Development Feasibility Analysis Guide
Overview
As an entrepreneurial real estate developer, you will be presented with numerous development project opportunities. Many of the projects will not be a fit and can be quickly dismissed. A few will warrant further study and perhaps result in an offer to purchase. Of those where offers are extended, a couple will result in an executed Purchase and Sale Agreement.
This guide covers the pre-development due diligence required for projects under serious consideration. When we say serious consideration, we mean the period from the time you begin contemplating an offer on a development site to the time you decide to go “hard.”
A Word on Predevelopment Capital
Having capital to pay for predevelopment costs, including the costs of detailed due diligence, is what separates developers from the “wannabes”.
Tying up a development site and conducting the necessary due diligence requires an investment of time and money. The money required may be several thousand to tens of thousands of dollars, depending on the size and complexity of the project.
Money invested at the outset of a project is high-risk capital. This kind of money is difficult to raise from outside sources and invariably comes out of the developer’s pocket.
Site Analysis – Can I Build My Project/What Issues Will Need to be Resolved?
The Desirability of the Location and Surrounding Neighborhood. Typically, location considerations are addressed early in the process. The desirability of the site is presumably what attracted the developer initially.
Some of the key factors to be considered when assessing a site’s location include:
The site’s place within the regional or metropolitan landscape. Is the site located in an up and coming area of town, a wealthy enclave, or an underserved community?
The site’s location within the specific neighborhood/ area of town. Is it a “Main & Main” location or a little off of the beaten path?
The immediate area/neighborhood surrounding the site. Consider neighboring property uses, the condition of the surrounding buildings and properties, street conditions, and nearby parks and architectural features.
Street location. Is the site on a busy corner, the going-to-work or going-home side of the street? Is the site visible and easily accessible?
Title and Survey. Reviewing title and the survey will confirm the legal existence of the site and illuminate restrictions on the use and development of the site.
Typical title and survey pick up encumbrances, encroachments, easements and other rights of third parties in or to a property. Contractual restrictions on use and development such as CC&Rs will be reflected (although not necessarily in detail), but land use type restrictions may not show up of record
An ALTA survey confirms the property’s location and boundaries. It also indicates the location of any easements and rights of way of record or evident from an inspection of the property, the existing improvements, any encroachments, and above-ground (and sometimes below-ground) utilities.
Zoning and Entitlements. Each governmental authority (city, county, municipality, commission, district) with jurisdiction over the property and from which a development approval must be sought will have its own approval process and disposition toward to new development projects. Understanding the land-use landscape and process is critical.
What can be built as of right on a development site can be determined by reviewing the applicable current Zoning Code, General Plan, Specific Plans, other land-use regulations, and the site’s existing entitlements. In most cases, the developer will not be building an as-of-right project and will need the appropriate governmental authorities to approve the specifics of the developer’s project.
Whether or not a project is an as-of-right project or requires additional entitlements, an experienced local land-use attorney will be needed to understand the approval process, timeline, costs, roadblocks, and the likelihood of success. Project approvals from development friendly cities may take less than a year and require a modest outlay of fees and costs. In large cities with challenging entitlement environments like Los Angeles, projects can take years to receive necessary entitlements and entitlement costs can run into the millions.
Environmental Review. Environmental due diligence is an assessment of the environmental risks and liabilities associated with a site, the process and costs of undertaking any required compliance and remediation work, and any permitting requirements. The environmental issues one may encounter depend on the type of project contemplated and location of the site and can include concerns related to underground storage tanks, hazardous substances, wastewater discharge, air emissions, water supply, wetlands, threatened and endangered species, and asbestos removal.
Utilities. It is critical to understand the availability of and costs associated with bringing utilities to a development site. Items to consider include determining the location of existing utilities and utility easements; the entities and districts providing service to the site; the capacity of existing utilities to serve the new development; and the cost of tap and connection fees that may be charged to the new development.
Additional Considerations. Other due diligence items that can be very important include floodplains, topography, cultural and historic preservation, geotechnical, water table, drainage, seismic activity, and traffic studies and drive times.
Site Analysis – Key Documents and Professionals
Below is a short list of some of the key professionals and resources that should be consulted when performing a Site Analysis.
Professionals
Attorneys
Engineers
Environmental Consultant
Surveyor
Title Insurance Company
Resources
Phase I ESA
Phase II ESA
Traffic Study
Geotechnical Survey
Topography Map
Aerial Map
Floodplain Maps
Wetlands Maps
Zoning and Planning Laws and Regulations
The NAHB provides a good checklist for land development.
Market Analysis – Who is the Target Market, Will the Project Work at this Location, How Will the Project Rent/Sell For?
Are there enough buyers and renters who will buy or lease your project at the price point you will be charging? Below are some of the key parameters in a market study.
Population and Demographics. Population and demographic data provide an understanding of the people who live in and around proposed project — how the population has grown and changed in the past and how demographers expect the population to evolve in the future. The data also is critical to understanding whether the target market for the project exists in sufficient numbers to support the project, be it buyers, renters, shoppers, or workers.
Local Economy. A strong and growing local economy often is the foundation for successful real estate development. Key components to consider in assessing the local economy include:
Regional economic output and growth
Comparison of economic data with similar regions
Business and political climate
Entrepreneurial activity
Population size and growth
Composition of the civilian labor force
Employment growth
Total employment and the unemployment rate
Education levels
Industrial diversity
Largest employers
Cost of living
Household income
Market Amenities and Attributes. What is available in the surrounding area that benefits or hurts the desirability of a site? Positives can include parks, shopping, walkable work/live environments, employment opportunities, public transportation, quality education, and entertainment and dining options. Negatives can include traffic congestion, a high cost of living, lack of entertainment and dining amenities, pollution, poor schools, high crime rates, a poor economy, and declining property values.
Competitive and Comparable Projects. Are there similar projects in the area? How have they performed and how will they affect the success of the proposed development? Further, what other projects are on the drawing boards? Are there projects currently in planning or development aimed at a similar target market?
Supply and Demand-Competition. When the development project comes to market, will there be sufficient demand at projected pricing? This analysis includes a mixture of demographic, economic and real estate specific market forces. Below are a number of factors that should be taken into considerations:
Key demographic and economic factor
Current supply of similar products
Supply growth
The development cycle
Rental rates/selling prices of comparable properties
Absorption and vacancy of comparable projects
Competitive projects on the board or currently being developed
How the proposed project can be distinguished from comparable properties.
Market Analysis – Key Documents and Professionals
Below is a short list of some of the key professionals and resources that should be consulted when performing a Market Analysis.
Professionals
Marketing professionals
Real estate brokers
Demographers
Resources
Federal, state and local government data (census, building permits, economic/labor)
Third party demographic data
Local maps
Broker site package
Comparable analysis
Financial Analysis – How Will the Project Be Financed and Will It Generate the Requisite Return?
Development Budget. Early in the due diligence process, a development budget will need to be created. This budget, which will be modified many times as the project crystalizes, will be based at the outset on a ton of educated guesswork and assumptions, prior experience, and third-party input. To create the budget a broad outline of the project, a preliminary developmental timeline, and assumptions regarding various cost and line items will be needed.
Financial Structure. How the project will be financed, including debt structure (leverage, costs, interest rate, and terms) and equity assumptions, including desired rates of return.
Pro Forma. The project pro forma will need to be created, combining the development budget, timeline, and financial structure. The pro forma will give a first indication of the profit and returns that might be expected from a project. At this stage, the pro forma should look really good. It is almost always the case that projects will take longer and cost more than anticipated. If the project looks tight financially at the outset, the project business plan likely needs to be reconsidered.
Financial Analysis – Key Documents and Professionals
Below is a short list of some of the key professionals and resources that should be consulted when performing a Financial Analysis:
Professionals
Attorneys
Architect
Engineer
Project managers
Contractor
Mortgage Bankers
Lenders
Equity sources
Placement agents
Resources
Proprietary and third-party construction cost data
Site plan
Development timeline
Conceptual plans and drawings
Zoning Codes