McGraw-Hill/Irwin ©2008 The McGraw-Hill Companies, All Rights Reserved CHAPTER16CHAPTER16 CHAPTER16CHAPTER16 Financing Project Development

16-2 Copyright ©2008 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

16-3 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved 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

16-4 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Financing Project Development Developer Phases  Land acquisition  Development and construction  Completion and occupancy  Management after completion  Eventual Sale Economic success and value creation

16-5 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved 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

16-6 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved 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

16-7 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved 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?

16-8 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved 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

16-9 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved 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

16-10 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved 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

16-11 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved 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

16-12 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved 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

16-13 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved 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

16-14 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved 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

16-15 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved 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 Floating interest rate

16-16 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved 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

16-17 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved 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

16-18 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Project Costs Cost per square foot of gross building area  Compare with comparable property Loans to cover improvement costs only 20% equity investment Holdbacks

16-19 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Profitability Before-Tax Cash Flows and After-Tax Cash Flows Net Present Value Internal Rate of Return Sensitivity Analysis Feasibility Analysis