Before we can even consider breaking ground on a project, there’s a significant amount of risk and cost involved in pre-development. We’re often investing heavily long before construction begins, spending on environmental surveys, geotechnical assessments, legal fees, architectural plans, and zoning approvals, to name a few.

The pre-development process makes sure the project is viable and removes as much risk as possible, but it never can remove ALL of the risk. We take on these costs without any guarantee that things will work out. This article covers the large items that we evaluate in this stage before a project is ready to move forward to the next stage.

During this pre-development process, we continually update our underwriting. Underwriting and assumptions at the outset are inherently incorrect. These are our best guesses at the time. The due diligence process helps us move these “guesses” and make them closer to reality. It’s an ongoing process that never ends. Finally, at some point we have enough information to move forward on the deal or walk away. Here is the process:

Step 1: Identifying a property/market

The first step is finding a property/market. I always start by looking at one key factor: job growth. This is because it drives population growth, which fuels the demand for housing. I focus on markets where people are moving in since that’s where the opportunity lies.

Once I find a market that shows promise, I dig deeper. Population trends are one thing, but I also want to understand the local government’s attitude towards new development. Some cities are open to growth and make it easy to push projects forward, while others put up roadblocks that can derail a deal before it even begins. I only focus on places where city officials are supportive since that makes the entire process smoother (although not necessarily easier).

From there, I focus on properties that meet my criteria, including:

• Sites that can support multifamily housing
• Great location in a growing community
• Near accessible transportation
• Near retail and other amenities
• In a location that would be a good fit for a new community
• When I drive the site, can I picture a new community

Step 2: Negotiating the purchase contract

When I get a property under contract, my approach is to make sure everything is ready before I fully commit. I’ll put down a soft deposit or a small hard deposit, but I won’t close on a property unless it’s fully entitled and all of my Due Diligence is completed.

I want to have control over the process, so I don’t speculate on land that might have problems later. Instead, I spend the time and money upfront on due diligence, such as architectural designs, environmental surveys, Land Use Council, and civil engineering, to name a few.

Others in the industry approach it in different ways:

• Upfront purchase: Full purchase of the land before the pre-development process using a bank loan or borrowing from high-net-worth investors. This method is riskier; it might take a while to get the project off the ground. Meanwhile, the interest on the loan keeps compounding, making the land more expensive over time.
• Purchase option: This method means the developer only buys the property once they’ve secured all the necessary approvals and financing. This strategy reduces upfront risk but leaves the developer without full control until they exercise the option.  In addition, it is also a difficult method to execute as most sellers are looking for certainty of execution.

There are, of course, hybrid versions as well that we can get into in another post.

Step 3: Zoning and variances

Hiring a good attorney to help you understand if your vision is possible is crucial. Without the right approvals, even the best-laid plans can fail. For many projects, including one in Newark, we had to apply for a variance because the property wasn’t originally zoned for residential units on the first floor.

Normally, first-floor units are a bad idea. However, in this case, the site’s topography made these units 6 – 8 feet off the ground. So technically, they are on the first floor, but in reality, they are raised.

Getting these approvals requires a plan and strong relationships with local officials. We had to present the case to the city’s zoning board, explaining why the changes made sense for both the project and the community. It’s a long and expensive process.

You should have some certainty before spending too much money and time. Sometimes, this is not possible, and in some markets like NYC, some projects are “as of right,” meaning there is a set building envelope that you can construct.

Step 4: Drafting architecture and engineering plans

The next step is to work with architects and engineers to verify the designs meet local zoning requirements and make the best use of the property. This includes are number of units, size of units, parking spaces (are they above ground, underground, or surface parked), how many elevators, whether we’ll be building a basement, and the laundry list goes on.

I recommend taking your time on this process, as all of your decisions will have a huge effect on the budget down the road. In one project I am working on, I was able to avoid an underground stormwater retention vault by working with my civil engineer. Just this decision alone may have been the difference to this project penciling or not.

In another project, the original plan only allowed for four units on the first and second floors. I knew that wasn’t maximizing the site’s potential, so we revised the plans, eventually increasing the property and tripling the unit count.

This involved coordination with local teams to get through zoning approvals. Sometimes, enlisting an architect or engineer even before the project is under contract can save money if it turns out your vision is not feasible.

Step 5: Environmental, geotechnical, civil, and more

Once we have the land under contract, we’ll hire teams to conduct various tests, including environmental surveys, geotechnical assessments, and more.

Geotech is a study to check the soil and make sure it can support the structures we’re planning. This is an expensive process with many nuances. In fact, it can be an entire post on its own. Spend the money upfront to eliminate huge problems down the road.

This will answer many foundation questions and ultimately help you hone in on your proforma. But please make sure to hire a reputable company that has history and information about the soil in your city or area.

On the environmental side, we start with a phase one environmental study to look for potential hazards. If something comes up—like contamination or underground tanks—we move to phase two, where we dig deeper and take soil samples.

Plan on doing both phases one and two in your budget. If you don’t require it, the bank or capital source likely will. Not to mention, if there is a real environmental problem, it makes the project not feasible very quickly.

For example, in our Newark project, we found underground hydraulic car lifts filled with hydraulic oil. We had to remove them and remediate the soil contamination, addressing each issue step by step until the site was clean and ready for development.

Step 6: Verifying clean title

We’ll conduct a title search to ensure that there are no hidden issues, such as liens or restrictions, that could derail the deal.

In one project, I ran into a deed issue. This was a deed restriction from 1998 that prevented multifamily development on the property. I worked with the city for over two and a half years to get that restriction lifted. Find a good title agent—not the one who takes you to the Knicks game but the one who is there for you when there is a problem.

Step 7: Underwriting

So, this is an art form and not a science. If you are not an Excel wiz, then hire someone who is. It’s easy to find analysts to help you. Good analysts are a bit more challenging, but they are available and, for relatively small money compared to other due diligence items, well worth it.

This process is the backbone of any deal. As I mentioned above, these inputs all start out as assumptions. As the process continues, these guesses become more factual. For starters, make sure the analyst is inputting the facts based on rents and unit matrix, capital costs, soft costs, and all of the other line items necessary.

At this point, we are not looking for an opinion, just the cold and hard data facts that are available.

Once you input the facts, then the real art comes into play to figure out how to make this deal pencil. That does not mean artificially increasing rents or lowering the cost of capital because your friend told you that the FED is going to lower rates. This is going to be another entire post, as there are many nuances to getting this right. This is the role of the developer, not the analyst.

Final thoughts

Real estate development is a full-contact sport 🥊.

The path to getting a project shovel-ready comes with up-front risk and investment. From environmental assessments to zoning approvals, every step has its challenges, and developers bear the upfront costs without any guarantee of success. Skipping steps or trying to cut corners is a huge mistake and adds greater risk down the road.

The MVP team leverages our years of experience to make this process go as smoothly as possible.