Real estate development is quite a bit different from traditional real estate investing. The appeal of real estate development is the potential for higher operating profits during ownership and larger capital gains upon sale. Just like investing, real estate development typically specializes in either residential or commercial properties. Most residential development projects are further specialized into apartment buildings or tracts of land for single-family homes.
Only the smallest development projects are undertaken by individuals. This might involve building a small cluster of duplexes or triplexes where the return on investment will come from rental income. This can be a profitable step up the investment ladder in today’s real estate market due to lack of inventory, competition, high real estate values, or other factors.
Besides long-term rental income, when selling duplexes or triplexes with full occupancy you can expect a return on investment in the 16% to 20% range. This may seem like a high rate of return but keep in mind that there is no positive cash flow until the properties are occupied with tenants. Of course, there are many variables. In a major metro market like southern California, it can take a couple of million dollars to complete the project. After a year of development, selling a small $2M development could earn $360,000 at 18%. A similar duplex or triplex project in the Midwest would probably cost closer to $350,000 with an 18% return on investment of $63,000.
Large scope projects include apartment buildings and tracts of raw land developed into single-family homes. These are almost always back by a group of investors that can be organized in several ways. From a pure developer viewpoint, it could be an individual operating a business entity such as an LLC that takes the largest risk. Unless the developer is already wealthy, he or she will have to bring in outside investors to fund the project. However, bringing in outside investors typically requires a substantial investment by the developer to first bring a tract of land under contract (often with an option to purchase).
Most investors still won’t put money in the deal until zoning laws are aligned with the project and permits are available. This requires the developer to perform due diligence that includes market analysis and Pro forma financial reports to entice early investors. These will be equity partners that own a substantial portion of the end profits. As a developer, you’ll be required to have some skin in the game as an equity partner that will likely be 3% to 5% of the project cost. Your equity will be a primary source of your profits at the end of the project. The developer typically also collects developer fees as the project progresses that range from 5% to 10%. Many developers continue as property managers until all of the houses are sold. All of this requires an individual developer to hire a team of specialists to bring the project to fruition (architect, civil engineer, general contractor, realtor, etc.). According to the National Association of Home Builders (NAHB), developers average about $3 million in gross profit on $16.23 million in revenue. That's an 18.9% percent profit.
With approval or based on modifications, the developer purchases the tract of land and subdivides it into smaller lots to develop and sell the lots individually. Costs for developing the land include hard costs such as land clearing and grading, and putting in utilities and roadways. There are also soft costs for legal fees, financing fees, and design/engineering fees. Some developers will build houses on the improved lots while others will just sell just the lots.
In 2021, the average land development project manager salary in the US is $99,100 according to the Economic Research Institute. Over the next five years, salaries are expected to increase 13% to $112,100. Most development project managers have either a Bachelor's or Master's degree in related studies (civil engineering, urban planning, finance, business management, or real estate degree). Primary responsibilities include:
As your development manager career progresses, you want to nurture professional and personal connections. This will either improve your value as a manager or move you towards establishing your own development company. Either way, the more people you know and have good relationships with, the more effective you become. You want to develop relationships with a wide range of professionals that include brokers to find deals, title agents to help with transactions, attorneys for development related legal matters, real estate investors, and anyone else who can contribute to making your process more efficient and effective.
Please share your knowledge and experience in the development world by leaving a comment.
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