By Bob Voelker, author of Mastering the Complexities of Real Estate Development
New developers come into the real estate development field in a variety of ways – as analysts with MBAs in finance, as architects or civil engineers or attorneys who make a career move, or as young developers with an MBA in real estate from a prominent university.
They arrive with a lot of book learning or experience in a related field but without any real-world experience in taking a project from dirt to completion and ultimate sale or refinance. As it relates to training time and opportunity, unfortunately most experienced developers are either not great mentors or are too busy chasing the next deal to devote the time and attention to effectively and efficiently educate their young proteges, who are often just thrown into projects and left to “sink or swim.”
Learning the ropes becomes happenstance and haphazard, which can be incredibly unfortunate given the high-risk stakes of real estate development, and the expanded learning curve and lack of solid mentorship wastes the untapped potential of the next generation of leaders.
Whereas it may take 5 years of on-the-job, project-by-project experience to learn the As to Zs of development, the series of procedures and processes, broken down into their component parts, can be systematically studied and ingrained in much greater depth over a significantly shorter period of time.
I recently ended my 35+ year real estate career, divided equally between law and development, serving as the senior vice president and general counsel with a Dallas high-rise residential developer, and recognized another hole in training young attorneys and developers, which can briefly be summarized as follows: “There are a lot of things that developers know that attorneys should know about development that would make them better counsel to their clients; and on the flip side, there are a lot of things that attorneys know that developers should understand that would make them better developers.”
One piece of advice to young developers: cultivate friends in other related disciplines – law, finance, architecture, engineering, interior design, land planning, etc. – and learn from them.
I wrote Mastering the Complexities of Real Estate Development to fill these perceived voids in the training of young developers, law firm attorneys and debt/equity associates, addressing the following topics that should be part of the early formal education of all entrants into the real estate development field:
How Developers Make Money
Developers take measured risk with a small amount of their money, leveraged with other people’s money, to earn fees and project profits that are proportionately larger than the developer’s capital invested as a percentage of the total capital.
Development Company Structure
A thorough grounding in the structure of the typical development company is a precursor to comprehending a development project. Real estate entity organizational structure is largely a creature of legal and financial concerns over isolating entities and risk.
Finding a Site
As the saying goes, real estate is all about “location, location, location,” although that axiom is really shorthand for the required level of investigation to determine a suitable site for a particular project. Strategically locating a successful real estate project is dependent on three inquiries: demographics, market research and local politics.
Acquiring a Site and Joint Ventures with Landowners
Once the appropriate submarket for the project is determined – based on demographics, market research and the political landscape – and a site has been located, discussions begin with the landowner to acquire the site. Although most development land is purchased directly, with certain prime sites in major metropolitan areas it is not uncommon for a wealthy landowner to instead be focused on either long-term income from the site via a ground lease or participating in a joint venture with the developer in order to share the upside potential of investing in the development.
Purchase & Sale Agreements, Contribution Agreements & Options to Ground Lease
Understanding the important provisions of purchase contracts, land contribution agreements and options to ground lease.
Keeping Tabs on Pursuit Costs, Avoiding “Dead Deal Costs” & Balancing the Pursuit Portfolio
The thoughtful development associate will closely monitor project pursuit costs and focus on balancing out his/her pursuit portfolio, with most potential projects being relatively easy single purpose development on zoned land that is directly acquired, with a smaller portion of the pursuits being “home runs” that are more complex.
The Proforma: Running the Numbers
A thorough understanding of the financial proforma for a real development project requires a solid foundation in real estate finance – the hard science of spreadsheets and the soft science of the key financial metrics by which lenders and equity partners evaluate projects competing for financing.
While debt and equity financing for the project is being secured, the developer should also be securing construction bids. Development associates should be aware of certain key provisions that are likely to either be heavily negotiated with the contractor or will be focused on by the GP and LP equity partners.
Development financing is made of 3 parts – the construction loan, limited partner equity and general partner equity. Financing is secured by the presentation of a financing package to potential debt and equity partners. The basic structures of limited partner and general partner equity and the fundamentals of construction loans are part of every project.
Selling the Project
After the project is completed and approaching full occupancy, the developer, along with its GP and LP partners, will need to decide to either sell the project or hold the project long-term. The LP Partner’s investment period may be longer term, whereas the developer may be more interested in selling the property and realizing its full “promote” profit. The partner will engage a broker, solicit bids, and then may proceed through a best and final process. The sale process also involves a detailed accounting for project expense prorations.
Each of these topics should be covered in-depth with each new analyst and development associate in the first year or two after the beginning of their career, greatly advancing their learning curve so that they can quickly become more helpful in the overall development process.