There is a fundamental element that extends to each of the main areas of the development of a new commercial real estate project, from the purchase of the land to the construction of the building, including attracting tenants, managing the space as owner and even the refinancing or sale of the project. This single component is money. All development projects need money, one has to acquire the land, pay some upfront costs, pay to have the project built, and pay to sustain the building while finding enough tenants to fill it.
Since development projects can be expensive, most developers turn to third parties such as commercial banks and investors to provide the money needed to “finance” the project. If a developer can fund a project, they can get it built. Obtaining financing, the money, therefore becomes the biggest obstacle to moving from the developer’s vision to construction, to completion and finally to an open, operational and successful development project. Almost all commercial real estate construction projects are mainly financed by debt. The debt usually takes the form of a construction loan from a commercial bank and is usually between 60 and 80% of the cost of the project. The advantage of construction loans is that the developer/borrower only pays interest during construction and for a short time afterwards, and then has to refinance the loan.
The remaining part of the project cost, the part not financed by the construction bank loan, is often referred to as equity. Equity can come from many sources, equity can come from the developer, the land on which the project is to be built or from third party investors. Do not forget that the bank lends only part of the money necessary for the realization of the project (60 to 80%). The equity investment funds the difference. Together, the construction loan and the equity investment constitute the necessary money or value and are often referred to as the development project, the capital stack.
Most developers realize early in the process that closing the construction loan is the most important step in making a new development project a reality. With the construction loan closing, a project moves from a hope of being built to a high probability of being built. Therefore, meeting the needs and demands of the construction lender and equity investors becomes the most important factor in moving a development project forward.
That said, funding for a development project is not always easy to obtain. It can take several months or even years to secure acceptable project financing. Although obtaining financing for construction and an equity investment may seem complicated, once again there is a single fundamental element that attracts almost all lenders and equity investors to a real estate development project. . We’ll explore this fundamental in detail with Part 2 of “How to Succeed, Buy the Land, Build the Building, Attract Tenants, Own and Own or Sell a Commercial Real Estate Development Project”.