Despite the negative effects of the COVID-19 pandemic, commercial real estate in the United States still boasts an impressive valuation of $1.0 trillion, according to IBISWorld. Some experts also anticipate substantial growth for the sector in the coming years. Nuveen has highlighted multiple factors that may cause commercial real estate to swell, such as:
- Pent-up demand for travel and retail
- Potential for an investment boom in green technologies
- The rise of real estate alternatives
- Urbanization is here to stay
Many investors deem commercial real estate an ideal investment vehicle, far too few have carefully considered the full commercial real estate development process — and all of its concomitant pitfalls. This post will broadly explain what commercial and industrial real estate development entails from preplanning to breaking ground to construction close-out. And while this content is presented as though a project has proceeded from scratch, the steps that commercial real estate developers must take in rehabilitation projects often looks very similar.
Continue reading our real estate development process checklist to learn more about what real estate development involves.
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What is Commercial Real Estate Development?
Before examining the development process, it makes sense to define just what is commercial real estate. At its simultaneously broadest and most concise, commercial real estate is any property that supports business-related activities rather than serving as a living space. By this definition, even relatively modest “plexes” (e.g., duplexes, triplexes, fourplexes). Would qualify as commercial real estate (CRE). However, most CRE offerings deal with larger properties and typically break down into one of the following categories:
- Industrial (e.g., manufacturing, warehouses)
- Multifamily (e.g., apartment complexes)
- Hospitality (e.g., hotels, resorts)
- Mixed Use
Additionally, many commercial properties can be further broken down into quality categories, such as:
- Class-A: new properties of the highest quality in the best locations
- Class-B: mid-tier properties requiring additional infrastructure work
- Class-C: older properties with substantial structural issues that are locating in undesirable areas
Rehabilitating, repurposing, and restoring existing properties can fall under the umbrella term of “commercial real estate development,” and many of the steps listed below will apply in such scenarios. However, when people mull over what is commercial real estate development, they typically envision the building of a commercial structure “from scratch” on a specific property purchased for that purpose. That is the process described in the following sections.
Site Selection and Evaluation
Other than nourishing a very general idea as to the type of project desired, the first step in a real estate development process flowchart involves selecting the development’s site. This involves choosing a site that will fit with your property. This requires you to answer a number of important questions:
- How big will your property be?
- Must it be readily visible to passersby?
- What kind and how many access points must you provide?
- Will the topography and soil type support your project?
- Will any extant or planned developments interfere with your project?
- What kind of public services are available?
If developers can answer such queries to their satisfaction, they will then move on to related matters that require additional due diligence.
After a developer has settled on a specific site, the decision making isn’t over. In fact, developers still have much data left to gather and numerous decisions to make. Their next step involves turning from the site to consider the wider CRE market.
While a specific site might seem perfect, developers must conduct feasibility studies that examine:
The local market. If you want to build an office building in an area where they’re overrepresented, you won’t have much success. Similarly, a locale that lacks any hotels may appear an ideal choice — until you realize that tourist traffic and business travelers never make their way through it.
Performance of similar projects. Understanding occupancy rates, the fiscal performance, and experienced hazards of related CRE properties helps to defray potential risk.
Zoning and municipal requirements. Many developers have waited years to receive the zoning necessary to proceed with their projects and considering urban-planning initiatives and the politics of zoning boards is a must. Additionally, some sites may not have adequate access to municipality-provided utilities. Finally, municipalities can require substantial fees, paperwork, and waiting periods for prerequisites such as environmental impact reports and various building permits.
Preliminary Budgets Established (Pro Forma)
Once developers have performed their due diligence and determined that property development is possible, their next step involves drafting a pro forma budget — and such budgets are possibly the most important step of any development project. Even ancient thinkers recognized the preeminence of proper planning, and one once said, “Which of you, desiring to build a tower, does not first sit down and count the cost, whether he has enough to complete it?”
At its most basic, such a budget should compare proposed expenses with anticipated revenue, providing a rough idea as to a developer’s anticipated profit. However, a preliminary budget also helps solidify expectations and clarify presuppositions. Budgets reveal just what kind of expenses a developer expects to incur in the following areas:
- Demolition (if applicable)
- Taxes and fees
- Third-party fees (e.g., consultancy)
Budgets are used to perform net present value calculations and determine break-even points. Careful observation of pro forma budgets can also highlight faulty assumptions, showing overly optimistic or pessimistic thinking in specific areas.
Hiring Architects, Engineers, and Consultants
After approving the pro forma budget, signing off on the development proposal, and finalizing a purchase contract, development begins in earnest. The developer will begin to hire professionals to design and implement the project. This may include:
- Structural Engineers
- Electrical Engineers
- Mechanical Engineers
- Structural Architects
- Landscape Architects
- Civil Engineers
- Strategic Consultants
- Consumer-Research Consultants
- Capital-Allocation Consultants
When hiring these professionals, developers must consider multiple factors, such as:
- The number of successfully completed projects
- Years of experience
- Awards, commendations, and certifications
- Delivery period
- Fee structure
Municipality Submittal and Review
Another important element of the development process involves submitting the design to the municipality and receiving approval after an administrative review. This will include a thorough review of the project’s zoning, site plan, and design. During this stage, developers must reach out to the local community for multiple reasons. First, ordinances may require some kind of communication with residents and extant businesses. Second, keeping the community abreast of development plans helps lessen resistance and less-than-graciously named NIMBY (Not In My BackYard) attitudes.
Additional steps that developers must take include satisfying the city entitlement process, which means receiving permissions for landscaping, roads, utility hookups, and the like. The city, county, or municipality will also need to conduct a public hearing and issue appropriate permits prior to the construction commencing.
After clearing these administrative hurdles, developers should have a much clearer idea as to how long the project will take and what exactly it will cost. Some of the expenses — especially those related to consultation, design, and planning — may have already been incurred. Developers can now confidently finalize their budget as they prepare to break ground, taking into account variables like insurance, permitting, and site preparation. As this part of the process wraps up, they will need to select an appropriate title company to hold the project’s funds and close escrow.
An old aphorism states, “Proper preparation prevents a poor performance,” and nowhere is that more true than with the commencement of commercial real estate development. It may seem as though plenty of preparation has already gone into the process, but several more steps need to take place before the breaking of ground begins.
First, the developer must hold a pre-construction meeting in order to define everyone’s roles, delegate responsibilities, establish quality standards, and generally set expectations. Pop psychologists have said, “Expectations are premeditated resentments,” and making sure that various managers, contractors, consultants, and third parties are on the same page regarding their duties helps avoid wasteful misunderstandings, conflict, and even potential legal actions.
Next, developers will start survey staking, a process by which contractors physically mark out the planned structure on the actual site. This helps determine the placement of features like curbs and driveways, as well as whether or not the stormwater can properly drain. Engineers may also take soil samples to ensure that the plans remain viable given ground composition.
Now the building part begins in earnest. Contractors will begin to execute the following:
- Earthworks. Often the soil in its raw state won’t properly support the proposed structure. Contractors will fill in, stabilize, grade, and test the soil.
- Foundation / Demolition. During new construction, contractors will pour the structure’s foundation. Existing structures may be razed, and the current foundation used or replaced depending on the situation.
- Exterior Construction. The frame of the building will be erected, the roof constructed, an HVAC system attached, and major utilities connected.
- Interior Construction. Walls, ceilings, duct work, insulation, floors, paint, fixtures, and all the things that you encounter on a daily basis in a building go in.
- On-Site and Off-Site Preparation. In addition to creating parking lots, other access points, and landscaping, developers must often build access roads.
Inspections & Construction Close-out
Once the construction has concluded, municipal inspectors will arrive to ensure that the structure and its surrounding environs meet all community standards. Once they do, they will provide a certificate of occupancy. The developer will also ensure that all rental equipment has been returned, that all finished items have been addressed, and that any necessary cleaning has been completed. At the point, all that remains is to turn the property over to a tenant.
If you’re looking to begin a development project, consider contacting us at GNP Realty to help helm your project. We have ample experience with multiple end-use scenarios, including everything from industrial construction to public housing to projects requiring LEED and WELL certifications. Our passionate team marries attention to detail with care for your concerns. Reach out to us today!