Commercial real estate development is a potentially lucrative but complex undertaking that requires substantial experience, due diligence, and planning. The entire real estate development process, from site selection to stabilization, involves various phases and can sometimes take several years depending on the scale or intricacies of a project.
Even if two properties of the same asset class are being built directly across the street from one another, they will each have distinct aspects and challenges, as a wide range of factors must be taken into consideration in the development of a property.
Nonetheless, whether it’s a high-rise office building in the city or a single-family rental (SFR) community in the suburbs, there are common pillars that form the foundation of the commercial real estate development process, which begins with market research and site selection.
Market Research and Site Selection
A sponsor should perform extensive research and due diligence to identify a feasible site for development. There are many factors that sponsors check when considering potential sites, and these may change depending on the target asset class. For a multifamily property, a sponsor will select a target market by analyzing macro-economic factors, such as:
- Population and job growth
- Employment hubs
- Supply and demand trends
- Economic diversity
- Development pipeline
After selecting a target market, the sponsor will choose a specific site by performing a micro-economic analysis of potential locations for factors like:
- Relative cost basis compared to similar properties
- Land use and zoning ordinances of the site
- Rent and sales comparables
- Environmental assessment of the site
- Neighborhood amenities and quality of life
Architecture and Design
The architecture phase of the commercial real estate development process involves conceiving the potential property that can be constructed at the selected site. Preliminary concepts or mockups may have been crafted prior to this phase to begin imagining the potential uses for the site, but even more detailed designs commence as this phase progresses.
For a multifamily property, teams will design the property’s layout, plans, and specifications, showing unit sizes and mixes, common areas, and amenities based on the business plan. They can refine the interior and exterior designs afterwards and tweak as necessary through value engineering. Engineering documents that define all elements of the project are also drafted, including schematics detailing mechanical, electrical, and plumbing elements of the project. The design and specifications will be submitted to the local government agency in order to receive approvals to commence construction of the project.
The entitlement stage focuses on receiving land use and building permits to construct the planned property. Land use regulations and building codes vary from city to city, so a sponsor’s experience in a specific market is advantageous. The plans will need to be approved not only for the design and characteristics of the proposed development, but also for its adherence to building codes and safety standards.
Typically, these applications are filed with the local government. Members of the local planning and development agency or the city council will review the submitted plans to determine if the project meets local, state, and federal guidelines and grant a decision. If approvals are not received, revisions to the project’s initial design may be required based off the government agency’s feedback. This may delay the project, so it’s important to mitigate potential issues through proper diligence and research prior to submitting plans. Once approvals are obtained, work to prepare the land for construction can begin.
Land Development, Sitework and Vertical Development
The physical development of a project includes land development, sitework, and vertical development. In preparation for construction, contractors place stakes throughout the site to map out features (including the property line and building walls) of the project according to the approved project plans. Land development and sitework entails excavation, backfilling, grading, utility connections, paving, adding walkways, and laying the property’s foundation. Vertical development includes framing the building, adding the roof, installing HVAC, and completing unit interiors and exterior property work.
Near the end of construction, the contractor and architect will prepare a “punch list,” identifying work still to be completed or items that need to be fixed prior to the final inspection of a building so that the property meets the contract specifications. These are typically minor items but must be finished before the project can be declared officially completed.
Lease-up and Stabilization
The leasing of a commercial real estate development begins prior to the property’s completion. Pre-leasing campaigns get commitments from tenants while construction is ongoing, but tenants cannot begin to move in since they cannot occupy an unfinished structure due to safety concerns. Once the project has been substantially completed in accordance with the plans and specifications, the sponsor will apply to the local government agency for a certificate of occupancy (commonly known as a “CO”). Sponsors must receive a CO, which delineates that it is safe to occupy the property, to begin tenant move-ins. A temporary certificate of occupancy may be issued by the government if the property is deemed safe to occupy but items that require approval still remain. With SFR and build-to-rent (BTR) properties, tenant move-ins may commence as each individual home is completed in the project, reducing lease-up time and development risk.
Having a smooth lease-up after construction is vital as the property can begin generating revenue. In areas with elevated levels of competition, the sponsor may elect to issue concessions to tenants — such as one or more months of free rent or complimentary amenities — to lure them.
Ultimately, the sponsor’s goal is to get the property to stabilization, which is typically when the property is at least 90% occupied and achieves the net operating income threshold that can support the property’s debt service. That benchmark is crucial because it allows sponsors to refinance the project’s debt, converting existing high-cost debt to develop the property with cheaper permanent financing. Investors may receive a capital distribution as a result of a refinance, returning a portion of capital, and taking some level of risk off the table. Stabilization also makes a property more appealing to prospective buyers, making it easier to realize the project through a sale, bringing an end to the real estate development process.