A real estate developer starts with a plan and turns that plan into a beautiful new building. There are many steps to becoming a real estate developer because the developer is also the owner of the property and the manager of the construction project. The tremendous number of tasks involved, especially for a developer investing in a multifamily real estate project, make the work difficult, stressful, and financially risky. But the satisfaction and the financial rewards that result from a successful project can be high.
A real estate developer buys the land to develop and hires the architects, engineers, and contractors. He or she not only arranges the financing for the project and takes full responsibility for its success, but also takes all of the risk. If the construction is never completed or if the building fails to attract enough new residents, the developer—and any other investors—bear full responsibility, while their teams are paid for services rendered. On the other hand, the developer has the greatest potential to gain from the project’s success.
Instinct and Training are Needed to Become a Real Estate Developer
It takes a certain personality to be a real estate developer. Only someone with a high tolerance for risk and stress, an ability to manage many undertakings at once, and an instinct for making deals and forging relationships is most likely to succeed. Besides that, a developer must be equipped with a considerable amount of technical and financial know-how and resources.
To be a successful developer, the more education and experience you have under your belt before starting out on your own, the more prepared you’ll be. A college degree in a related field—business, engineering, or administration, for example—is helpful, and an advanced degree is even better. Various professional organizations in the real estate and construction industries offer certificates that are worth pursuing, too. Attaining these certificates requires extensive training and highly specialized knowledge. Even after sharpening your education, several years of practical experience with a real estate company, a construction contractor, or a real estate investment or management firm is recommended. This knowledge and experience can prepare you for the research and planning necessary to develop a property.
Real Estate Development Involves a Lot of Financing
A real estate developer must have access to a lot of capital—funds that can be tied up for two years or more during construction. Much of the capital can come from loans, but not all. Developers generally take out a construction loan at the start of the project, and financing can potentially be much more complex than that.
A construction loan, as the name implies, is used to finance construction. It is distinguished from other loans by the fact that it is disbursed in installments as needed or on a monthly basis. Interest accrues only on the portions that are released. The loan-to-value (LTV) ratio on a construction loan is the portion of the total project cost that it will cover— usually 60 percent. That means the developer needs to come up with 40 percent of the cost from other sources as a down payment and to fund the portion of the construction not covered by loan proceeds. In addition, lenders may ask for guarantees tied to the completion of the project. That could involve collateral.
A construction loan might cover the cost of buying the development property and preparing it for construction if the developer has organized the process well enough for it to move seamlessly from one stage to the next. If not, the construction loan could be the third loan associated with the development, after a commercial mortgage has been secured for the land and a real estate development loan has been taken out to prepare it for its new use. Preparing a construction site can be a major part of the project. It may mean razing existing structures, digging basements and driving in supports, or other large-scale improvements. This multipart financing is considerably more challenging to arrange. Each loan will have its own conditions—rate, term, guarantees, etc.—and will require planning and negotiation. Each consecutive lender is likely to demand that previous debt be settled to maintain a first lien position.
Once construction is completed and the building is occupied, the construction loan can be refinanced (and must be if the maturity date arrives). The new loan is typically a longer-term loan based on stabilized property operations, and it usually has better terms than the construction loan since the lender’s level of risk is considerably lower for a completed, occupied building than for a construction project. At this point, the developer’s investors should receive a significant portion of their returns via distribution of excess loan proceeds or by the sale of the property if the developer chooses to exit (sell) the project.
Additional financing may be needed if there is a funding gap between the end of construction and the beginning of longer-term financing. Traditionally, this is called a bridge loan and it is a relatively small and expensive loan that is intended to be replaced very quickly. Often, borrowers pay interest only on a bridge loan and then repay the loan amount when permanent financing comes through.
Joint Ventures Attract Talent to Real Estate Development
Real estate development does not have to be a solo endeavor. Developers can team up in a joint venture and split the financial and organizational responsibilities to make them more manageable. This is a particularly beneficial arrangement for a novice developer, as it dilutes the risks and provides support in aspects that may be unfamiliar, such as project management, permitting, understanding zoning restrictions, contracting an architectural design firm, and obtaining an environmental analysis report and a certificate of occupancy.
Besides those practical considerations, a joint venture can be an invaluable opportunity for a developer to form new professional relationships. Because of the vast number of parties involved in a development project, it is crucial to have a wide circle of professional connections—experienced and knowledgeable individuals to turn to for specific services and to clarify expectations. Forging these relationships goes hand in hand with building a reputation in professional circles as a dependable business partner.
CWS typically develops its own properties but at times will work with a joint venture partner when there is an exceptional opportunity.
At CWS Capital Partners, we are a fully-integrated multifamily real estate investment management firm that offers everything from due diligence and risk management to transaction support and property management. We specialize in assisting our clients with 1031 exchanges, acquisitions, repositioning, and development. We own and manage luxury multifamily investment communities in major markets around the country, and we employ a team of experts who can help you hone your investment strategy.
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The information provided here is for your general informational purposes only. It should not be considered a recommendation or personalized advisory advice. CWS has made this third party information available from authors it believes are knowledgeable and reliable resources. However, its accuracy or completeness cannot be guaranteed and sentiment may change due to legal or economic conditions.
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