Commercial land development is a profitable enterprise for those who are willing to follow the process. Below is a step by step guide to doing it right.
The cityscape, ever-evolving, stands as a testament to human ingenuity and ambition. It's a reflection of our desires, dreams, and the way we shape the world around us.
At the heart of this transformation lies the art and science of commercial land development – a dynamic process that blends creativity, economics, and innovation to breathe life into vacant lots and barren tracts.
Today commercial land development is a major contributor to the US economy, according to data from the NAIOP, a national commercial real estate development association. In 2022, about $826.9 billion was spent on commercial land development, resulting in a $2.3 trillion contribution to national GDP, $831.8 billion personal earnings, and a support of 15.1 million jobs.
Moreover, “the average annual return of commercial real estate over 20 years is roughly 9.5%, nearly 1% greater than the S&P 500's average annual return of 8.6% over the same period of time,” according to Mark Tiefel, President of Capital Equity Group, Inc., a private real estate investment firm.
In essence, commercial land development is not just an opportunity to showcase ingenuity as bare land is turned into business; it is also a proven way to earn higher-than-average returns.
But turning land into a commercial property is not easy.
“Developing is probably the highest-risk position in the commercial real estate industry,” said Lee Kiser, Principal of Kiser Group, a multifamily brokerage firm. Successfully navigating it therefore requires a clear understanding of the commercial real estate development process.
In this article, we will outline the 8 stages of commercial real estate development and identify the important steps you must take at every stage to ensure success and minimize risk.
[Do you want to close more commercial land deals without having to worry about earnest money? Sign up for Duckfund to get the earnest money you need for every commercial real estate transaction.]
“Location, location, location,” says a popular real estate quote attributed to Harold Samuel, founder of Land Securities, a property company in the UK.
When it comes to commercial real estate development, location is everything; it is often the difference between a great investment and a failure.
For one, this means buying land in places where demand for commercial real estate (in general) is high. According to Catalyst Capital Partners, a real estate investment firm, the top 10 real estate markets in the US at the moment are Nashville, Atlanta, San Jose, Austin, Charlotte, Phoenix, Boston, Dallas-Fort Worth, Tampa-St. Petersburg, and Raleigh.
Another alternative is to anticipate locations where demand is most likely to rise. “Find out where the people are going and buy the land before they get there,” said William Penn Adair, a Native American actor and humourist.
In our case, this means identifying locations where businesses are actively migrating to or where businesses are developing at a higher-than-average rate.
After selecting a state or city, there is still a need to select the right type of location within it.
Of course, this will depend on the type of property you want to build (office building, retail stores, multifamily units, mixed-use buildings, warehouses, industrial buildings, etc.). If you already have a property in mind, then the task is to select a site that will be appropriate. Therefore, you will need to create a checklist of what must be present to make a potential site appropriate for the property you are considering.
The checklist will consider factors like:
However, it must be said that not all real estate opportunities follow this process. Sometimes, a real estate developer finds a piece of land and then considers if there are any commercial opportunities for it. In that case, the site itself is a given, the type of property is the unknown.
Nevertheless, even in such scenarios, you must still do an evaluation to ensure that the site truly fits with the property type you ultimately selected. For example, if you determine that the location will be good for an office space (because of access points), you must also consider if it’s big enough to include parking spaces.
Again, location, location, location.
Once there is a coherence between the site and the property you have in mind, you must move on to do some initial research and feasibility studies before proceeding with the purchase.
This process is also called due diligence and it is mostly about potential legal issues.
The most important party here is the municipal government in charge of the location in view. Initial research will involve speaking to them to know if the site has any legal issues (encroachment, liens, zoning restrictions, etc.). Also, you will want to know everything that will be legally required to develop the type of property you envisage on this site.
An initial go-ahead from the municipal government is a must.
A related issue is confirming that the seller has legal entitlement to the piece of land. Here, you will need to work with a lawyer that can help verify all the relevant documents to ensure there is no foul play.
How do commercial developers make money?
Some sell the property to another investor while others hold it for renting or leasing. However, the ultimate value of the property depends on how much income (net operating income) the investor who decided to hold it can make from it.
Consequently, even if you don’t intend to hold for long term, you must have the potential net operating income of the property in mind before you decide to go on with the development process.
This is where a feasibility study comes in.
Basically, this is you talking to the community about your plan and getting their feedback. “What do you think about a hotel at XXX; are there enough tourists and visitors to justify this development project?”
Next, you should also look for published demographics data and market research reports that will provide insights into the local market.
If there are similar commercial development examples in the community, you might also want to consider their current performance (say occupancy rate and annual rent) to get an idea of what you can expect from a new building.
Another consideration is how the general economic conditions affect this market. How does the business cycle affect the CRE market in this location? Then you can look at economic forecasts for the foreseeable future to understand the future prospects of the CRE market.
While you can do the feasibility study on your own, you might get better value if you outsource it to a market research firm. On the other hand, it might be more cost-effective to talk to a real estate broker or agent who understands the local market and can help you answer most of the important questions you have.
Given the amount of money it takes to invest in commercial land development, a combination of the three won’t hurt. It’s better to be safe than sorry.
Even if a feasibility study has said there is a market for the property you want to develop, you still need to consider the finances and put some numbers to it.
To this end, you will need a preliminary budget (also called a pro-forma budget) that details everything you need to spend to bring the commercial development land for sale or for rent/lease.
Some of the cost components of a development project include:
You will most likely require the services of a professional quantity surveyor (or similar experts) to get accurate estimates of the most important item in the list: construction. But the need for accurate estimates extends to all the items in the list.
It’s also important to add a contingency buffer (miscellaneous costs) to the expenses to prevent underestimation since it’s better to overestimate construction costs than to underestimate them. A 10-20% buffer won’t do any harm.
The other side of the budget (income) will depend on what you intend to do with the building. If you plan to sell, you will need to appraise the value of the property once it is completed. Again, you will likely need the services of a professional real estate appraiser to get some accurate estimates.
By comparing the budgeted expenses and the expected sales price, you can determine if the project will be profitable.
If, on the other hand, you want to hold the property for rent/lease, you will need to estimate your net operating income. With this, you can estimate your cap rate (which is your annual rate of return). If you prefer other methods of estimating rate of return (IRR, for example), you can also use them to get a sense of your annual return on the project.
It’s only after all these steps that you can then proceed with the purchase of the land.
Remember that it’s better to say “no” to a piece of land even after spending money on all these steps than to proceed and be locked in a non-viable investment.
During initial research, you have gotten an initial go-ahead from the government. It is now time to prepare the necessary reports (environmental report, etc.) and documentations (survey, site plan, etc.) for the processing of various approvals (zoning and building permits).
Similarly, it may be legally required to consult with the community before construction begins (as a form of Corporate Social Responsibility). Even if such is not required, it is still wise to let the local community know that the project you once talked to them about (at the “feasibility study” stage) is about to start.
This consultation is also important from an ESG perspective, according to Levi Kelman, the CEO of Blue Onyx Companies, a property management firm. “How will this building improve the region’s economics? What benefit will it bring to the area’s local businesses? In 10 years, what will have made this development a better choice for our community than the many alternative options? These are the questions developers must prepare to answer.“
In this guide of how to develop land for commercial use, we are now coming to the actual property development (construction) stage.
Some developers prefer to outsource the whole process to a construction firm. These are often partnerships between various professionals (builders, architects, landscape architects, civil engineers, electrical engineers) that will handle the various aspects of the project.
Others may prefer to work with a general contractor (project manager) with whom they will work to get the necessary workers and materials for the construction. While this option might be more cost-effective it will usually be time-inefficient.
Once that decision has been made, you can start requesting bids. If you are working with a construction firm, they will submit a bid for the entire project. And if you hire a general contractor, he will be responsible for collecting bids from various subcontractors and evaluating them.
When assessing bids, the emphasis should be on value for money. An inferior product or work might be cheaper but it might compromise the quality of the project. Therefore, when comparing construction costs, quality should also be evaluated.
After selecting the best bids, the work can begin.
But there is one more thing to do: talk with the building company or general contractor to ensure you are all on the same page regarding budget and project timelines. Everyone should know what they are responsible for.
With all that settled, the work proper can start. Below are the standard stages in the construction of a commercial building:
However you choose to carry it out, you should not be aloof from the construction process. You will need to regularly request for written reports from the development team as the work progresses. In addition, you need to schedule site visits as well as visit unannounced to see if the work is going on according to plan.
The municipal government will usually request regular updates or schedule their own inspections to verify that you are within the limits of your permit.
When you finish the work, the government will schedule a final inspection. This final inspection will confirm that the property is safe for occupancy and in accordance with all relevant standards. If they are satisfied, they will issue a certificate of occupancy.
In addition, you must also do a close-out of the project. Some of the tasks involved here include returning all rented items, getting all necessary documents, checking the functionality of all the equipment installed, and cleaning the inside and outside, etc.
In essence, you are doing everything necessary to make the property ready for the tenant (if that is the route you want to take).
Even if you are not renting, you also need to close-out so that buyers can see the property in a good condition.
Did you notice that the actual land purchase is only step 4 of the commercial land development process? You have seen the land in step 1 but you are not ready to purchase until step 4.
Sellers have reacted to this by demanding that potential buyers pay earnest money (or soft deposit) before conversations about the land (or property) can proceed. This is used to separate serious buyers from those who are probably just doing market research.
So, before you can take the time to do all the necessary initial research, feasibility studies, and budgeting, you will need to pay a certain percentage of the purchase price (an average of 5%-10% in the US) as an expression of serious interest.
At Duckfund, we provide earnest money financing for CRE investors who don’t have the liquidity needed to pay. It only takes 2 minutes to apply and successful applicants can get access to cash within 48 hours. We don’t request credit reports, and we only charge a 2% financing fee on all transactions.
If you want to succeed in commercial land development, quick access to earnest money is non-negotiable and that’s what Duckfund provides. With it, you can negotiate multiple transactions and do your due diligence before completing a purchase.
[Do you need earnest money to start the negotiation process for a piece of commercial land you want to develop? Sign up for Duckfund to get the funding you need within 48 hours. No credit report asked.]
