a single tenant Some developers specialize in specific development phases Most developers will consider a serious offer to purchase at any time

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?

Risks & Feasibility Project Risks Specific Component Risk 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

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

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 if the developer might own the property for a short while

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 lending may lead to overbuilding

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 “take out” commitment “takes out” the construction lender

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

Lender Requirements Permanent lender common contingencies: Time limit to acquire a construction loan Completion data for construction Minimum leasing requirements and approval of main leases Gap financing provision Expiration date Approval of design and material changes

Lender Requirements Construction or Interim Loan Mini perm loan Usually local lenders who… Know the local market Monitor construction progress Disburse funds as phases are completed Mini perm loan Monthly draw method Floating interest rate

Lender Requirements Closing the Interim Loan Assignment of commitment letter Create obligation between interim and permanent lenders Triparty buy-sell agreement Create obligation between all three parties

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

Project Costs Cost per square foot of gross building area Compare with comparable property Loans to cover improvement costs only 20% equity investment Holdbacks

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