Most investors find real estate and add a few rental properties into their portfolios for diversification. Unfortunately, they stop there.
Other investors will learn more and find that investing in commercial real estate and alternative assets with an experienced team can make real estate investing a whole lot easier – and often more lucrative.
Then there is the super-savvy investor who begins to see the big picture. They begin to see construction crews taking raw land and building popular amenities or in-demand apartment communities, and more. They, naturally, wonder what it looks like to invest in that stage of the real estate process.
This is where commercial real estate development investing comes in.
What is a Commercial Real Estate Development?
Developing real estate is another type of real estate investment that allows investors to pool their money together to purchase land that is intended to be developed into a commercial real estate asset. In fact, land is often discussed as a completely different asset class. This occurs because it is often purchased and developed (i.e. subdivided, zoned, and planned), then sold to a team that can build. Or, the same team can take the project from soup to nuts.
Typically, an operator will raise capital to purchase raw land and take the project to a point of sale. This process begins with extensive research as to the feasibility of the project and physical site, on top of regular market research performed for the success of any real estate investment,
Once financing is secured and private equity (through group investments) is raised, the land is purchased. Developers often need to work with local governments to secure permits or request zoning approvals at this time, as well as begin to engage engineering firms, and construction companies to place utilities, divide parcels into lots, and even construct one or multiple properties that will be sold.
As a passive investor in the project, you don’t have to do any of this very detailed work. You will, likely, need to understand how long this process will take since you won’t begin receiving returns until the property is producing enough income to distribute.
By investing in a real estate development fund, investors can deploy their capital without having to source the deal or figure out how to develop the land themselves. Instead, the fund’s experienced management and operations team will handle these tasks, allowing investors to enjoy the potential returns that this asset type can provide.
Just as with any real estate investment, it is essential that investors perform their own due diligence on the operations team and the track record they have in completing the type of deal. Real estate development is no exception. An operator team needs to understand the local permitting laws, the engineering requirements, and many other specific elements of development.
Reasons To Invest (And NOT Invest) In Real Estate Development
Reason #1: Leverage Experts To Do The Work
The primary advantage of investing in a real estate development investment opportunity is the ability to passively invest in real estate without having to worry about the day-to-day management of the process.
The management team will take care of all the details, from sourcing the land and developing it into lots to managing the construction process and ultimately selling or managing the completed property. This makes it an ideal investment for those who want to invest in real estate but don’t have the time or expertise to develop land or manage a property themselves.
Reason #2: Potential For Higher Returns
Another advantage of investing in a real estate development fund is the potential for high returns. Real estate development can be a lucrative investment, particularly when the properties are developed into cash-flowing commercial real estate assets that generate rental income.
Reason #3: Diversification Within Real Estate
Investing in a real estate development project is also a way to diversify your investment portfolio. Real estate is often considered a hedge against inflation, and it can provide a stable source of income over the long term. By investing in a real estate development project, you can add real estate to your investment portfolio in different markets and at different stages of the real estate cycle.
Deploying capital into a real estate development fund is also a diversification tool within the broader world of real estate investing. Many real estate investors have capital in physical assets, like apartment communities, and receive distributions primarily from rent collection. They leverage land development as a diversification play and a longer-term strategy. This can help you spread your risk across different asset classes and potentially increase your overall returns.
Two Reasons To NOT Invest In Real Estate Development
Reason Not To Invest #1: Potentially High Risk
It’s worth noting that the higher returns of real estate development are also associated with higher risk, as there are many factors that can impact the success of a development project. Additionally, it may be many months or even years before the asset will be producing income, in which time many unpreventable things can happen – like a global pandemic.
This risk can be mitigated. It’s important to do your due diligence before investing in a real estate development fund and ensure that the management team has a strong track record of success and multiple exit strategies in place.
Reason Not To Invest #2: Minimal Short-Term Returns
As already noted, real estate development projects do not typically provide initial short-term cashflow as the project may take many months to be completed and begin producing income. This may be mitigated by phased construction, allowing for a portion of a project to be completed and leased-up such that partial returns can occur sooner. Investors looking to maximize returns over a longer period of time (rather than receive a great cash-on-cash return immediately) may find real estate development a better fit for their goals.
Stages of A Real Estate Development Project
Here’s an expanded overview of the 6 stages involved when a real estate development investment project is initiated:
Stage #1: Finding Land
The first stage of a real estate development fund is to identify and acquire suitable land for development. The fund’s management team will typically use their expertise and network to identify properties that meet their investment criteria, such as location, zoning, and development potential.
Stage #2: Entitlements and Engineering
Once the land is acquired, the management team will begin the process of obtaining the necessary entitlements and permits from the local government to develop the property. Ideally, they’ve already worked with local representatives during the acquisition process to confirm the suitability of the land for development.
This process can include zoning changes, environmental permits, and other approvals. The management team will also work with engineers to design the site plan and infrastructure.
Stage #3: Horizontal Infrastructure
Once all the necessary approvals are obtained, the management team will oversee the construction of the horizontal infrastructure, which includes water, sewer, and street improvements.
This stage is critical as it sets the foundation for the entire development.
Stage #4: Building Construction
Once the horizontal infrastructure is complete, the management team will begin construction of the building or buildings. Depending on the investment strategy, the buildings may be single-family homes, medical facilities, retail, apartment buildings, or other asset types.
The management team will oversee the construction process, ensuring that it is completed on time and on budget.
Stage #5: Property Sales Or Property Management
Once the building is complete, the management team will either begin marketing and selling the properties or they will begin management of the property. Sellers could include individual investors, other syndication groups, owner-occupants, or institutional buyers. The management team will work to maximize the sale price while ensuring a timely and efficient sales process.
If the asset will not be sold, but rather continued to be held by the same ownership team, a property management plan will be implemented to place tenants into the building and start collecting income. Passive investors may begin to see cash flow at this time.
Stage #6: Investor Returns:
Once the development project is fully sold, the passive investors will receive their initial capital plus any proceeds from the sale. The exact returns will depend on the terms of the investment, such as the preferred return rate, profit-sharing structure, and other factors.
Benefits of Investing In A Real Estate Development Fund for Passive Investors
Real estate investors leverage real estate development within their portfolios for several reasons. Benefits to investing in this phase of real estate development include:
- Potential for high returns: Investing in a real estate development project can be a lucrative investment strategy, with the potential for high returns if the land or properties are sold at a good price.
- Control over the development process: By purchasing the land with an experienced development team, you can better understand the quality of the construction and minimize any potential repairs that may require capital in the initial ownership years.
- Diversification of your investment portfolio: Investing in land can help to diversify your investment portfolio and reduce your overall risk.
- Tangible asset: Land and the buildings constructed on it are tangible assets that you can see and touch, which can provide a sense of security and stability in your investment portfolio.
Conclusion
In conclusion, investing in a real estate development project is an attractive option for investors looking to passively invest in real estate. It offers the potential for high returns, diversification, and the ability to deploy your capital without worrying about day-to-day property management.
However, as with any investment, it’s important to do your due diligence and ensure that the management team has a strong track record of success before investing in a real estate development fund.
Next Steps
Here at Cochran Capital, we give you access to real estate investing opportunities that give real cash flow, equity and appreciation, not to mention tax advantages for high-income earners. We want to help you leverage the power of commercial real estate investing in your portfolio so you can take advantage of these benefits.
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