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There is a fundamental component that pervades each of the major areas of developing a new commercial real estate project, from purchasing the land to constructing the building, attracting tenants, managing the space as a landlord, and even until refinancing or selling the project. This single component is money. All development projects require funding, the person must acquire the land, pay some upfront costs, pay for the construction of the project, and maintain the building while finding enough tenants to fill the building. Must pay to support.
Since development projects can be expensive, most developers look to third parties such as commercial banks and investors to supply the necessary funds to “finance” the project. If a developer can finance a project, they can build it. Getting financing, money, therefore becomes the biggest hurdle from the developer’s point of view to move towards construction, completion and ultimately, an open, operational and successful development project. Nearly all commercial real estate construction projects are financed mostly by debt. The loan is generally in the form of a construction loan from a commercial bank and usually ranges between 60-80% of the project cost. The clear point about a construction loan is that the developer/borrower pays only interest during construction and for a short period thereafter and must then refinance the loan.
The remaining portion of the project cost, the portion not funded by a bank construction loan, is often referred to as equity. Equity can come from a number of sources, equity can come from the developer, the land on which the project is to be built or from third party investors. Remember that the bank only lends a part of the money needed to complete the project (60-80%). Equity investments fund the gap. Construction loan and equity investment together create the necessary funds or value and are often referred to as a development project capital pool.
Most developers realize early in the process that closing a construction loan is the most important step in a new development project becoming a reality. With the closure of the construction loan a project will likely be built to a higher than expected level of construction. Therefore, meeting the needs and demands of the construction lender and equity investors becomes the most important factor in taking forward a development project.
That being said, it is not always easy to get funding for a development project. It can take months if not years to close acceptable project financing. While obtaining construction financing and equity investment may once again sound complicated, there is one fundamental component that attracts nearly every construction lender and equity investor to a real estate development project. We’ll explore this fundamental component in detail with Part 2, “How to Successfully Buy Land, Construct a Building, Attract Tenants, Become a Landlord, and Own or Sell a Commercial Real Estate Development Project.”
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