Real Estate Feasibility Ch 16 End Chapter Questions

Front 1

What are the sources of risk associated with project development?

Back 1

market risks and project risks

Front 2

are the result of unexpected changes in general market conditions affecting the supply and demand for space.

Back 2

market risk

Front 3

are the result of choosing a specific location to develop a property and the design of the project.

Back 3

project risk

Front 4

What are some development strategies that many developers follow? Why do they follow such strategies?

Back 4

1) owning and managing projects for many years, 2) selling projects after the lease-up phase, and 3) developing land and buildings for lease in a master-planned development or “build to suite” for single tenants. . Following a particular strategy allows the developer to have a balance between use of external contractors, architects, real estate brokers, leasing agents, and property managers and having this expertise within the firm.

Front 5

How can development projects be differentiated from one another in the marketplace?

Back 5

Developers can try to differentiate themselves in many ways including the type of property that they develop (e.g., various classifications of use, construction quality, space quality, and tenant type.)

Front 6

Describe the process of financing the construction and operation of a typical real estate development. Indicate the order in which lenders who fund project development financing are sought and why this pattern is followed

Back 6

In general, developers must first line up permanent (long-term) financing that will be used once the project is complete and being operated with tenants before they can get a construction loan. It is necessary that the construction loan is repaid when the permanent loan takes over.

Front 7

What contingencies are commonly found in permanent or take-out loan commitments? Why are they used? What happens if they are not met by the developer?

Back 7

Contingencies commonly found in permanent or take-out loan commitments include: 1) a maximum amount of time to obtain a construction loan commitment, 2) a date for completion of construction, 3) minimum rent-up (leasing) requirements and an approval of major leases, 4) an expiration date of the permanent loan commitment and any provisions for extensions, and 5) an approval by the permanent lender of design changes and substitution of any building materials.

Front 8

What is a standby commitment? When and why is it used?

Back 8

A standby commitment is an agreement by a lender to provide permanent financing for a property once construction is complete. It is used by a developer to obtain construction financing, because construction lenders typically require the commitment of a permanent lender before a construction loan will be made.

Front 9

is often used by developers who are still shopping for permanent financing, but need a commitment in order to obtain the construction loan. Thus, the standby commitment is like an option that the developer can use as a source of financing, but may choose not to if a better alternative is found.

Back 9

stand by commitment

Front 10

What is a mini-perm or bullet loan? When and why is this loan used?

Back 10

A mini-perm or bullet loan is a construction loan that, in effect, becomes permanent financing when construction is complete. When construction is complete, the developer begins to make payments (principal and interest) similar to those made on permanent financing with the exception that the loan typically has a 3 to 5 year maturity with the balance (balloon payment) due at that time

Front 11

Third-party lenders sometimes provide gap financing for project developments. Why is this lending used? How does it work?

Back 11

Gap financing is necessary when a construction loan is not sufficient to cover the developer’s needs until the project is complete and the permanent loan is available. It is available from lenders who expect to be repaid from proceeds of the permanent loan.

Front 12

A presale agreement is said to be equivalent to a take-out commitment. What will the construction lender be concerned about if the developer plans to use such an agreement in lieu of a take-out?

Back 12

A presale agreement differs from a take-out commitment in that proceeds from the sale of a property are used to repay the construction loan rather than the permanent loan. The construction lender must be sure that the agreement requires the buyer to purchase the property at an amount that is sufficient enough to pay off the construction loan and that there will be no contingencies in the agreement that allow the purchaser to cancel the agreement.

Front 13

A presale agreement differs from a take-out commitment in that proceeds from the sale of a property are used to repay the construction loan rather than the ------------

Back 13

permanent loan

Front 14

Why don’t permanent lenders usually provide construction loans to developers? Do construction lenders ever provide permanent loans to developers?

Back 14

Permanent lenders are often national companies, such as large insurance companies, that do not have the in-house capability of underwriting construction loans and monitoring a project during construction. Thus, construction loans are typically made by lenders, such as commercial banks with a local presence. Construction lenders, on the other hand, may be willing to make a permanent loan, although they may find it more profitable to focus on construction loans or mini-perms.

Front 15

What is the difference between the assignment of a take-out commitment to the construction lender and a triparty agreement? If neither device is used in project financing, what is the relationship between lenders in such a case?

Back 15

The tri-party buy-sell agreement goes beyond the assignment of the take-out commitment and provides that the permanent lender will notify the interim lender that the take-out commitment is in full effect, that the permanent lender will indicate whether all necessary plans and documents have been reviewed and approved prior to closing the construction loan, and that the permanent lender will provide the construction lender with notice of any violations in the terms of the loan commitment by the developer and the time available to cure such a violation.
In the absence of either assignment of the take-out commitment or a triparty buy-sell agreement, the construction lender has no way to force the developer to close on the permanent loan and repay the construction loan.

Front 16

What is the major concern construction lenders express about the income approach to estimating value? Why do they prefer to use the cost approach when possible? In the latter case, if the developer has owned the land for five years prior to development would the cost approach be more effective? Why or why not?

Back 16

The income approach usually provides a good indication of the expected value of an income-producing property once construction is complete and it has been leased-up. The projected value should exceed construction costs, if this is not the case, the project is not feasible and the loan should not be made. Assuming that the project is feasible, using the cost approach would provide a more conservative estimate of value, especially if the land has appreciated in value from its original cost to the developer.

Front 17

What do we mean by overage in a retail lease agreement? How might it be calculated?

Back 17

Retail leases often specify a minimum rent that must be paid by tenants, as well as a percentage rent provision whereby the tenant pays rent based on a percentage of sales revenue once sales revenue exceeds a specified minimum amount. The amount by which the total rent exceeds the minimum rent is referred to as overage rent.

Front 18

The amount by which the total rent exceeds the minimum rent is referred to as

Back 18

overage rent

Front 19

What is sensitivity analysis? How might it be used in real estate development?

Back 19

Sensitivity analysis is a way of determining how sensitive the expected results of projects are to changes in the underlying assumptions. This is an excellent way of evaluating the riskiness of a real estate development project.

Front 20

It is sometimes said that land represents “residual” value. This statement reflects the fact that improvement costs do not vary materially from one location to another whereas rents vary considerably. Hence, land values reflect changes in rents (both up and down) from location to location. Do you agree or disagree?

Back 20

If improvement costs do not vary significantly between different locations, then the difference in rents may be often attributable to differences in the productivity or suitability of the land for that development and hence the land value becomes the residual value. (Author’s note: In recent years there has been more of an awareness that once a development is complete, some of the income may reflect a return on the “business” aspects of the development, e.g. a successful hotel that is a part of a national franchise or a nursing home. Thus, the appraiser must be careful not to attribute this business value to the land.)

Front 21

Why is the practice of “holdbacks” used? Who is involved in this practice? How does it affect construction lending?

Back 21

Holdbacks are used by construction lenders to be sure that a developer has met all of his or her obligations before all of the funds from the construction loan are given to the developer.