Smaller scale developers utilize traditional bank financing as the main source of funding. Local banks
typically act as partners with smaller scale developers and provide funding to projects which meet
their lending standards and risk profiles. Lending at the small scale is very much relationship based.
Modeling the financing component of development requires assumptions to be made about the
equity, loan terms, and interest rates. As part of the data collection process, RKG interviewed several
local developers who provided reality-based data regarding project financing.
The equity investment on the part of the developer which is required to obtain financing is dependent
on many factors, some of which include: financial wherewithal, experience, project type, etc. Lenders
require developers to contribute funding towards the project. The percentage of equity required is a
variable within the model that can have a significant impact on the overall financial return. Typically,
if a developer can secure financing which requires a smaller percentage of equity contribution, then
the overall project return will be greater because the initial out-of-pocket cost will be less. The benefit
to the developer is that they minimize their risk when they do not have to contribute large amounts
of equity. For the modeling exercise, the default equity requirement was set at 25% for both owner
and rental developments, this value can be changed within the model by the user.
The length of the loan is dependent on the type of project under construction. For for-sale units, the
loan is repaid once the units have sold. In this case, the loan period might last for 1 or 2 years
depending on the time it takes for a project to be constructed and the units sold. For rental projects,
the loan term can be variable. Developers have different exit strategies depending on their investment
philosophies; some developers will hold a project for 10 years and then sell it, while others just build
and hold the property. For the analysis, the model was calibrated to assume as a default that the loan
for a for-sale development would be two years, and that for rental properties the loan term would be
20 years.
Financial institutions provide funding based on the viability and potential success of a project, and
the interest rates charged are evaluated against the developers financial standing and ability to
complete the project. A range of interest rates could be charged to a developer depending on their
track record, development program, or equity contribution. The higher the interest rate, the greater
the overall cost to the developer. Small fluctuations in interest rates can have large impacts on the
project financial return because the cost of debt service can substantially increase, thus rendering a
project infeasible. Some developers contribute greater amounts of out-of-pocket equity as a means of
lowering the interest rate on the loan. The default model assumptions for interest rates were 5.5% for
rental developments and 5.0% for ownership developments. The higher interest rate for rental
developments was used because the loan term is longer than that of the ownership developments.
Density Bonus
Density bonus is a regulatory tool that provides a developer the right to build a greater number of
units than the existing underlying zoning dictates in exchange for some public benefit (in this case,
