The Shopping Center Development Pro Forma
Reprinted With The Permission From The Real Estate Finance Journal
By Richard J. Brunelli
Shopping center development feasibility calculations often begin “on the back of a napkin” when a developer meets the land owner and begins to negotiate a price. Large or small, the same four elements of development are estimated, added, carried, and compared to an average income projection to create a quick “feel” for feasibility. Those elements, which add up to the total cost, are:
Land cost;
Soft costs;
Site work; and
Hard (building) construction cost.
The total development cost must be carried via some combination of borrowed monies and equity, and the developer must factor in an expense and vacancy factor to project the profit picture. Here is how a “back of the napkin” pro forma may shape up for a typical 220,000 square-foot strip center in northern New Jersey.
Land costs $ 42.50 per square foot
Soft costs $ 16.78 per square foot
Site work $ 15.16 per square foot
Hard construction $ 40.67 per square foot
Total cost $115.11
Cost to carry (constant) 0.1143
$ 13.16
Add 10% to cover
vacancy and expenses
and return on equity X 1.1
Average Rent Required $ 14.48
Sophisticated shopping center developers today are using microcomputers to develop more careful forecasts. Each line item must, however, be originally estimated or based on realistic information and professional assumptions. An example of the “back of the napkin” pro forma expanded into a detailed schedule projection is shown in Table 1.
Inexperienced developers will find it difficult to estimate many of the line items that need to be filled in the development budget, especially when they have just begun to consider the purchase of a particular property.
A due diligence period of two to three months is usually required to gather basic information necessary to take most of the guesswork out of the development budget. Unfortunately, with the approvals process being so time-consuming and unpredictable, early pro-formas are rarely accurate and must be updated as new information on costs, projected income, and financing rates becomes available. One of the biggest unknowns facing most shopping center developers today is the cost of off-site improvements and other extraction’s that various governmental authorities demand as a condition of approvals.
Interest Unpredictability. The most unpredictable soft cost is the interest required to carry the project during construction and through a lease-up period until the rents are stabilized. Sometimes, due to expiring option periods, the land is purchased months prior to the developer’s being ready to start construction. Carrying that land could be extremely expensive.
On-site work can usually be budgeted carefully early in the development process when detailed improvement cost estimates are provided by the project
TABLE 1. DEVELOPMENT BUDGET
PER
SQ. FT. TOTAL
Raw Land Cost $334,000 per acre x 28 acres $42.50 $9,350,000
Soft Costs
Option deposit funds 150,000
Project management fee 50,000
Approval process overhead 120,000
Architects, design, landscape, construction 127,780
Engineer (site) 90,000
Approvals attorney 20,000
Engineer (environmental) 20,000
Engineer (traffic) 10,000
Construction loan fee (1%) 200,000
Permanent loan fee (1%) 200,000
Interest on land, soft costs and site work 450,000
Interest on hard costs during construction 488,820
Construction attorney 20,000
Leasing attorney 25,000
Financing attorney 10,000
Taxes during construction 50,000
Lease-up reserve, lost rent until stabilization 500,000
Leasing fees and marketing 770,000
Township fees (construction) 40,000
County and state fees 20,000
Other permits, sewer, water 20,000
Developer’s fee 250,000
Insurance 60,000
Total Soft Costs $16.78 $3,691,600
Site Work
Clearing 80,000
Grading and fill 320,000
Storm water 392,000
Water 5,000
Sewer 495,000
Electric 10,000
Gas 10,000
Paving, curbing, sidewalks 715,000
Lighting 56,000
Landscaping 61,600
Pad work 50,000
Pylon signs 40,000
Tap fees 75,000
Contaminated soils removal 270,600
Off-site work 756,000
Total Site Work $15.16 $3,336,200
Hard Construction Costs
Dry goods anchor 100,000 sf 30.65 $ 3,065,000
Supermarket 55,000 sf 54.00 2,970,000
Sub-anchor 12,200 sf 42.00 513,240
Satellite 5,593 sf 38.00 592,547
Satellite 15,593 sf 41.00 639,327
Satellite 15,593 sf 41.00 639,327
Pad 3,000 sf 0 0
Pad 3,000 sf 0 0
Total 220,000 sf $ 2.40 $ 528,000
Contingency & general conditions
Total Hard Construction Costs $40.67 $ 8,947,441
Total Development Costs $115,11 $25,325,241
engineer. Unusual subsoil conditions can, however, create enormous unexpected costs. Conditions from rock to quicksand can create an economic nightmare. More recently in New Jersey, developers have been required to remove any contaminated soils from a site before construction can commence. Therefore, site
TABLE 2. FIRST YEAR STABILIZED RENT ROLL PROFORMA
BEGINNING YEAR 1
RENT/ SF SF ANNUAL RENT
Dry goods anchor $10.00 100,000 $1,000,000
Supermarket 13.00 55,000 715,000
Sub-anchor 17.00 12,220 170,000
Satellite 21.00 15,593 327,460
Satellite 21.50 15,593 335,257
Satellite 23.00 15,593 358,647
Pad 20.00 3,000 60,000
Pad 25.00 3,000 75,000
Total Square Feet 220,000
Total Base Rent $3,041,364
Average Base Rent
Dividing by 220,000 sq. ft. $13.82/sf
Add:
Common area maintenance 0.75/sf $ 165,000
Insurance 0.40/sf $ 88,000
Real Estate Taxes 1.25/sf $ 275,000
Common Area Maint. Mgmt. 0.11/sf $ 24,750
Total Reimbursements $ 2.51/sf $ 552,750
Gross Income 3,594,114
Less vacancy @ 5% on noncredit income –56,945
Gross Income After Vacancy $ 3,537,169
Operating Expenses
Common Area Maintenance $ 165,000
Insurance 88,000
Real Estate Taxes 275,000
Management Fee @ 4% of total base rent 121,654
Replacement reserves @ 2% of total base rent 60,827
Total Operating Expenses – 710,481
Net Operating Income $ 2,826,688
may need to be deemed clean by an environmental engineer and approved as clean by a governmental authority before an accurate projection of the cost of site work can be formulated.
There is a Catch-22 with regard to estimated hard (building) construction costs in the early stages of shopping center development. Unlike the construction of an office building, where the developer and architect control the specifications of the building to a large extent, a shopping center is built around a variety of anchor, sub-anchor, and satellite tenants—many of whom require turnkey or special delivery specifications.
Tenant Costs. Typically, a developer will have a good idea as to the types of anchor tenants best suited for a particular site. The cost of constructing those tenants’ prototypical plans can be estimated, or actual costs capped, during the early stages of lease negotiations. Negotiations with anchors often commence before the site is even tied up. Developers are anxious to see what the anchors will pay so as to determine the economic feasibility of the project before risking option monies on a property. In many cases, developers will work closely with certain anchor tenants and/or their broker representatives to project building costs and the income stream those stores will ultimately generate, as shown in Table 2.
On the income side, an accurate projection of satellite rentals is crucial to success. Clearly, the satellite rentals, and often the last 10 percent of the space in the center, provide the basis for the developer’s return on investment. Developers not familiar with a market’s rental rates should consult with local leasing experts early in the consideration of any property.
Finally, financing rates and terms must be projected, as shown in Table 3. Since rates may fluctuate by several points from the time a property is controlled by contract to the time a permanent loan is placed, it is best to prepare perceived worst-case and best-case scenarios with regard to interest rates an debt coverage ratios. This is essential to projecting the amount of equity required and bottom line return on that equity.
TABLE 3. FINANCING SCHEDULE AND RETURN PRO FORMA
Net Operating Income $ 2,826,688
Divided by capitalization rate 9.5% 0.095
Value on sale 29,754,610
Debt coverage at 1.2 ratio, income earned,
net operating income + 1.2 = 2,355,573
Assume financing constant
interest and amortization
@ 11.43; $2,355,573 + 11.43 =
Total Available for Permanent Loan $20,608,690
Total project cost 25,325,241
Less permanent loan – 20,608,690
= Equity required $ 4,716,551
Cash on Cash Return
Net Operating Income $ 2,826,688
– Permanent loan payment (constant) $ 2,355,573
Cash Flow $ 471,115
Cash on Cash Return = Cash Flow 10.01 %
Equity
Sale Projection:
Gross sale value 29,754,610
Less closing expenses, legal & commission (3%) – 892,638
$28,861,972
Total Project Cost 25,325,241
Net Profit On Sale $ 3,621,372
Profit as a Percent of Total Equity 76.78 %
Often, the only way a developer will generate an attractive profit from building a center will be by incorporating a large developer’s fee into the pro forma and then planning to sell the property on completion to an institution, whose cost of money will be significantly lower than conventional commercial mortgage rates. In many cases, a developer may have no choice but to sell a project upon completion.
Summary. Careful attention to the proforma throughout the development process will help ensure the success of the project or, at least, the limitation of losses. A Line-by-line review of each and every cost item by the developer and the developer’s trusted associates should be conducted on a periodic basis—ranging from weekly to monthly, depending on the stage of the project.
As in many businesses, experience, hard work and careful planning usually lead to success. When it comes to shopping centers, let the pro forma be your guide.