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Industries & Professions /
Real Estate Developers
The developer's actual day-to-day activities vary depending on the type and size of the project. A developer may be involved in purchasing 500 suburban acres and developing 1,000 condominiums, a couple of parks, a golf course, and a small shopping center with a grocery store, full-service dry cleaner, video rental store, and health club. Or a developer may renovate and remodel an existing structure, such as a warehouse, for use as a restaurant and office space.
Whether a group of investors approaches the developer or the developer searches out investors, the first step is to structure the development entity, a group made up of the project owner (the person or group who will receive the profits or suffer the losses from the proposed development), the investors who put up the initial equity funds, and the developer. In many cases, the developer is the owner. These individuals may establish a development entity with only one owner, a partnership with a lead owner, a limited partnership, or a corporation that sells stock to stockholders.
The legal definitions of each type of entity vary according to locale, and the benefits and risks of each are quite different. The developer, who facilitates the process of structuring the contract, is concerned with three main issues—managing risk, gathering equity to facilitate borrowing money, and creating a functioning structure with a limited number of people involved in decision-making.
The developer's job at the beginning of a project has been compared to pitching a tent in high wind—the toughest thing is getting the first corner nailed down. In negotiating with potential investors, the developer brings all interested parties to the table to secure an initial commitment of equity funds. Without equity, the developer is unable to approach banks or insurance companies for loans to complete the project.
The developer might come to the table with $100,000 of personal money to invest—or none. With an excellent track record and a solid proposal, the developer's involvement in the project may be enough to secure the confidence of potential investors. But the developer must show a willingness to protect these investors by creating a development entity that exposes them to only reasonable risk.
Most investors want to risk only the equity money they contribute. In other words, if the project fails, they do not want to be held liable for all the money lost. The contract therefore must protect their other assets, such as their homes, savings accounts, and other investments, in case of a default on the loans. The contract must be written in such a way that the investors are willing to accept the risk involved.
After securing the equity necessary to convince financial institutions to participate in the project, the developer approaches these institutions (primarily banks and insurance companies) to secure financing.
Most development projects require both short-term and long-term financing. Banks often provide the money to buy land and complete construction. However, to receive this short-term financing, sometimes called a construction loan, the developer must already have equity funds from the investors. The equity money might equal from 10 to 40 percent of the total amount of the loan.
Insurance companies are the most common providers of long-term financing, which is used to pay off the construction loan. Long-term financing commitments are based on the economic projections of the completed development and usually must be obtained before securing short-term financing. Occasionally one institution will provide both the short-term and long-term financing, but this is less likely to happen with larger projects.
Another participant in real estate financing is the government. Sometimes a municipal government will issue a bond to raise money from taxes. These funds may provide long-term financing to a private developer for the construction of a stadium, for example, or for some infrastructure improvement, such as widening the streets. Municipal governments frequently participate in projects to develop run-down areas of the city. In exchange for shouldering some of the financial risk, the city stands to benefit from the increased productivity of the renovated neighborhood.
Before receiving a building permit, the real estate developer may have to complete impact studies to assess how the proposed project will affect the community and the environment. He or she may also have to meet with the zoning board if there are regulations that the new building will be unable to meet.
At this stage, the project needs an architect. The architect's first job usually is to hire a structural engineer and a mechanical engineer. Together they create the building plans, which the developer submits to the building department.
This process of creating the plans involves consideration of economics, aesthetic architectural concerns, building codes, and other legal constraints imposed by the community. This is one of the most exciting and important times in the development process. Through the competition of the interests of all the involved parties, the best use for the site evolves, and the project is born.
While waiting for the building permit to be issued, the developer also puts the building plans out for bids from general contractors. The general contractor selected for the job hires subcontractors, such as carpenters, plumbers, roofers, and drywallers.
In applying for the building permit and preparing to break ground on the construction site, developers spend a lot of time dealing with government regulations. They must make sure that they understand and meet building codes designed to ensure the safety of future occupants. Windows in a residential building, for example, must have a certain number of square feet for light and a certain number for ventilation.
Developers must be aware not only of building codes but also of laws affecting construction. New buildings, for example, must meet handicap access codes to comply with the Americans with Disabilities Act.
On large projects, such as the development of a skyscraper, the developer will contract out much of the work, such as public relations and advertising, the completion of impact studies, and the general contractor's job. On smaller projects, however, the developer may perform some or all of these functions.
As general contractor, the developer is involved on a daily basis with work at the construction site. If someone else is hired as general contractor, the developer may only be involved at weekly construction meetings, where the architect, engineers, and various subcontractors discuss progress and changes necessary in the plans.
In either case, the developer, who is ultimately responsible for the success or failure of the project, must be knowledgeable about all aspects of the development process and capable of hiring a group of people who can work successfully as a team. Though the developer may or may not be an investor who stands to lose money, the developer's career is on the line with every project.
If a developer secures city approval and necessary funds to construct a new office building in a highly visible spot, the whole city may be watching. The local government officials may have used their influence to change zoning laws in favor of the project. Therefore, their reputations may also be riding on the building's success. If, for example, the construction costs exceed the initial estimates, and the developer is unable to raise the additional money to cover the costs, construction on the building may be halted at any stage, and the empty shell may stand for years as an eyesore in the community.
Failure to complete such projects successfully inhibits the developer's ability to secure investors and government cooperation in the future. Depending on the terms of the developer's contract, it may also mean that the developer is never compensated for the time and work spent on the project.
Once the project is complete, the developer's role depends on the specifications set forth by the development entity. With a high-rise residential building, for example, the developer may be involved in selling or renting the apartments. As an owner in the project, the developer may be involved in the management of rental property for many years.