What Is A Self-Financing Real Estate Development Project?

by Bruce Kirsch on September 25, 2014

Almost sounds too good to be true, like a perpetual motion machine. Let’s find out what it really means.

Gaslight Square by Abdo Development in Arlington, VA -- a self-financed development project

At its most basic, a “self-financing project” is one that uses its own newly-developed collateral value to generate or secure funding for further project development.

As an example of generating funding, let’s use a residential condominium project that has multiple separate buildings. Let’s say you get a construction loan for the first building, and you sell it out (as every pro-forma cheerily indicates) and make a 20% profit. If the overall development plan calls for subsequent buildings, you can plow that profit back into the project to build the next building. This can go on for multiple rounds depending on sales and how many more buildings there are to build. (Here’s an example of a project of this type).

As an example of securing funding, let’s use the same physical project described above, but assume that it is to be operated as rental units. Once the first building is built and occupancy is stabilized, you could refinance the project with a permanent loan (secured by the operating asset), pay off the construction loan in full, and use excess proceeds to equity from the permanent loan funding to fund the construction of the subsequent buildings.

A variation on securing funding is if the construction funding is structured as a line of credit, which is paid down upon the refinancing, freeing up credit to pursue the further development of the project.

Please put thoughts, comments and questions below.

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As a follow-on to last week’s post on NPV, we note here that there is also a fundamental difference between solving for the IRR when cash flows are measured in annual increments vs. in monthly or other non-annual increments.

As the example spreadsheet embedded below shows, the IRR is by its nature an annual calculation, producing an annual discount rate as its result. Thus, when measuring non-annual cash flows, to be sure that the result it returns to us is meaningful, we must adjust for the different time period increment in the following way:

=(IRR(range of time zero and projected values)+1)^non-annual increment-1

If we don’t do this, then the cash flows will be discounted far too aggressively because Excel will think that each column represents 12 months, not something less than 12 months. To get the cells to light up in the example below, you’ll need to download the embedded file below by clicking on the Excel icon in the bottom of the embed border.

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60-Second Skills: Annual vs. Monthly NPV Formulas

by Bruce Kirsch on August 24, 2014

There is a fundamental difference between solving for the NPV when cash flows are measured in annual increments vs. in monthly increments.

As the example spreadsheet embedded below shows, the NPV is by its nature an annual calculation, using an annual discount rate. Thus, when measuring monthly, to be sure that the result it returns to us is meaningful, we must adjust for the different increment in the following way:

=NPV((1+Rate)^(1/12)-1,range of projected values)+Time 0 investment amount

If we don’t do this, then the cash flows will be discounted far too aggressively because Excel will think that each column represents 12 months, not 1 month. To get the cells to light up in the example below, you’ll need to download the embedded file below by clicking on the Excel icon in the bottom of the embed border.

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