CONSTRUCTION FUNDING the Process of Real Estate Development, Appraisal, and Finance
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Collier7317-ffirs-v3 08/07/07 i CONSTRUCTION FUNDING The Process of Real Estate Development, Appraisal, and Finance FOURTH EDITION Nathan S. Collier Courtland A. Collier Don A. Halperin JOHN WILEY & SONS, INC. Construction Funding: The Process of Real Estate Development, Appraisal, and Finance, Fourth Edition. Nathan S. Collier, Courtland A. Collier and Don A. Halperin Copyright © 2008 John Wiley & Sons, Inc. Collier7317-ffirs-v3 08/07/07 ii This book is printed on acid-free paper. Copyright 2008 by John Wiley & Sons, Inc. All rights reserved First Union and Compass Bank are the property of the respective trademark holders. Published by John Wiley & Sons, Inc., Hoboken, New Jersey Published simultaneously in Canada. Wiley Bicentennial Logo: Richard J. 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Wiley also publishes its books in a variety of electronic formats. Some content that appears in print may not be available in electronic books. For more information about Wiley products, visit our web site at www.wiley.com. Library of Congress Cataloging-in-Publication Data: Collier, Nathan S., 1952- Construction funding : the process of real estate development, appraisal, and finance / Nathan S. Collier Courtland A. Collier Don A. Halperin.—4th ed. p. cm. Includes index. ISBN 978-0-470-03731-7 (cloth) 1. Construction industry–Finance. 2. Mortgage loans. 3. Leases. 4. Real estate development. I. Collier, Courtland A. II. Halperin, Don A. III. Title. HD9715.A2C59 2007 690.068’1–dc22 2007006908 Printed in the United States of America 10987654321 Collier7317-ftoc-v3 08/10/07 iii Contents Preface vii Foreword x Acknowledgments xii I BACKGROUND 1 1 Characteristics of Real Estate 3 2 Different Types of Business Organizations 17 3 Negotiation 43 II THE DEVELOPEMENT PROCESS START TO FINISH 65 4 The Development Process: An Overview 67 5 Market Studies, Site Feasibility Analysis, and Selection 93 6 Creating the Project Pro Forma 106 7 The Appraisal 138 8 Sources of Financing, the Loan Application Process, and Term Sheets 167 9 The Commitment 190 10 Closing the Loan: The Note, Mortgage, Construction Loan Agreement, and Unconditional Guaranty 217 iii Collier7317-ftoc-v3 08/10/07 iv iv Contents III EVOLUTION OF THE DEVELOPMENT PROCESS 241 11 Joint Ventures 243 12 Condominiums and Condominium Conversions 266 IV CASH FORECASTS AND THE TIME VALUE OF MONEY 329 13 How to Forecast Cash Needs During Construction 331 14 Basic How-to-Do-It Time Value of Money Calculations 342 APPENDIX A 384 Exhibit A-1 Real Estate Promissory Note 384 Exhibit A-2 Mortgage and Security Agreement 396 Exhibit A-3 Construction Loan Agreement 426 Exhibit A-4 Real Estate Unconditional Guaranty 444 Exhibit A-5 September 2000 Market Reports, Orlando and San Jose 454 APPENDIX B 460 Exhibit B-1 Hidden Lake 460 Exhibit B-2 Apartment Complex Put On Hold 461 Exhibit B-3 Hidden Lake Gets Approval 462 APPENDIX C 464 Exhibit C-1 Letter of Intent 464 Exhibit C-2 Letter of Intent 465 Exhibit C-3 Letter of Intent 466 Exhibit C-4 Letter of Intent 469 Exhibit C-5 Letter of Intent 471 Collier7317-ftoc-v3 08/10/07 v Contents v Exhibit C-6 Letter of Intent 478 Exhibit C-7 Letter of Intent 482 Exhibit C-8 Letter of Intent 486 Exhibit C-9 Letter of Intent 488 Exhibit C-10 Converted Condos Offer Additional Space, Storage Areas 490 APPENDIX D Interest Tables 492 APPENDIX E End-of-Chapter Answers to Questions 517 Index 529 Collier7317-fpref-v3 08/07/07 vii Preface When we mean to build, We first survey the plot, then draw the model; And when we see the figure of the house, Then must we rate the cost of the erection, Which if we find outweighs ability, What do we then but draw anew the model In fewer offices, or at last desist To build at all? —William Shakespeare, The Second Part of Henry IV (Act I, Scene 3) This book takes the reader through the real estate development process in an easy-to-understand format, starting with land acquisition and ending with permanent financing, emphasizing the financing and appraisal aspects. An understanding of the basics of the real estate development and financing process is of tremendous benefit to anyone whose life or livelihood is impacted by the real estate sector. The authors’ guiding principle in this text was to give a concise synopsis of the real estate funding and development process to aid anyone working with a developer to understand the developer’s point of view. Whether you are an engineer, architect, surveyor, general contractor, or potential investor or de- veloper, this book will broaden and deepen your understanding of every developer and development project. Following an actual 260-unit apartment community through the development process, this book explains all aspects of the process in easy-to-understand terms with real-life examples and anecdotes. To give the reader a front-row seat at the unfolding of the development process, the appendices, illustrations, and examples include loan documents used by major financial institutions and exhibits drawn from actual appraisals. Written by Nathan S. Collier, a highly successful developer and owner-operator of multifamily communities, this edition is an extensive revision of a classic text- book favorite. In addition to his success as a multifamily developer, Collier, who holds a BS in Finance, an MBA, and a JD degree, also is a registered real estate broker, licensed building contractor, member of the Florida Bar, and a certified public accountant (CPA). At a time when the simultaneous pass rate for all four parts of the CPA exam hovered below 25 percent, Collier passed on his first sitting, scoring among the vii Collier7317-fpref-v3 08/07/07 viii viii Preface top ten individuals in the state of Florida. He has served as an expert witness on behalf of the Florida Department of Professional Regulation, been an instructor for a nationwide LSAT (Law School Admission Test) preparatory course, and taught graduate and undergraduate courses for the University of Florida’s Warrington College of Business. He is a life member of the University of Florida Foundation, which oversees a billion-dollar portfolio. Collier is on the Board of Directors of the National MultiHousing Council (NMHC) and a member of the Real Estate Roundtable and World Presidents’ Or- ganization. His property management and development firm is Paradigm Properties, Inc., whose Web site may be found at www.teamparadigm.com. The book is divided into three major parts, which, although related, are largely independent. Part I, “Background,” is introductory. Chapter 1, “Characteristics of Real Estate,” gives an overview of the real estate sector and several of its unique aspects. Chapter 2, “Different Types of Business Organizations,” outlines the fundamen- tals of various types of business organizations and is intended to acquaint those without a business background with the various types of business organizations they may find in the real estate field and the pros and cons of each. Chapter 3, “Negotiation,” rapidly covers the fundamentals of negotiation. After having been virtually ignored by academia, the field of negotiation is now a topic of serious study at many top business and law schools. Perhaps because every piece of real estate is unique and the development process is so chaotic, successful negotiation is a vital part of every successful development. Therefore, an under- standing of the fundamentals of negotiation contributes largely to the success of any development project. Part II is the heart of the book, dealing with the development process itself, from start to finish. Chapter 4, “The Development Process: An Overview,” gives a brief insight into the development process and includes an excellent outline of the process. Chapter 5, “Market Studies, Site-Feasibility Analysis, and Selection,” covers the factors involved in determining the proper market-selection techniques to apply to find the perfect site and the elements of a correctly conducted feasibility study to verify that the conditions conducive to the success of the project exist.