Development vs. Acquisitions

Not to get too off topic, but I have dealt with construction lenders who do not allow partial pay down of the loan during the term...only interest accrued during the period and anything else has to sit in the project account to pay future requisitions. This was a real kick in the nuts when trying to schedule equity pay ins.

"decrebepro"

Biggest differences are going to be:

• Including an full fledged development budget rather than maybe just a couple capex items
• Running the development costs through the cash flow based on when you think they're likely to occur (some people like to do a bell curve or s curve here)
• Modelling the sources and uses such that the debt begins to draw based on costs incurred (typically with all the equity/mezz going in first)
• Including an operating deficit function within the development budget so that you're setting aside a line item for the first few months where operations are yielding negative cash flow
• Modelling an iterative interest reserve within the budget for the construction debt (you'll want a circ breaker here). Then you'll usually model an interim income offset against the interest reserve - such that any positive net cash flow that occurs during the construction period first goes to offset interest expense, then goes to knock down the debt or offset debt proceeds
• Underwriting the actual lease-up/absorption of the property - e.g. you're absorbing x units per month with some % of income abated due to concessions, meanwhile some of your expenses are ramping up based on occupancy

That’s a great response.

FYI: Construction interest will be LIBOR (at least for another year or so) plus a set spread. So need to include forward-looking monthly LIBOR projections.

The hardest part is likely determining the percentage of each monthly draw, along with accurately hitting the absorption rate and overall deal timing.

Need to include FF&E, all of the pursuit/design costs (which can top $1.2M for institutional grade MF), along with calculations for builders risk insurance, tax rates during construction and then at stabilization (which requires a tax study). And need to handicap what the utility costs will be.

Also need to include construction interest reserves, operations reserves, hard and soft cost contingencies, impact fees and construction permits (which can widely range from $150k to $2M+), cost of bonds/letters of credit, and development fee.

New development pro forma modeling is much more complex than running a model for an acquisition. It’s not really something that someone without experience can do...in my opinion. This is because you need reference points on several line item costs, many of which you would need to obtain from third party sources.

Furthermore, you have to determine how to factor in potential construction cost escalations, how to phase in operational costs, and even (many times) include some up front costs like marketing expense and off site leasing center during construction.

The biggest metric is terms of whether a deal is a go/no go is the yield on cost at stabilization. In this market...in my opinion...when it comes to MF...anything sub 6.2% is a marginal deal...between 6.2-6.8% is a respectable deal...and anything above 6.8% is a solid deal. I’ll also say that anything in excess of 7.5% is either a very rare homerun or the result of faulty analysis.

Happy to answer any further questions.