The developer justifies the project by pointing to existing or projected demand for the property after completion.
For speculative projects, the leasing risk is high because there are no identified tenants at the outset, the construction risk can be high if the project design is unique, and the pre-development risk can be high if financing is difficult to obtain or regulatory hurdles abound.
One important note for equity investors is that obtaining construction financing from a bank or other lender is a very rigorous process, and if a developer already has a construction loan arranged, it usually means that a number of major hurdles have been cleared.
Perhaps the greatest impediment to capital formation at this stage is the local jurisdiction permitting.
There are usually two distinct approvals required to begin construction: land use approval and building approval.
A land use permit is a governing jurisdiction’s approval of the project on a conceptual level.Two factors can play a big role in the risk of a given project: the project type and stage.As shown in the graph above, the project type can determine the steepness of the risk curve across the project life cycle.The early stage of a project focuses on due diligence, research and permitting. Investing at this stage carries the greatest and most varied risks because there are many unknowns.Some of the common steps in this phase include: In commercial real estate, the sponsor is an individual or company in charge of finding, acquiring and managing the real estate property on behalf of the partnership.For this reason, the land use permit, while not the final approval for construction purposes, is often the greatest hurdle to achieve project financing.Some items that might delay land use approval are: By granting a building permit, a jurisdiction is approving a project on a technical level.An example of a project type with relatively low risk across all stages of the life cycle is a retail “build-to-suit” project.In a retail build-to-suit, a developer secures a long-term credit tenant, such as a Mc Donald’s or Walgreens, and develops a property to suit that tenant.As each step in a development project is completed, overall project risk incrementally abates.Early in the cycle, there are more potential obstacles and unknowns.