Friday, June 21, 2019

A New Development

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One of the perks of my veteran status in the commercial real estate wars is I occasionally get to share my knowledge with a new person in the business. One such conversation occurred this week - which I believed to be column worthy. “How is a development deal underwritten?”

Following are the considerations:

Land. A new project requires buildable land. Duh! However, the land doesn’t have to be undeveloped presently. Specifically, in Orange County, many of the new projects are a re-development of sites containing obsolete buildings - the Boeing campus in Anaheim and the Beckman campus in Fullerton are a couple of examples. Both of these sites were purchased, the old improvements were scraped and beautiful new structures emerged. As we venture east - our likelihood of finding raw, undeveloped land increases. Each site has its own special mix of zoning, city entitlement processing, access, topography, and off-site challenges such as curbs, gutters, streets, utilities, etc. Finally, the land must be owned by a ready, willing, and able seller prepared to meet the market price a developer will pay.

The market demand. What are occupants craving? Generally, a developer must understand the mentality of the folks who will lease or buy the new buildings. As an example - currently in North Orange County - there is a shortage of available industrial buildings between 20,000-50,000 square feet. Coupled with this shortage is an acute demand for this product. Conversely, another category - Regional Mall space - has a glut of availability. So now the developer’s task is to figure out a way to build a project of 20,000-50,000 square foot industrial buildings upon a site as described above.

Income stream. So once the new premises are complete - what is our expectation of rent? This is tricky yet critical - as the development’s viability depends upon this metric. Taken into account must be - recent lease comparables, available stock, and the direction of the market - up or down. As an example - inland there are very few currently existing, vacant buildings 100,000-150,000 square feet for sale. However, the cavalry of new developments is coming as there are several projects under construction.

Cost to produce. Coverage. How many square feet can I build on the site? In simple terms - if the site is one acre (43,560 square feet) and I can construct 20,000 square feet - my coverage is 46%. Why is this important? Because all the cost categories follow. If we pay $50 per square foot for the land - a total of $2,178,000 - we must now divide by the coverage in order to determine our land cost “under building”. $50 per square foot divided by 46% equals $108.69 - which is the land cost component attributable to the building. We now must layer in construction costs plus “soft costs” - things like interest carry - remember we have some time before the structures are finished. Now - based upon what we paid for the land and our estimate of construction and soft costs - we have an idea what our building will cost us to produce.

Exit strategy. Even though this item was left until last - it’s actually the first consideration in any development or investment deal. What’s the end game? Do I plan to lease the buildings and hold them as a long term investment? Or should I simply sell them vacant upon their completion and pocket the proceeds - less of course Uncle Sam’s, and Cousin Gavin’s taste. I could lease the product and then sell the income stream as a leased investment. Regardless of the exit strategy - each has its own risk, reward, and profit potential.

So, in its simplest terms -there you have it. Development 101.

Disclaimer - development may be hazardous you your health and may cause extreme anxiety, heart palpitations, hair loss, rapid aging and is not for the faint of heart. Proceed with extreme caution.

Allen C. Buchanan, SIOR, is a principal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at or 714.564.7104. His website is

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