As we go through our regular lives of driving on highways, working in buildings, parking in massive underground structures, and enjoying open space, we often forget to acknowledge how these structures were developed. Many only think about the construction phase of a real estate project, but in reality, so much goes into any physical change we see in the environment through local government and planning control.
Zoning plays a large role in a real estate development. The use of a project must fit the zoning code. For example, if a particular area of a city only allows for low density residential use, likely, the only developments that can exist are single family homes. Different cities differ greatly when it comes to their municipal zoning and regulation codes, Los Angeles prides itself is preserving low density neighborhoods and historical buildings making the entitlement process of a project extremely difficult in this particular city. New York City on the other hand, allows more high density developments so many areas have increased floor area ratios allowed, higher height limits, and less square feet per unit required. Some cities even have strict building color regulations. In Newport Beach, CA, for example, homes can be one of three shades- tan, white, or brown.
The entitlement process for any real estate development, from a small single family home to a massive corporate skyscraper, is usually the most difficult and can be extremely costly. City governments do not simply donate their time to approve plans, go over building and safety, and give permits. City and entitlement fees can make or break the way a project pencils in the underwriting phase and often, permits can delay a project’s timeline if there as a miscalculation from an architect engineer or if the building design does not meet every rule of code. A delayed project, waiting for a permit, can cost the real estate developer thousands of dollars for everyday held and can be detrimental to paying back investor equity. The main challenge with the entitlement process for a large project like a large retail or entertainment center is the communities enthusiasm for the development. Many times, the neighborhood rejects the development due to nuisances like increased traffic, increased rents, noise from construction, or changing the dynamic of the neighborhood. Often, developers must do community outreach in any form, from going door-to-door to further explain the project to hosting events with free goods to promote positivity associated with the project. A Los Angeles neighborhood, Boyle Heights, has rejected many new projects in fear of gentrification and has even protested famous artists from having studio space in Boyle Heights, fearful that it will make the area more expensive and impossible for current residents to afford.
Commonly, real estate developments are funded by 55%-75% debt, usually from a bank and sometimes from a private lender, and 45%-25% equity. Of the equity raised to fund the project, normally, around 90% of it is sourced by an investor or Limited Partner while the other 10% is given by the development firm, the General Partner, who will carry out the project until disposition, repay the debt and equity at the end of the project, and will hold the title of ‘owner’ on the building. In some rare cases such as Rick Caruso’s development company, Caruso, investors are not needed to source equity and the General Partner, in this case, is the Limited Partner. Deals in lending and deals in investing are tailored to the timeline of a project, economic health indicators like LIBOR and Treasury Reserve, level of risk within the investment, and market indicators like rents and sales.
The construction phase of a project does have a tremendous deal of pressure to finish the project on time. Normally, real estate developers hire a General Contractor who either does all construction in house or seeks out Subcontractors to carry out specific jobs like grading, demolition, drywall, etc. Sometimes phased construction is used on a project, many times a renovation , and requires new permits from the city after construction ends on the previous phase and before the construction begins on the following phase. When phased construction does not get the permits for following phases perfectly on time, the project suffers greatly as the job site is under construction with halted work but still requires a superintendent onsite everyday and security on watch every night.
After the project is completed, there are still many steps before it can be operated as a business or sold. Series of inspections occur to ensure that the building is safe and meets code, Certificate of Occupancy must be earned before tenants or buyers can move in, even mailboxes and their placement must be approved by USPS. When all is approved, many times projects still must find retail, office, or residential tenants to fill their building and start earning revenue to payback their investors. When a project is for sale after completion, investors and lenders can gain their money back quicker as the developer usually gets a large payment at the sale which is underwritten to cover all liabilities.
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