The most common financing structure for real estate development projects involves a combination of equity and debt financing. Some form of developer capital is required as a deposit to the lender to fund the deal. It is not common for developers to finance their projects entirely from their own cash reserves. Indeed, to mitigate risk, developers often seek equity participation from sources other than their own cash reserves or other assets. There is a wide variety of strategies to attract sources of capital to invest and participate in a real estate development project. Understanding how and where to find and secure equity participation can be the difference between financing and not financing a promising real estate development project in today’s market.
There are several key elements that are critical to project financing, including: a) Proper location, b) Proper design, c) Strategic development plan, d) Feasible financial pro forma, e) Feasible market study, f) effective marketing/sales, g) Strategic deployment strategy, h) Comprehensive operations strategy, i) Experience of the development team, and others. Impeccable documentation of these key elements helps create a more “bankable” development package for the lender; However, without adequate project equity, excellent documentation and experience may be irrelevant for funding purposes. Simply put, a great plan, great documentation, and even high-level experience are not enough to get financing on their own, but they must be combined with the right capital to effectively meet lenders’ financing requirements in today’s challenging economy. current.
The recent decline in economic conditions, the limited availability of credit, the devaluation of properties and the general decline in lending for real estate development in the United States has created the need for a high level of financial creativity to effectively structure the financing of real estate development projects in today’s market. Capital can be provided in a variety of forms, including cash investments, property, equipment, and professional services. A creative developer can rebuild the lender’s capital requirements by raising equity from outside sources, including:
equity investors
Professionals such as architects, engineers, lawyers and consultants
equipment providers
corridors
Land owners/sellers
Municipalities
Government entities
Local businesses and professionals
Equity arrangements are typically structured through contractual agreements between the developer and the parties that contribute capital to the project. In a common scenario, the developer offers some kind of benefit or incentive to the capital provider in exchange for their capital contribution. The following are several examples of such arrangements:
The owner contributes ownership to the project in exchange for a percentage ownership in the project, or a profit-sharing arrangement that takes place after the project is completed. The property is used as equity for the project, and the lender may place a mortgage on the property to secure his position.
The project architect contributes all design-build work, engineering work, and permitting services in return for double the cost of the work, to be paid for out of project revenues upon completion of the project. The lender accepts the value of the completed work as capital because it would otherwise be a cost to the project. The incentive for the architect is the ability to double his fee by becoming a partner in the deal.
A municipality provides a TIF voucher for the project. The bond can be assigned to the lender and used as principal for the loan. The benefit for the municipality is the creation of temporary and permanent jobs, the aesthetic improvement of the area and the increase in economic activity that will take place after the completion of the project.
ยท A local business owner provides a cash investment to the project in exchange for an agreed percentage of ownership in the deal. The future value and projected revenue is the benefit to the business, in exchange for the cash needed by the project for financing purposes.
These are just a few examples of common equity contribution agreements by external parties that are associated with real estate development projects and assist in the financing process. A creative developer can formulate and implement effective strategies to present and propose the equity investment opportunity to potential parties to attract their participation. The following are some tips to achieve this goal:
Tips to attract capital participation in real estate development projects:
1) Prepare a professional real estate development plan for your project, or have a professional prepare it for you.
2) Prepare a complex financial proforma that provides a concise summary of the uses and sources of funds, the financing structure and the status of operations; but also provides elaborate details on the following pages. Your financial pro forma must be conservative, credible and show reasonable profitability and return on investment over time.
3) An effective market/feasibility analysis is necessary to demonstrate the demand and economic viability of your project based on demographics, statistical data, market trends, and other factors.
4) Letters of support from the local municipality, other government entities, local businesses, business organizations, and community organizations can help add validity to your concept for the proposed real estate development project.
5) Prepare a professional multimedia presentation that outlines the strengths and benefits of the project and outlines the capital investment opportunity.
6) Prepare all investment documentation for equity investors, including an equity investment agreement, partnership agreement, subscription document, prospectus, etc. Your attorney should help you in this area to ensure that SEC laws are followed.
7) Invite potential venture capitalists to a pitch meeting by sending a professional letter outlining the highlights of the opportunity. Follow-up by phone and/or email.
8) Meet with equity investors privately to negotiate a specific deal with each based on their individual equity contribution to the project. Have all documentation ready for investor review and signatures.
The rest is up to you. Your enthusiasm, professionalism, experience, and ability to build on project strengths while demonstrating how you will overcome project challenges are important factors in attracting equity participation. If this is not your strong point, you may want to consider working with a consultant or other professional who can help you in this area.
It is important to demonstrate the real benefits of your proposed equity investment opportunity to equity investors; how they will benefit from their shareholding in the project; and all other ancillary benefits that may be advantageous to them and/or their business (such as community improvement, new jobs in the area, increased economic activity in the area, etc.). If your project is feasible, you can demonstrate profitability, development and management experience, and is properly documented; So there’s no reason why you can’t attract the equity that will leverage the financing needed for your real estate development project, even in a challenging economy.
