Understanding the Stages of Commercial Real Estate Development 

At first glance, and even with a more in-depth look, most people cannot imagine the depth of detail that goes into commercial development. The stages of commercial real estate development start with ideation, or a concept, and after a nearly exhaustive series of planning and approval steps, the project actually makes it to production; hopefully with a successful completion that is on time, and on budget.

Pre-development

Embarking on a commercial development project does not begin on a whim, nor is it implemented that way. Prior to even proceeding to designing the project, much effort – and capital – is invested in the process to help determine feasibility and to ensure success.

Team Selection & Assembly

CRE development is not a one-person show. It takes a team. How large the team is, how specialized it is, and when each participant is hired will be unique to each project, but there are some commonalities.

• Project Manager
• Architect
• Engineers
• Designer(s)
• Broker(s)
• Legal

Market Research 

As with all business, an idea only becomes a profitable one if there is enough demand for the product of that idea. The same holds true with commercial real estate. It is relatively easy to dream up the idea of the latest Class A office building, a series of retail stores, a mega warehouse, or the most luxurious hotel, but if there is no demand for the finished product, then it becomes nothing more than a lofty idea, or a financial loss if actually implemented. Areas to consider with market research are:

• Product demand (type/pricing)
• Location
• Traffic
• Infrastructure
• Zoning
• Demographics
• Economic factors
• Building regulations / restrictions
• Operational costs

Site Selection & Zoning

Just as it may have been easy to dream up the idea and concept, it can also be wishful thinking that a project can be placed anywhere of your preference.

Whether there is open space (land) available, or it comes through the removal of an existing structure, having the space does not immediately translate into the allowance to create the next big commercial wonder of the world as it may have allowed in years gone by.

Over the years, more areas and cities have formalized their planning. As a part of that, a zoning system for the area is put into place.

The zoning plan outlines areas where specific types of development can occur. This helps keep residential areas quiet and friendly to living, while other areas are dedicated to noisier industrial development. That is a generalization because there are many sub-categories that further regulate the types of development within the main categories. There are also pocket-zoning situations where sections of land may not match the neighboring properties, but in general, there is an area approach to the planning.

To give you an idea, here are some of the zoning classes and their restrictions/requirements for Nashville TN: Zoning Classifications Nashville TN

The key takeaway here is that before ANY action is taken in regard to acquisition, or even investing into planning for a specific location, zoning is not an optional aspect to consider. You must check with your local government entity about your options, and any required measures to sync your project with any proposed site.

Development Phase

Architectural Design & Planning

For most projects, the developer will select an architect early in the process to assist with the initial planning stages including site selection. The talents of the architect are often thought of as drawing or designing the building, but their value to a developer extends much further. Architects can advise on site selection, site plan development, building materials and finishes, as well as designing for energy conservation.

The process of designing commercial spaces will be diverse as would be expected when the product types can range from a simple shell of a warehouse on rural land to a luxury hotel in the heart of a major city.

Zoning Approvals & Legal Requirements

Earlier, we introduced the zoning aspect to commercial development in regard to preliminary site considerations. There comes a time in the process where the approval needs to be solidified with the governing body, else it may be the end of the road for your project. The process may include and address:

• Site plan approval
• Rezoning application (and hopefully approval)
• Parking requirements
• Permitting (use & occupancy)
• Improvement design

Debt vs Equity Financing Options

Financing commercial real estate development is a unique proposition. It is unlike financing most other items or projects that people are familiar with. It is definitely not like financing residential construction for those of you who may be involved with that sector.

Commercial development is perceived to have more risk, so most investment comes from commercial lenders and not from banks. How the investment occurs is generally in two broad forms:

• Debt – This is exactly as it sounds. Capital is borrowed by the developer to implement the project, and the lender is expecting repayment by a specific time – often at the completion of the project where financing may be converted to a long-term option.
• Equity – This option is where investors inject capital into a project, and instead of expecting repayment by a final date like debt, the investors become partners or part owners in the project. They anticipate recovering their capital through a variety of strategies that may include cash flow from holding the finished product, and/or through the eventual sale of the finished project.

Construction Phase

Construction is often perceived as the actual “development” due to lack of knowledge about everything that goes into the process prior to this stage. This stage is where things become more tangible, and it is at this stage where many will suggest a feeling that the project is really happening.

Contractor Selection & Project Management

Most likely started earlier in the process, the selection of a general contractor is one of the key elements for the construction stage. A couple clarifications about general contractors are:

• “General” is a loosely applied term because even general contractors can have niche areas of expertise. This can be at the personal level as well as a company level. For example, one general contractor (and company) may specialize in medical facilities while another in multifamily.
• A general contractor and project manager are different positions. A general contractor manages the production or construction of the project (which some may define as one type of project manager). The actual project manager on the other hand manages the entire development project. This includes the construction (through the GC) as well as all the other aspects such as legal, zoning, financing, etc.

For the construction stage, the project manager will play a part in hiring the general contractor (GC). As a team, they will source the subcontractors and suppliers required to implement the project.

Stages of Construction

With every project being unique, there will be specialty aspects to the build, but most construction aspects will all into these stages.

• Site preparation – This is where excavation takes place, drainage systems are installed, utilities are placed, and miscellaneous preparations are made to begin the addition of improvements.
• Foundation – Footings and foundation support the entire project and include concrete pads/slabs, and can even include piles in unique soil situations.
• Framing & Roofing – During this stage, the project becomes a shell where the focus is establishing a “dried in” environment on and in which everything else can become part of.
• Mechanicals – Connecting to the utilities established earlier in the process, the mechanicals are operational utilities of the project. They include HVAC, plumbing, electrical, gas/propane, communications.
• Exterior – This stage includes all finishing of the exterior. Materials for this finish include wood, brick, siding, stone, stucco, metal, concrete as well as any specialty trimming and decorative finishes.
• Interior – Finishes used for this stage are as diverse as the imagination. Traditionally, walls are finished with sheetrock/drywall followed by trim and paint. Flooring includes raw concrete, wood, carpet, stone, tile. Lighting and plumbing fixtures are finalized during this stage.
• Landscaping – Working off a plan that was designed back during pre-construction, and after all exterior work is complete, the landscaping is installed. This includes grass, shrubs, trees, rock or mulch beds.

Managing Construction Risks

Commercial development includes a number of risk types ranging from financial to liability. During the construction phase of the project, a few new types of risk are introduced, so measures need to be taken to mitigate the potential harm.

• Builders Risk Insurance – Theft and damage are genuine concerns on a build site. Theft of supplies and equipment can occur from outside sources, or even from an unscrupulous hired trade. Damage can occur from on-site accidents as well as acts from Mother Nature. Examples of damage this insurance assists with: theft, fire, wind, lightning, theft, flood.
• General Liability Insurance – This coverage helps provide protection against claims made that imply the contractor is at fault for causing harm or damage to others. This may include bodily harm, property damage, or personal injury.
• Workman’s Comp Insurance – This is coverage that assists when a worker becomes unable to work due to a work-related injury. It can also serve in a capacity where a worker dies from a work-related accident.

Budget Control & Cost Management

The spending of capital begins at the first step of the pre-construction process, and enters a new phase during construction. It is of the utmost importance that the budget be adhered to in order to ensure the project’s completion.

While this may seem like a simple task with all the pre-planning done, the fact is that the world market is an evolving environment, so the costs of yesterday are not always those of today. Also consider that some projects require lengthy pre-construction times leaving plenty of opportunity for costs of labor and materials to change (and rarely downward).

To help ensure expenses stay on course, a strict system of regular reporting should be implemented from the beginning, so any discrepancies or adjustments are resolved early and the pot of capital does not run dry.

Post Development

Leasing Strategies & Tenant Acquisition

While this stage appears in the final phase of the process, the planning for it and possibly even some of the implementation was actually at the very beginning. Commercial development is not an accidental process. It is planned with intention, and this includes identifying the target market (tenant type) on the front end of things during the ideation and planning stages.

The lease strategy is a core component to the project and should be outlined from the onset of the planning. For a project to be financially viable, it has to be known how the profit will be generated, so the leasing strategies including pricing and terms are planned in the beginning as part of the design and modeling, and implemented here in the final stages.

Tenant acquisition is a process that can be implemented from nearly day one of the process, and can also be part of the original planning. Once the targeted tenant type has been identified, strategies to reach and acquire those tenants should be rolled out.

Marketing the Commercial Space

Whether it is day one or near completion, marketing of a commercial space is crucial to filling it with tenants. While marketing includes advertising, marketing is not solely advertising. Marketing is building an image of a product that drives demand.

When it comes to marketing commercial spaces, the target market (tenant type) should be identified in as much detail as possible, so the preferences of that target market can be used in your presentation of the product. For example, if your target market includes tech companies, then your tactics and advertising should include presentations formatted to appeal to techies which are most likely going to be in contrast to those who may be opening a furniture store.

Learn as much about your potential tenant, and build strategies to reach them beyond the traditional methods of broadcasting through MLS and commercial property databases.

This is also where teaming up with the right broker early in the planning stages will help with tenant acquisition. With the target market having been identified, the broker will be able to assist not only with catering the space to that type of tenant, but the experienced broker will also have a network through which to reach those prospects.

Property Management & Exit Strategies

Exiting a commercial development or investment is simply the plan to recapture the capital put into it. The plan for investing or developing commercial real estate usually falls into two categories:

• Develop & Hold – This where a project is developed (or purchased if simply an investment), and the property is operated/managed as a cash-flowing entity. The outlook is longer-term possibly for cash-flow reasons in addition to capturing appreciation over time. As you read earlier, the financing for this strategy often includes equity investment.
• Develop & Sell – This strategy is one where the project is sold to new investors (who may want to hold, but either did not or could not implement the build on their own). Built-to-suit can also fall into this category where the finished project is sold to the new tenant (who becomes the owner).

Bottom Line/Conclusion

Commercial real estate (CRE) development is not an endeavor for newbies, and as outlined it is quite different from construction and development in other sectors like residential. Tremendous resources and a person with an extreme attention to detail are contributors to a project’s success. That being said, our world around us is filled with incredibly intricate projects, so the proper planning and implementation can provide tremendous results.