Real estate development and new construction, by the numbers

The development budget: four buckets

Total development cost breaks into land and acquisition, hard costs (the physical construction — priced per buildable square foot), soft costs (design, engineering, permits, legal, financing fees and the carry itself), and contingency. The discipline is keeping the buckets separate: hard costs escalate with materials and labor, soft costs escalate with time, and a budget that blends them hides which risk is growing. Contingency is a budget line, not a mental buffer — typically set as a percentage of costs and treated as spent until proven otherwise, because change orders will find it.

Go deeper: How to Build a Real Estate Development Pro Forma · Hard Costs vs Soft Costs in Real Estate Development

The construction loan is a different animal

Construction debt is sized by loan-to-cost — the loan against the total budget, the development analogue of loan-to-value — and it funds in draws against completed work rather than all at close. Interest therefore accrues on the drawn balance, not the commitment, and it accrues while the project produces no income; the interest reserve that covers it is itself part of the budget. Rate, term and the draw schedule belong in the model explicitly, because a slower project pays interest longer on a larger average balance.

Go deeper: Construction Financing: LTC, Draws & Interest Reserve

The schedule is a cost line

Every month of the build carries interest, taxes, insurance and overhead, so time behaves like a trade cost that never bids competitively. A defensible pro forma states the construction duration and the lease-up period as explicit assumptions and prices a slip — because the question is never whether a delay would hurt, but how many months of delay the profit can absorb.

Completed value, stabilization and lease-up

The exit side of the model is what the finished building is worth: either a value per square foot for a for-sale project, or — for a property you will operate — stabilized NOI divided by an exit cap rate. Stabilization is the point where occupancy and rents reach normal operating levels; the months between completion and stabilization have real costs and reduced income, and belong in the model rather than in the gap between two spreadsheets.

Yield on cost and the development spread

Yield on cost — stabilized NOI divided by total development cost — is the development world’s cap rate: what the project earns on what it took to build. Compare it to the market cap rate the same building would trade at. That gap is the development spread, and it is the entire argument for building instead of buying: if the spread is thin, you are taking construction risk, lease-up risk and schedule risk for a return the market would have sold you without them.

Go deeper: Yield on Cost in Real Estate Development

Where development deals break

The two big misses are correlated: hard costs run over in the same conditions where exit values come in soft. Underwriting a development means pricing that pair together — re-running profit at a higher cost per foot and a weaker exit at the same time — plus the quieter risks: entitlement and permitting delay before the first draw, and a lender whose loan-to-cost leaves more equity to raise than the sponsor planned. A pro forma that has never been re-run at its bad case is a brochure.