Managing a development project is more complicated than it looks.
Getting it designed and entitled is tough work. Actually building it is even tougher. But in these economic times, nothing is tougher than actually financing your project. So what are the key things you should be doing and thinking about as you try to finance your next development project? Here are four key things to think about:
2. Pre-Leasing Quantity
3. Pre-Leasing Quality
As silly as it sounds, it takes money to get money these days. We've spent the last ten years as a nation getting drunk off of sweet leverage. People have been able to get 100% loan-to-value on their projects, and it has thrown us all out of whack as values have declined.
These days, you have to have equity. You might need as much as 40 or 50% of the building's value in equity. For many developers this means you may need an institutional equity partner just to get financing. For the entrepreneur, this means you should stockpile cash carefully and build relationships with investors to cover your financing gap.
2. Pre-Leasing QuantityPre-leasing your space is important as well. If you can get 100% of your space pre-leased, you can probably get very favorable financing terms. Why? Because your loan is often based on loan-to-value not loan-to-cost.
In other words, the value of your building is based on the cash flow coming from leases. A 100% pre-leased building will have a lot of cash flow to finance. This could mean that your loan may be only 70% loan-to-value, but your cost to construct might only be 80% of your value now that the space is leased up. You have created value.
Here's a quick numerical example of the scenario above. Let's say you built a building that costs about $10 million. If you have signed leases generating $1 million of cash flow in the first year, and cap rates are at 8%, then your project's value is approximately $12.5 million. If loan to value is 70% you can get a loan for $8.75 million. This item represents approximately 87.5% of your costs, however. This means you only need to come up with $1.25 million in equity.
In simple terms, the more pre-leasing you complete to generate cash flow the better your loan terms can be. For a loan with a 10 year term and 30 year amortization, this up-front pre-leasing effort can make a huge impact.
3. Pre-Leasing QualityAs important as quantity is, don't forget that you need quality as you pre-lease. Leasing to a credit tenant such as a governmental entity or publicly traded brand-name corporation will give your lender warm fuzzies. Leasing to too many ventures with thin balance sheets could hurt you. A lender may make a deduction from your cash flow for expected costs related to leasing to poor credit tenants. So try to lease to the highest quality tenants possible.
Finally, to get the financing at all these days you may need a guarantor. This means you need some high-net worth individual to co-sign on the loan to guarantee your performance. You may also need to cross-collateralize the loan and put up something else in addition to the property as collateral. These are tough times for financing, but if you are sure your project is a winner then a guarantee is an option you should consider.