Exam Preparation Document for
Construction and Real Estate
1. Monetary Policy, Interest Rates, and Construction Loan
Monetary Policy and Interest Rates
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Federal Reserve's Objective: Achieve maximum employment and inflation at 2
percent over the long run.
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Federal Funds Rate: Maintain the target range at 5-1/4 to 5-1/2 percent.
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Inflation and Interest Rates: The formula i = πe + real rate + ΣRP indicates the
components that determine interest rates.
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Reducing Inflation: Likely to require below-trend growth and could soften labor
market conditions. Higher interest rates and slower growth are methods to control
inflation.
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Federal Reserve's Actions: Reducing holdings of Treasury securities and agency debt
and agency mortgage-backed securities as a method of controlling inflation and
economic stability​​.
Construction Loan
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Example Case - Parker Road Plaza: Includes a 3-month construction schedule and a
3-month lease-up and stabilization period. The construction interest rate is 7% with a
construction lender commitment fee of 2%.
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Loan Details: The presentation provides an example with specific calculations like the
Internal Rate of Return (IRR) for a construction loan.
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Important Ratios:
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Debt Coverage Ratio (DCR): NOI/(Annual Debt Service) with a range of 1.20 to
1.60.
Loan-to-Value Ratio (LTV): Loan Amount / Property Value. Higher LTV indicates
less equity, more leverage, more risk of default, and no equity cushion.
Loan-to-Construction Costs: Loan Amount/Construction Costs. The property is
underwritten to the lower of the two ratios (LTV and DCR)​​.
2. Construction Budget and Project Management
1. Preconstruction Phase
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General Contractor/Construction Manager Responsibilities:
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Manage design to maintain budget and schedule.
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Develop a holistic budget, including construction costs, professional services,
FFE (Furniture, Fixtures, and Equipment), and A/V technology.
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Identify project milestones and timeframe for achieving completion goals.
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Evaluate constructability and owner goals, including long-term maintenance,
life cycle costs (LCC), and building systems selections (exterior, mechanical,
electrical)​​.
New Construction Project Documentation:
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Collect comprehensive information to minimize risks and improve accuracy.
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Essential documents include surveys, geotechnical borings, construction
documents and specifications, and specialty consultant documentation.
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Consider environmental analysis, development agreement requirements,
tenant requirements, and building equipment needs​​.
2. Construction Phase
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Budget and Schedule Management:
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Continuously monitor and adjust the construction budget and schedule.
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Manage design changes and risk management in terms of quality and billing​​.
3. Risk Management Tools and Techniques
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Budget Development:
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Material Cost Changes:
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Adapt to fluctuations in material costs and delivery schedules.
Value Engineering:
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Include contingencies and allowances for unknowns such as underground
obstructions, unsuitable soils, structural reinforcement, and existing building
system issues.
Identify opportunities for cost reductions to meet budget constraints.
Lease Terms and Requirements:
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Understand and manage lease-related risks​​.
4. Contracting a General Contractor
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Contract Types:
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Options include Time & Material, Negotiated, Cost Plus GMP (Guaranteed
Maximum Price), Design/Build, and Lump Sum contracts.
Evaluating Alternatives:
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Consider different space generations, base building systems, and tenant vs.
landlord responsibilities​​.
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3. Development Proforma: Assumptions, Inputs, Case Study
1.
Financing Overview:
a. Combines debt financing, equity investment, partnerships, and various loan
types.
b. Equity capital, often mixed with some loan, is used to purchase land.
c. Construction loans are typically sourced from local commercial banks,
mortgage companies, or savings and loan associations.
d. Loan amounts are based closely on the cost of improvements, with a
preference to not finance soft costs​​.
2. Loan Submission Information:
a. Includes a detailed description of the development, market analysis, and
pro-forma cash flow analysis.
b. Permanent lenders tend to avoid construction loans due to unfamiliarity with
local conditions and construction practices​​.
3. Typical Loan Structures:
a. Short-term financing: Used to sell the property after completion and lease-up.
b. Permanent loan and construction loan: For retaining ownership.
c. Construction loan and mini perm loan: Ownership for a short period, typically
5-7 years, taking on interest rate risk.
d. Permanent loans are often provided by life insurance companies, pension
funds, or large commercial banks​​.
4. Permanent Lender Contingencies:
a. Include time limits for acquiring a construction loan, construction completion
dates, minimum leasing requirements, approval of main leases, and
design/material changes.
b. Gap financing provisions are used when actual costs exceed projected costs​​.
5. Construction vs. Permanent Loans:
a. Recourse vs. non-recourse loans.
b. Variable vs. fixed interest rates.
c. Short-term (local banks) vs. long-term (Wall Street pensions, insurance, etc.)
financing.
d. Construction loans start with a zero balance, and draws are paid out during
construction. Interest accrues but is wrapped into the loan balance.
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Developers often hold back a portion of subcontractor fees until work is
completed for potential repairs or changes​​.
4. Estimating
1.
Definition and Importance:
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Estimating is not exact science; it requires construction knowledge, common
sense, and judgment.
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It involves determining probable construction costs based on technical
knowledge, experience, cost databases, and interpreting design intent​​.
2. Purpose of Estimating:
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Essential for decision-making for owners, designers, and contractors.
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Helps in project acquisition decisions, cash flow prediction, evaluating bids,
developing initial schedules, and tracking costs and productivity​​.
3. Project Life Cycle & Estimates:
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Different phases include Planning, Design, Bidding, and Construction, each
requiring different types of estimates: Conceptual, Preliminary, Detailed, and
As-built, respectively​​.
4. Estimating Accuracy:
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Accuracy depends on the amount of information available and varies from
±25% in the planning phase to exact in the construction phase​​.
5. Types of Estimates:
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Budgets (conceptual/preliminary estimates) predict unknowns.
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Bids are based on fully designed documents for accurate bidding​​.
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Conceptual Estimates require little or no design and are based on verbal or
written project descriptions​​.
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Preliminary Estimates use preliminary design documents (0-75% complete)​​.
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Bid Estimates are based on final documents (100% complete)​​.
6. Assumptions, Qualifications, Exclusions:
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Include design, construction, and owner contingencies for unforeseen items
and changes​​.
7. Scope Reviews:
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Ensure bids are comparable across subcontractors, general contractors,
engineers, architects, etc​​.
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8. Rules of Thumb:
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Include estimated percentages for design fees, engineering fees,
contractor/general conditions, CM/GC fees, testing agency fees, and
commissioning fees​​.
5. Scheduling
1.
Project Planning:
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Involves answering various questions related to cash flow, site logistics,
budget, manpower, sequencing, equipment, permitting/inspections, safety,
and more​​.
2. Creating a Schedule:
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Determines project duration, critical activities, roadmap for communication,
and status (on schedule, behind, ahead).
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Helps identify delays and impacts of changes​​.
3. Scheduling Components:
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Includes activities, milestones, durations, start/finish dates, relationships,
resources, critical path, and float​​.
4. Types of Activities:
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Preconstruction, construction, and closeout activities​​.
5. Productivity and Durations:
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Measures how much work can be accomplished, usually stated as a rate per
hour.
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Includes a detailed example calculating total cost per day of a crew​​.
6. Relationships in Scheduling:
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Different types like Finish-to-Start, Start-to-Start, and Finish-to-Finish.
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Involves managing lags and overlaps between activities​​.
7. Critical Path and Float:
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Critical path is the longest continuous path through the schedule.
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Float refers to the number of days an activity can be delayed without affecting
the overall project completion​​.
8. Level of Control:
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Detailed activity lists offer greater control over the project.
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BIM and phasing are used for complex projects​​.
6. Partnerships and Adding Value
1.
Importance of Partnerships:
a. Partnerships in real estate are crucial for pooling resources, sharing expertise,
and distributing risks.
b. They can involve various entities like individual investors, development
companies, financial institutions, and even public sector bodies.
2. Types of Partnerships:
a. Joint Ventures: Two or more parties combine resources for a specific project.
b. Limited Partnerships: Include general and limited partners, where the latter
typically provide capital but have limited liability.
c. Strategic Alliances: Partnerships formed for ongoing mutual benefits, not just
single projects.
3. Creating Value through Partnerships:
a. Leveraging Expertise: Each partner brings unique skills and knowledge,
enhancing the project's potential.
b. Financial Strength: Partnerships can access larger pools of capital, allowing for
more significant or more ambitious projects.
c. Risk Sharing: Reduces individual exposure to financial risk.
4. Key Considerations:
a. Alignment of Goals: Partners should have aligned interests and objectives for
the project.
b. Clear Roles and Responsibilities: Defining each partner's role helps avoid
conflicts.
c. Legal and Financial Agreements: Detailed agreements outlining the
partnership terms, profit-sharing, and exit strategies.
5. Adding Value to Real Estate Projects:
a. Market Analysis: Understanding the market to identify opportunities for
high-demand developments.
b. Effective Planning and Design: Creating projects that meet or exceed market
expectations in functionality and aesthetics.
c. Sustainability and Innovation: Incorporating sustainable practices and
innovative designs can increase a property's long-term value.
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6. Challenges in Partnerships:
a. Managing Relationships: Effective communication and conflict resolution are
vital.
b. Regulatory Compliance: Navigating the legal and regulatory landscape.
c. Market Risks: Real estate markets can be volatile; partnerships need to be
prepared for market shifts.
7. Valuing Real Estate
1.
Real Estate Valuation Methods:
a. Market Approach: Compares the property with similar properties that have
recently sold in the same area. Adjustments are made for differences in size,
quality, and features.
b. Income Approach: Used for investment properties and is based on the income
the property generates. It involves calculating the Net Operating Income (NOI)
and applying a capitalization rate.
c. Cost Approach: Based on the cost of replacing or reproducing the property
minus depreciation. It's often used for unique or new properties.
2. Factors Influencing Property Value:
a. Location: The most critical factor; properties in desirable areas tend to have
higher values.
b. Condition: Well-maintained properties usually fetch higher prices.
c. Market Trends: Economic conditions, interest rates, and local real estate
market trends can significantly impact property value.
8. Risk in A Deal
1.
Identifying and Assessing Risks:
a. Types of risks include market risk, credit risk, legal and regulatory risks,
environmental risks, and construction-related risks.
2. Risk Mitigation Strategies:
a. Risk Transfer: Using insurance policies or passing certain risks to other parties
via contracts.
b. Risk Avoidance: Choosing not to engage in activities known to carry risk.
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c. Risk Reduction: Implementing measures to reduce the severity or likelihood of
the risk.
9. ACRE Valuation
1.
ACRE Model Explained:
a. ACRE (Advanced Commercial Real Estate) is a valuation model that typically
includes various financial analysis tools and methods used to assess the value
of commercial real estate properties.
b. Components might include cash flow analysis, discount rate determination,
and consideration of market factors.
2. Practical Examples of ACRE Valuation:
a. Usually involves case studies where the ACRE model is applied to real-world
scenarios, demonstrating how different variables and market conditions can
affect property valuation.
10. Book Quiz 4 - Ch. 3 & Ch. 4
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Key Concepts from Chapter 3, Page 130
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Highlights from Chapter 4, Pages 219-221
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