Andrew Thompson
Even in a healthy economy, development projects encounter multiple legal hurdles before owners, tenants or customers pay the first dollar toward the success of the venture. In this economy the hurdles can be even higher.
Once a property is identified, most developers seek necessary approvals for their plans from local authorities before purchasing the land. In fact, unless the developer is a cash buyer, it’s likely to be necessary to attain the appropriate zoning, plan amendments and other approvals before a lender will approve the financing for a deal.
The scope and type of development will generally dictate the amount of time it takes to get the approvals necessary to get shovels in the ground. It’s easy to understand how cost affects the overall timeline; it’s a little harder to see how the matrix of commercial versus residential development, owner occupied versus rental property, or single versus multi-use development may affect the process.
Largely due to the economy, residential rental properties are “hot” at the moment. Regardless, this type of project can be very slow to progress. Why? In Hamilton County communities, rental properties have been disfavored among city councils, development commissions and the electorate. Multi-family buildings have been particularly unpopular, but now, with the protracted housing slump, they are sometimes the only projects that can obtain financing, and there is an extraordinary demand for rental residences right now.
Commercial development proposals usually come with considerable complexity, lots of public inquiry, and sometimes additional steps in obtaining approval. The environmental impact of a commercial project is much different than a residential project, and it is generally weighed against nearby residential interests in the “quiet enjoyment” of one’s own property.
Financing
If a project is to obtain some form of public financing, an entirely new layer of legal consideration is likely to come into play. If any kind of bond financing is to be used, the underwriting guidelines must be reviewed carefully to ensure that the project remains in compliance with the requirements of the bond’s conditions for financing.
Public finance is often tied very closely to investment in public infrastructure. Infrastructure improvements are often the ultimate deal makers or deal breakers for a new venture. If there is poor traffic flow, a lack of parking, inadequate water and sewer resources, etc., the project is not likely to succeed. This means local government has a vested interest in making sure the infrastructure fits the project.
Private financing comes into play once the deal is approved on all levels in the local community. Generally, a bank is waiting in the wings and watching to see that the deal that is approved is one that fits within the bank’s underwriting guidelines. Bank financing is the most common source for capital for all but the largest development projects. A thorough review of all loan documentation is critical in closing on a new loan. Retaining an attorney to review these documents and assist you in closing the transaction is vitally important. There are numerous risk management issues to consider, and important covenants a borrower will be required to abide by to obtain the financing and make draws against a line of credit as the project proceeds.
Minimizing Risk
Current economic conditions play a significant role in managing the legal risks of development. If a developer cannot find tenants, or sell subdivided units of his property, the deal can quickly turn upside down. Once this point is reached, it can be very difficult to correct.
That said, there are steps a developer can take on the front end to protect its interests. Of course, the most obvious is to minimize draws except where there is income lined up to cover the debt service. Most development deals come with key tenants or buyers already lined up. The “anchor” clientele becomes much more important when the economy is slow, and leasing other space is challenging.
Property management agreements can play a dominant role in the process and a developer should negotiate these carefully, as well as any other agreements in play as the project moves toward final success.
“Experience taught me a few things. One is to listen to your gut, no matter how good something sounds on paper. The second is that you're generally better off sticking with what you know. And the third is that sometimes your best investments are the ones you don't make.” - Donald Trump
Real estate investment and development is more challenging than any time in recent history. Planning wisely for the many contingencies helps keep the downside in check.
Andrew J. Thompson is a sole practitioner at the Thompson Law Office LLC in Carmel. Reach him at andrew@businesslawindiana,com
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