8. Components of project development

This is part of a Series in eight parts. Here are the other posts.

1. On commercial Real estate
2. Defining project Value in CRE
3. Identifying Risks in RE
4. Sample table Project development
5. On Construction contracts
6. Essential types of project development
7. Capital funding
8. Components of project development

This post is the last one in the series on Project development. It is based on the book of Alda, Hirschner: Projektentwicklung in der Immobilienwirtschaft, 2009. There are six big milestones in each project development:

1. Feasibility study
2. Buying the land/property
3. Project development contract
4. Realisation contracts with Architects, Controlling, Construction
5. Contracts to the usage of buildings: leases
6. Facility management

I will present each of them in detail.

6.1. Feasibility study

A RE project is feasible, when the analysis determines, that there is a reasonable likelihood of project success: under limited resources and specific constraints you can achieve explicit objectives. Reasonable likelihood – is referring to the developing risks from the developers, the public, and the end users. The feasibility study must define the project risks. You should analyse the following topics:

• Market: you simulate the Demand analysis with comparing the project with similar projects. You check the similar location and similar project types (optimum would be to have a similar project very close to you). Do not limit yourself just to finished projects, check out also other planned projects.
  • Try to estimate the future demand and correct for your income from the project.
  • There are two types of market analysis: the Aggregated (you analyse the whole market; easy to form, nice to see trends) and disaggregated (a localised study to your neighbourhood).
  • Quantitative analysis: surface supply, surface total, empty surface, size of new constructions. Qualitative analysis: Location and building quality, such as size, flexibility, functionality, construction quality, equipment standard.
• Location: The hard (Geographic location, traffic, economic structure) and soft factors (social structure, investment climate, economic structure). The hard factors are easier to change. The result is usually a SWOT analysis.
• Use concept: you do a request catalogue, a room book. Important is the communication with the architect.
• Competition: make a comparison with a similar object, either size, location, of both. It is ok, if the building is still under construction. The goal of this analysis is to test the market (but also the capacity of the competition). The usual criteria are: Rents, Location, and Building quality.
• Risks: very important part, as the study should include as many potential risks as possible. Here is the chapter about risks. I will quickly list them: Sponsor Risk, Debt risk, Cap rate risk, Tenant risk, Leasing risk, Physical asset risk, Entitlement risks, Construction risks, Market risk, Geographic risk.
• Profitability: it is the last analysis in the feasibility study. You transform the previous analyses into a number, with which you can make a financial prediction of the project. There are two principles, the static and dynamic process. The difference between them when the payments are made:
  • Static Investment process: The time of the payment is not considered/important. This has an effect on the rates, both for borrowing or holding money. To do:
    • Cost comparison calculation
    • Profit comparative calculation
    • Profitability calculation
    • Amortization calculation
  • Dynamic investment process. The whole cash flow is important.
    • Net present value method
    • Annuity method
    • Internal rate of return method
    • Payoff method
    • VOFI method (visualization of financial implications). Can be problematic as the investment cannot be divided into subsegments.

To sum up. The Feasibility study should contain the following points

1. Project description
2. Project fundamentals
3. Project idea (concept of use, sales pipeline, involved parties)
4. Timeframe
5. Location and market analysis (current state, macroanalysis, microanalysis, other risks)
6. property, connection, construction regulations (description of the property, property relationships, connections, planning of the construction site, parking spaces, buying price, other risks)
7. Areas, with reference sizes, execution standards. Specifications, other risks.
8. Total expenditure estimate, including saving potentials, risks and costs security.
9. Income and value analysis, based on market situation: rents, profit, yield, project profit, capital gain, possible speculation gain, cash flow and value development, risks, improvement suggestions.
10. Financing concept
11. Other

6.2 Buying the Property

I will just quickly sketch out what the contract should involve:

1. Signing parties
2. State of the property, land register, building directory (sachstand, grundbuchstand, baulastenverzeichnis)
3. Objective of the contract (property, other objects on the property)
4. Selling price: the sum, due date (usually after registering the property under buyer, or when the last owner emptied the plot, or if there are any legal processes, after the processes are due), default on payment, if any criteria are not met.
5. Financing of the buying price
6. The state of the property, any physical or legal problems/errors/issues.
7. Regulation on any contamination, if present.
8. Ownership handover, transition of benefits, burdens, dangers, liability, taxes and duties.
9. Costs/duties to neighbours, costs of public utility
10. Any approvals (genehmigung) or rights of purchase.
11. Cancelation rights.
12. Regulation on costs to execute this contract.
13. Taxes (Grundwerbsteuer, Einkommensteuer, Umsatzsteuer)
14. RE Agent’s clause, if necessary.
15. Final provisions (written form, place of fulfillment, jurisdiction, salvatory clause)
16. Full legal authority transfer.
17. Tips and instructions from the Notary.

6.3 Architecture contract

The key elements are:

1. Contract parties
2. Goal of the contract
3. Basis of the contract
4. Delivery of Architecture, per HOAI phase
5. Due dates (Terminplan as an addon)
6. Honorar, usually on HOAI
7. Payments and payment forms.
8. Changes and added work
9. Abnahme – rollover
10. Duties of the architect
11. Duties of the investor
12. Subplanners (Static, LA, HLS)
13. issue of documents
14. security against damages, mistakes
15. Insurance
16. Cancelling the contract
17. Copyright and usage rights of the building.
18. Confidentiality
19. Final provisions (written form, place of fulfillment, jurisdiction, salvatory clause)

6.4 Project controlling, Projectmanagement

Contract should include the following:

1. Signing parties
2. Scope of the contract
3. Basis of the contract (grundlagen)
4. services provided (divided into phases)
5. Timeframe
6. Compensation
7. Payment tranches and sum
8. General obligations of both parties (reports, confidentiality)
9. Responsibility for failures
10. Cancelling the contract
11. Insurances (liability)
12. Final provisions (written form, place of fulfillment, jurisdiction, salvatory clause)

6.5 Construction contract

There are many types of contracts (I already wrote about it), but there are three key types:

• Engaging companies on upfront defined works and materials (LV). They are responsible for just the “prescribed” part.
• GU/GÜ system (Generalplaner). The construction company takes over the project as whole, and does also some planning jobs. This type is better for the investor, as it moves the risks to the constructing company. But it also raises the prices for the project (and sinks the quality).

The Contract:

1. Signing parties
2. Scope of the contract
3. Basis of the contract (Grundlagen und Bestandteile)
4. services provided (Plans, written services LV, installations, etc.)
5. Execution, Coordination, and Support.
6. Subcontractors.
7. Timeframe, Penalties
8. Compensation
9. Payment tranches and sum
10. Changes and additions (LV, Nachträge)
11. Participation of the investor
12. Technical approval (Abnahme)
13. Risks and insurance
14. Responsibility for failures
15. Securing of transportation and traffic, including responsibility (for delivery)
16. Security on the construction site
17. Cancelling the contract
18. Prohibition of illegal work practices, security of workers.
19. Following the Law on Use and Changes
20. Confidentiality, data use
21. arbitration clause
22. Final provisions (written form, place of fulfillment, jurisdiction, salvatory clause)

6.6 Project development contract

Project developers are usually also investors in the projects. But sometimes they are providing services for other investors. In that case, do not forget to include these infos into your contract:

1. Signing parties
2. Scope of the contract
3. Basis of the contract (structured into segments: 1 feasibility study, 2 Construction law, 3 construction, 4 sales)
4. services provided
5. Timeframe, Penalties
6. Participation of the investor (Procurement, contact with authorities)
7. Representing the investor
8. Compensation with bonuses
9. Payment tranches and sum
10. Responsibility for failures
11. Cancelling the contract
12. Insurance
13. Final provisions (written form, place of fulfillment, jurisdiction, salvatory clause)

6.7 Construction control contract

This one is not always needed. The controlling role is to represent the investor on the construction site. They prepare the technical documentation, and follow on the financial goals of a project. I always had a good experience with them.

6.8 Renting contract

The object of the rent: the surface, of course. But there are some interesting cases, when the building is not yet built. In that case, the tenant can influence the final form, but only in the frame of the Build permit.

The beginning, ending and the length of renting: If the construction is still on the way, it is hard to define the start of the renting. It is possible to leave the beginning (and the end) open. For companies: maximal length is 30 years, cancellation up to 3rd day of the quarter. Usually, some kinds of extensions can be agreed upon.

Rent and costs: this is the goal of the whole development and the size of the rent defines everything from the size and quality of the project upwards. There are three types: flat-rate rent, rent per m2, turnover rent. You can also put caps or combine more types of rent. DIN 277 defines the exact size of the surface you can put out to rent. see these sketches.

Here is how the contract should look like

1. Signing parties
2. Object of the rent
3. Usage of the object
4. Beginning and the length of the rent
5. Cancellation
6. Rent and other costs
7. Paying mode
8. Calculation, return of the rent (under which conditions), reduction of the rent
9. Maintenance
10. Construction changes
11. Advertising, rights to place company names on the facade
12. Return of the object of the rent
13. Subletting
14. Competition clause
15. Traffic security obligations
16. Allowance for the landlord to visit the property
17. Security of the object
18. Liability of the landlord
19. Number of rentiers
20. House rules
21. Final provisions (written form, place of fulfillment, jurisdiction, salvatory clause)