Finance For Real Estate Development Pdf

[Valorie Carlee]

Yesreal estate development is expensive. And developers often must pledge some of their capital to get a project up and running. But where does the rest of the money come from? Is it debt or equity? How expensive is that financing for the developer?

In real estate, the capital stack refers to the layers of financing that make up a project. It usually comprises both debt and equity and highlights the priority at which interested financial parties hold claims for repayment.

The graphic above depicts the priority and relative risk levels of each type of financing. Although common equity sits at the top of the stack, it has the lowest priority. This is because it receives a return only after all other parties in the transaction have received their agreed-upon payment.

The most senior debt conversely sits at the bottom, has the lowest risk and equivalently lowest return, but has the first claim for repayment and can subsequently foreclose on a property if the debtor fails to meet their obligations.

To better understand how the capital stack overlays on a project, we must also conceptualize the various phases of a real estate development. Traditional developments can be broken down into 4 broad phases:

But as a project progresses, an approved development becomes more and more likely. Milestones like site plan approval, permits, and land entitlement are gates that further increase a project's likelihood of success. And as a project becomes less speculative, more traditional forms of debt financing are willing to commit funding at a lower return threshold.

Traditional bank loans can take a variety of forms depending on the phase of a project. For example, land acquisitions can be facilitated through land loans, while land development and construction costs are financed through construction loans in the form of construction draws. And once a property reaches a certain occupancy threshold, construction financing can be converted into a long-term debt instrument.

A real estate syndication is the aggregation of resources (usually capital) to acquire a piece of real estate or fund a venture. A general partner, who in this case would also be the real estate developer, would structure a deal and court investors (limited partners) to pledge capital towards that project.

The Jobs Act of 2012's implementation in 2016 paved the way for the democratization of real estate development, and subsequently, investment in development for non-accredited and accredited investors.

The legislation allows real estate developers to solicit investors with no substantive prior relationship through wholly online mediums like social media. It also gives less capitalized investors the opportunity to invest in projects historically reserved for the ultra-wealthy.

In a real estate development, the sponsor (general partner) is an individual or team that takes the lead on a project. They are also colloquially dubbed the 'real estate developer' because they'll take the active project management role, while limited partners (other equity investors) take on a more passive role.

A real estate joint venture is a situation where multiple parties combine resources and work together to complete a transaction. Most commonly, a JV is structured between capital partners, but partnerships are not only limited to cash contributions.

Joint ventures may also involve a credit or experience partnership. For example, a novice developer may bring on a more experienced party to help navigate the project, or a credit partner may be required to help sign for a project's debt.

If you remember, mezzanine debt is senior to both preferred and common equity and subordinate only to a senior debt instrument. As a result, it is more expensive than senior debt from a cost of capital standpoint. Still, it offers real estate developers an option to close the funding gap between traditional financing and sponsor equity.

In practice, mezzanine debt is usually not secured by collateral, and notes typically have a shorter duration than senior debt. But a well-structured mezzanine loan can reduce the developer's capital investment and increase a project's ROI.

A build-to-suit is an arrangement where a commercial building is custom designed and built for a specific end-user. The project is usually managed by an investor or real estate developer who covers all development financing. In return, the operating company will sign a long-term lease on the space.

Effectively, a property is sold to an investor, with the operating company subsequently leasing the space back from the new owner. As a result, the proceeds from the sale can be more efficiently allocated to help close the funding gap for a new real estate development project.

Developers should expect to navigate a unique set of regulatory hurdles and requirements for each different type of financing in the capital stack. But outside of lender-specific due diligence requirements or SEC challenges, there are a couple of best practices universal to the fundraising process.

A feasibility study is like a traditional business plan. It serves as the foundation for a successful real estate development project by assessing all site investigation, research, and preliminary due diligence items against potential pitfalls and associated financial costs.

But because you know problems are an inevitability, you can plan for them. A stress test serves as a simulation to determine the feasibility of a project under certain economic or environmental conditions. By assigning a probability or likelihood to possible outcomes, you can determine the profitability of a project even under the worst conditions.

Because the developer is the single point of failure managing the entire project, investors need confidence that the developer will achieve a project's stated goals. Credibility comes in the form of relevant development experience or experience as a co-general partner or investor on other projects.

Real estate development almost always requires some sort of outside development financing. So if you're a small business with questions about build-to-suit, or an investor navigating the real estate syndication process, Marsh & Partners' real estate consulting services can help.

We've helped investors optimize their balance sheets and secure cheaper funding through portfolio recapitalizations and helped businesses unlock capital and finance future development through a sale-leaseback.

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BS Real Estate and Finance and Development (REFD) is a groundbreaking joint degree offered in partnership by the USC Marshall School of Business and the USC Price School of Public Policy. The program combines the strengths of Marshall in real estate finance and investment and the strengths of Price in real estate development and urban planning for an innovative and immersive experience for students beginning in the Fall of 2024.

The BS Real Estate Finance and Development (REFD) degree is a four-year 128-unit program in which students take courses at both Marshall and Price and their diplomas will reflect the names of both schools upon graduation. Students will take courses in in real estate finance and investment at Marshall and in real estate development and urban planning at Price.

During their freshman and sophomore years, students will establish a solid foundation in Business and Real Estate. This groundwork is achieved through core courses in Economics, Accounting, and Finance, coupled with introductory classes on Real Estate. Paired with concurrent career preparation courses, this comprehensive foundation equips students for hands-on internship experiences following their sophomore year. In their junior and senior years, students will delve into more advanced aspects of Real Estate, including Finance, Investment, Development, and Planning, through in-depth coursework and experiential learning opportunities.

MREFA represents the educational, pre-professional and social interests of students pursuing studies and careers in Real Estate Finance at the USC Marshall School of Business. MREFA is open to all USC students, and activities include industry panels and speaker events, weekly general member meetings, technical trainings (ARGUS, underwriting, financial modeling), and possible office tours, treks, and other hands-on professional development opportunities. MORE

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