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What is Commercial Real Estate Development (CRE)?

Discover the essentials of CRE development, covering key stages, strategies, and insights for successful commercial real estate projects.

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Commercial real estate is real estate intended to generate revenue.  This can be revenue for the owner, and it can be revenue for the tenant utilizing the space or land.  The development of real estate can be defined by a wide scope of actions ranging from minimal improvements to a piece of land all the way to the completion of a complex facility. It can include infrastructure work to land, the design and construction of buildings or facilities, and can even include the establishment of farming or manufacturing processes.  Commercial real estate development is the series of steps taken to generate revenue from real estate.

What are the sectors of commercial real estate?

With commercial real estate having so many options, there are what we may call sub-classes or sectors of the industry.  Some of the most popular are:

  • Multi-family residential (five or more units)
  • Retail
  • Industrial
  • Warehouse
  • Office
  • Institutional
  • Religious
  • Flex space
  • Mixed-use
  • Land
  • Healthcare
  • Hospitality (restaurants, hotels, etc.)
  • Special Purpose (arenas, convention centers, etc.)

How are CRE developments planned?

Planning the project is the first step to successful completion. This involves clearly defining the product and purpose, knowing the desired financial outcome, determining location, and ensuring the demand and market will support the desired return. Some of the most significant steps of the preconstruction process include:

  • Siting
  • Market analysis
  • Evaluation of capital resources
  • Preliminary design
  • Team selection
  • Government permitting

What are the key CRE development stages?

Like most large projects of any type, everything cannot be accomplished at once, so there is planning to be done followed by a progression of steps.  It is not uncommon for commercial real estate projects to require years from the ideation stage to the point of completion.

Stages in the CRE development process include:

  • Planning – This is somewhat of an all encompassing phase that can include the ideation, land search, prelim design, modeling to determine the feasibility of a project.
  • Design – This includes teaming up with the professionals in the aspects required by the project. This may include land-use design, infrastructure, and architects & engineers if buildings are being constructed.
  • Financing – The stages prior to this will allow for a project to be estimated in costs which will provide lenders to value the project for financing purposes. Financing can be through traditional lenders or equity partners.
  • Permitting – Development does not occur without the blessing of the governing body for the area where it is taking place. Hearings, approvals, and permitting can all be part of the process in order to gain permission to proceed.
  • Building – This is the actual construction phase of the project that will involve the general contractor and usually an arm of sub-contractors.
  • Marketing – Assuming a project is not a build-to-suit, and being built on speculative needs, marketing will announce to the world that the owner is seeking tenants.
  • Leasing – This includes negotiating with potential tenants to the point of a formal documented lease that satisfies both tenant and owner.
  • Management – Not all developers or developments include property management services, but for those that do, this includes implementing a system of monitoring the real estate, managing the leases, maintaining the facility and grounds.
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Building the right development team

As we have already mentioned, commercial real estate development requires a team of professionals if a project is to be implemented successfully. The team often consists of:

  • Developer – This is the “idea person”. The one leading the charge on making the concept a reality, but coordinating everything needed to accomplish the goal.
  • General Contractor(s) – Although called “general”, this leader usually has expertise in the type of project being implemented. This person (and company) coordinates the sub-contractors that actually do the work. This person’s experience may also allow him/her to consult on the project.
  • Architect – This is the designer of improvements to the land. This may include buildings, bridges, or special use facilities.
  • Engineer(s) – Engineers play a key role in so many aspects of the process including the design of the structures as well as the site work. These may include civil engineers for the site and traffic, structural engineers for foundations, structural components, and materials, and mechanical, electrical, and plumbing engineers for the systems.
  • Legal – The legal team assists with contracts involved with acquisition, leases, sales, labor, as well as with documents involved with zoning and permitting.
  • Project Manager(s) – The size of the project will dictate the size of the management team, but these managers are in charge of the flow of the project as a whole.
  • Brokers – Real estate brokers may be involved on the front end with acquisition of properties, and also with leasing or sales. Not only do brokers provide transactional performance, they can also inject invaluable information about tenant expectations in the market which can help owners and designers when it comes to selecting the finishes for a project.

What are the design steps?

A preliminary design is required before costs can be estimated. In most states, this must be prepared by a licensed architect and civil engineer. A developer might provide a sketch of what is envisioned so the professionals can start seeing the concept, but eventually refinement and formal design are needed to provide cost estimates.

The developer selects the top-level team, but the designer and engineer can recommend experienced general contractors for the type of project envisioned. Although called “general” in terms of “general contractor”, many firms have their specialties, and tapping that experience means a refined budget and a more stable completion process. The GC will usually select the subs for the developer’s approval.

This is the core team with the knowledge, experience and capability for budgeting, final design and delivering the completed building.

How is CRE financed?

Financing CRE is different from residential. The development is riskier, and many banks are reluctant to offer loans, especially to new CRE developers. Two funding mechanisms are used for commercial real estate development: debt and equity. Each one has its purpose in relation to project objectives. 

  • Debt is borrowed money paid back with a specific end date. Funds can come from commercial banks, private lenders or other nontraditional sources. Debt is usually used when a project strategy calls for an early exit. It lets developers take the profit on the front end.
  • Equity is a process that generates revenue from institutional investors, private investors and others who are in for the long term and look to take profits on the back end when the project is sold. They invest money in exchange for becoming limited partners in the project (ownership). Occasionally, a general contractor looking to be a developer may also provide an equity investment.
  • Public-private partnership is a third option that involves a local government, state agency, or nonprofit organization. In this arrangement, the public partner contributes some or all of the money to develop the project. Profits are normally a fixed amount set in the contract.

What permits are required for CRE development?

Obtaining entitlements from local governments is a complex process for CRE development. Local planning, zoning, and development codes dictate the end use of a development based on its location. Regional, special district, state and federal codes and permits can also exist, so the permitting process can be extensive, and sometimes even exhausting. 

The type of project may dictate the different levels a developer may have to journey through. Some projects have to go through hearings in which the public may voice their support or opposition. This feedback can sometimes spawn ideas for additional project requirements, so the project best suits the community and sometimes appeases the public. Hearings can even lead to the termination of projects if the opposition is substantial enough.

This stage and process can also require that extensive infrastructure improvements paid for by the development be part of the approval. The permitting process requires public hearings, interaction with neighbors, and sometimes the complexity requires a zoning attorney to represent the developer to help navigate the process.

The preconstruction phase of development

Once entitlements are received, the preconstruction phase is the most important stage in CRE development. This starts a regular series of meetings between the developer/owner, architect, and contracting team. Before a shovel goes into the ground, the team evaluates:

  • Budget – Not only is everything on target at the beginning, but also taking measures to ensure the project remains on course and doesn’t experience extreme overruns.
  • Permitting – A review is done to ensure all of the proper permits are in place in order to prevent any stoppages in production.
  • Government Requirements – This is at all levels: Federal, state, local. This does not only affect the timeline, but also the budget, and can even put a project in jeopardy if something has not been approved, was not properly filed, or implemented at all.
  • Contractors – Confirming the proper selection has been done for each step of production.
  • Timeline – A careful review of the production timeline helps prevent cost overruns, and proper delivery date.
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Construction

Even before construction begins, there have usually been tremendous efforts, and even substantial capital investments. When it has been properly done, everything seemingly seems to start coming together with the beginning of site preparation and infrastructure installation. The project manager leads the team with the architect and general contractor to anticipate problems, keep the project on its timeline and ensure milestones are met. A lot can come up during the construction process, from material delivery delays to labor shortages to change orders to meet city codes.

Stages of CRE construction

Although each commercial project is unique in size, type, and purpose, they will follow a core set of stages.

Site Work

With every piece of land being unique, and every project and purpose also being unique, the preparation process that the land will undergo can include a wide array of steps.

  • Site clearing and demolition – The removal of unneeded natural growth, as well as the removal of any unneeded previous improvements made to the land. This process may include removing trees, brush, buildings, bridges, parking lots, driveways, and even private roads.
  • Excavation – This is where the site starts evolving and taking shape. Excavating may include the removal or addition of soil, or even possibly the swap of soil due to type. The removal of natural rock may take place, and the addition of rock filler may later be added. As a part of this process, blasting may occur. It is the excavation process that shapes the land and preps it for all successive stages including the construction of buildings, and even streets, parking lots, and driveways.

Foundation Work

After excavation is complete, and building(s) are part of the development plan, it is time for the foundation work. With a diverse set of scenarios, this stage may include:

  • Pad – Creating the proper pad for a building falls between excavation and foundation work. Some cases may require the building of substantial rock pads from filler material while other situations may already have nearly flat and level land.
  • Footings – This is the component that substantially supports the weight transfer from the structure to the ground. These are typically implemented by digging trenches into the soil into which forms are placed to produce a concrete footer in the dimensions required for the loads and soil type.
  • Foundation/Slab – In many commercial applications, the type of foundation will be a concrete slab. This is constructed by placing forms (temporary walls that shape the concrete), installing metal rebar according to the engineered plans, and pouring concrete into the forms.

Exterior Construction

Nearly every building will be different in terms of design and construction. There may be some exceptions such as replicating plans for restaurants or hotels, but there are usually variances. Most buildings will still proceed through these stages:

  • Utilities – These often require trenching, so it is logical that these be the first step before anything else is put into place. Utilities include communications, power, gas, sewer, water.
  • Framing & Roofing – There are many structural components available today, but the most common will be steel or concrete. Some commercial framing may be done in wood, but that is more typical for residential. Framing includes the outer shell of the building as well as interior walls. Roofing on commercial structures may include asphalt shingles on pitched roof types, but many will instead have flat roofs and have membrane roof coverings.

Interior Finishing

The extent and type of interior finishing spans a wide spectrum. For example, one build may be an empty shell of a warehouse, and the next build may be a 20-level 5-star hotel. The warehouse is obviously going to have minimal finishes, whereas the hotel is going to have extensive finishing that appeals and attracts guests. Here are some of the possible interior aspects that occur during this phase:

Operational & Mechanical Components

  • HVAC – Heating, Ventilation, Air-Conditioning. Some developments may not have this if they’re warehouses without office spaces. Other developments will require this throughout. This includes all ductwork, zone sensors, dampers, and control wiring.
  • Plumbing – Consisting of everything from supply lines to drains, plumbing can be a very intricate system especially if for a manufacturing facility, or special use such as food production.
  • Electrical – This usually refers to high voltage, and like plumbing, it can vary greatly with how extensive the system is required to be. A single small warehouse will be much different than a data center.
  • Low Voltage – This type of electrical usually includes systems like sensors. Security, cameras, alarms, gate controls are examples.
  • Insulation – Available in a wide array of types, insulation may be blown, sprayed foam, rolled, or panels.

Spatial & Cosmetic Components

  • Wall Finishing – Usually in panel form, options include drywall, wood panels, fiber board, metal. Some may be available pre-finished which eliminates the painting stage for this component.
  • Ceiling Installation – Business offices may utilize drywall/sheetrock, but those open to an industrial look may opt for exposed beams or trusses. Other types include drop ceilings which are more efficient to install and provide quicker access for repairs.
  • Trim & Moulding – More typical for finished office, hospitality, and consumer spaces, trim and moulding includes the finishing component along the joints where walls meet the floor and ceiling. It can also be along door openings, or anywhere else a finished look is required. Traditionally wood, vinyl, plaster, and extruded rubber for special shapes are also options.
  • Paint & Finishes – This can apply to walls, ceilings, and even floors. It’s the final finish on the raw material before it’s user-ready. This is usually implemented in stages that includes the identification and resolution of surface flaws along the way.
  • Flooring – Including concrete finishing, carpet, hard wood, vinyl, engineered wood, tyle, stone, and a number of other synthetic options, these are installed toward the latter part of the project as to prevent damage.

The progression toward completion

Every developer (and tenant) looks forward to completion. Along the way, the project goes through a number of inspections at specific stages, so that anything in need of resolution can be addressed before the project proceeds too far. These stages will include all the major milestones we have outlined with the structure and systems. Once construction is complete, and all inspections have been passed, the regulating authority will issue a certificate of occupancy which allows the facility to then be used.

How is CRE marketed?

The success of a commercial real estate development is measured by the continued demand for the product which translates into ROI (return on investment). Assuming a project was not build-to-suit (intended for a specific tenant), filling a development with tenants requires a complete marketing strategy, which the leasing brokerage or in-house management implements.

As mentioned earlier, the broker may have played a part in assisting the developer and design team with their vision because the broker can bring information about what tenants expect, and what competitors are offering in the market. Part of that process involves the broker assisting with interior design, decor, and amenities. The broker will know what property technology is expected, the amenities needed for the building class, and what lease rates the market will bear.

The entire development process included an aim for a specific target market. A specific type of tenant. Either the developer’s team or broker will implement a marketing plan based on statistics on how to best reach those potential tenants. Advertising, events, and personal networks can all play a role in the marketing machine to secure tenants.

Conclusion

The development of commercial real estate includes an extremely wide array of scenarios that include developing raw land to re-developing a building that already exists. No matter the situation, the purpose of commercial real estate is to generate revenue either through the development process, sale of the finished product, or tenant occupancy. The process is extremely intricate and involves acquiring the property, building a solid team of professionals, having a disciplined approach to budget and timelines, and efficiently exiting or leasing the finished product. It all includes substantial risk, but also potential for great reward.

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Eric Jay Toll is an award-winning business journalist based in Phoenix, AZ with 12 years of experience in media and a specialty in economic development and commercial real estate. Eric came to development journalism from 30 years in the private... Read More »

Shaun Larson is the Managing Editor at Developer.com, where he spearheads development and operations through a wealth of expertise from a multifaceted background originating in the field of computer science. Having founded several successful companies in the e-commerce, web design,... Read More »