How do developers fund new construction?

Question

What is the process that a developer goes through to fund a large new construction project?

Shane Melanson · Answer

@Michael Dusold - The way I fund my developments may be different than others.  So, it's not the only way to do it.

1st. I buy the land outright- with cash.  As I syndicate, this means, I raise the money from my investors and close on the land.

2nd. I De-risk my Deal

- I don't buy on spec. So, I've either got pre-sales (in the case of my industrial condos - where during due diligence and prior to  removing conditions, we pre-sold 70%).

- Or, I will pre-lease and find my anchor tenant(s).  So my downside is breakeven (provided I've done my homework on construction costs).

I generally have my drawings near completion to go in for a DP during DD.

I will have a very good # from my GC on the development at this time (we won't go to tender until we remove conditions and have an approved DP).

During this, I'm speaking with my bank.  How much debt can I get?  When?

In a development- you're running many process simultaneous - so it's hard to say do this first and this second.

My main focus:

1. what is the demand for my site (and how much revenue can I generate).  I will adjust my site plan and renderings numerous times to accommodate the demand for the market

2. how long will it take?  Timing is critical (DP, BP, leasing, construction).

2(b). how much will it cost?  Does the deal make sense?  Can I achieve the rents or sales required to justify the development (I like 100% ROE, or 35%+ leveraged returns.  Development is risky, and if I don't have sufficient buffers and incentives, then the deal is too skinny)

3. What are the risks?  what can wipe me out?

4. How much debt will the bank give me and when?  What thresholds are required.  My bank wants about 65% pre-leasing or sales to advance funds.

5. Once I have this, I raise my equity and then extra.  One of the biggest mistakes I've made in the past is raising too little money and then having to go back to investors for more.  This is something you'd rather not have to deal with.  The project paid out very well still- but, during construction, was stressful for me.

Does this give you enough to work from on securing your debt/equity?

You may want to have a commercial mortgage broker with experience in construction financing assist to.  They can help you through some of the steps above- what I've given you is the high level on how I look at and do my deals.

Jay Hinrichs · Answer

just like anything else  Equity  plus debt..  just much bigger numbers.

need much more experience etc.

Jay Hinrichs · Answer

@Shane Melanson  Cash calls are not fun.. unless you state that there will be cash calls from time to time.

In todays market we are doing the same  CASH for the dirt.. and only hang debt on horizontal and vertical.

we are in the SFR space so a little different than your commercial deals we cant really pre sell legally .

So one just keeps very good tabs on market conditions.. But for today in our market I call this pivoting.

we pivoted to minimum debt from 3 to 5 years ago were we had max leverage and really juiced the IRR s

still make plenty of profit cash wise.. but much safer if we have to hold for a period of time we are not forced into fire sales.

Jay Hinrichs · Answer

back in the day I bid on a property in Ft McMurray.. it eventually it was sold to Canadian Tire.  I lived in Kelowna for a time.

I found lending money to be a good thing for me at that time.. I got the delta on the exchange and rev CA did not withhold my proceeds from my payoffs.. :)  unlike when I sold real estate that I owned they kept 25% until I filed a tax return.

sure wish I still owned the things I bought in Kelowna though boy it blew up !!!

Greg Dickerson · Answer

@Michael Dusold what type of project? How large? As @Jay Hinrichs mentioned it could be a combo of traditional equity and debt from you only or just straight equity or just debt.

It all depends on the type of project, land cost, your experience, your financials and the overall profit potential.

Guifre Mora · Answer

@Michael Dusold usually 4:1 ratio for jumbo size loans

It’s just like any other real estate financing your financials your equity debt and reserves

Justin Morrow · Answer

We have been very successful in helping developers with C-PACE financing for commercial developments in the United States so they don't have to raise as much equity in the capital stack.  We then come in as the senior debt in the capital stack.  Our developer clients need 10%-20% less for construction financing.

Shane Melanson · Answer

@Jay Hinrichs - you're right, cash calls are no fun.  We had contemplated it and our investors knew in advance it was a likely outcome (if we couldn't get conventional funding).  We were doing an 1,153 acre resort development with short term leases (banks didn't like the short term nature of the leases- even though it was to our benefit).

Res is a different game- sorry, I can't comment on that.  I like the pre-sales/leasing angle in CRE.  But see many a res builder/developer do well.  Just not my core (although, now that I think about it- I'm looking at 150 unit TH development now).  I'm speaking to broker next week on how the debt will work to figure out how much equity will be required on my end.

How do developers fund new construction?

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