Hard Costs vs. Soft Costs in Real Estate Development: What’s the Difference?

Real estate development and investing are complex processes, with a wide range of activities for investors to track and manage for a successful project. Budgeting and tracking costs are one of these tasks, and it is incredibly important to the overall success of any project — especially in a market with uncertainty and price fluctuations.

An important distinction that investors and developers should be aware of is the difference between hard costs and soft costs in real estate development. Hard costs refer to the tangible costs associated with a development project, while soft costs are more intangible expenses. In this blog post, we’ll discuss the differences between hard costs and soft costs in real estate development and how to manage them best.

What are Hard Costs?

Hard costs are costs directly related to the construction of the physical asset. Think “brick-and-mortar costs” of the project, as well as labor costs for construction of the real estate development.

Some examples include:

Materials and supplies such as drywall, timber, and tile
Labor costs like carpentry and plumbing
Clearing, grading, excavation
Equipment
Landscaping
Utilities

In general, estimating hard costs is straightforward, as gathering information about the costs of materials and services for development is readily available. However, as projects are underway, unforeseen changes or challenges can add to these hard costs, such as a rise in the price of materials or additional development requirements. Additionally, different markets will have fluctuations in hard costs. Having a solid estimate of the hard costs of any development project is essential to staying on budget and capturing as much profit from the investment as possible.

What are Soft Costs?

Soft costs are all expenses indirectly related to the development of a property. Because these costs are not visible, they can be less obvious, but nonetheless are essential to the development of the asset. These costs provide for the strategic and admin work involved in any development project and can be more difficult to accurately account for when planning.

Some examples include:

Architecture /Engineering
Inspections
Permits
Taxes, legal fees

Whereas hard costs end at the completion of construction, soft costs can continue and include building maintenance, insurance costs, and other fees.

The Importance of Considering Both Types of Costs

As an investor, understanding and estimating the hard and soft costs of a project is essential to its success. Hard costs may face challenges based on the geographic location of the project, fluctuations in supply and labor pricing, and the overall skill and experience of the budget developer. Soft costs require experience in the market to accurately project the invisible costs that build up as the project moves forward.

As projects are completed, investors need to reflect on how accurately their hard and soft costs were estimated and examine what trends appear. Is there a line item that is being consistently missed that is added later into the project? What recurring issues pop up throughout the process that must be addressed? By gathering and evaluating data from each project, investors can understand where their budgeting issues lie and be better prepared for the future.

Investor Loan Source, a private money lending company, provides high-quality investment property loans to private real estate investors at the lowest costs possible. Our process for providing real estate investors with private lending is unique. We place emphasis on the hard asset and value of the collateral (property) and less on the borrower. Our asset-based real estate investment loan model means we can provide more money lending to more investors than is available from standard bank loan models. At Investor Loan Source, providing real estate investors hard money loans is our business; it’s all we do. We offer several business real estate loan products designed to serve a variety of investors and property profiles, including private money lending for properties to sell on owner finance.

To learn more about Investor Loan Source, visit our website or follow us on LinkedIn, Facebook, and Twitter. To apply for a loan, click HERE.

Top 3 Reasons to Invest in Multi-Family Properties

Are you wanting to grow your investment business but don’t know where to start? Multi-family properties can be a great option for investors looking for growth and the possibility to step back from the daily management of the asset. Multi-family properties offer many advantages over other types of investments, and there are several compelling reasons to invest in them. In this blog post, we’ll discuss the top three reasons why investing in multi-family properties is a smart move for your portfolio. By understanding the potential benefits, you can make an informed decision about whether multi-family investments are right for you.

1. More Cash Flow

Compared to the monthly income of single-family properties, multi-family investments have the potential to bring in exponentially more income per month through various strategies. The larger the property, the greater potential there is for rental income. For example, when a multifamily unit is vacant for a short period of time, it is less painful than when a single-family home is vacant, leaving no income at all for the investor (meanwhile, costs do not stop for an unleased house). Investors still earn a significant portion of the rental income from other units without drastically changing the bottom line. Multifamily units are also more responsive to changes in renal prices, with multiple leases requiring renewal at different times throughout the year. This means multifamily investors can capture rises in rent prices proactively, increasing the property’s overall income throughout the year. Lastly, investors can also add non-rental revenue, such as on-site amenities, additional parking, and premium units that bring in additional money. With all that extra cash flow, multifamily investing can be a great tool for building wealth in one transaction.

2. Fast & Simple Portfolio Growth

Which is faster, buying a 10-plex or buying 10 single-family homes? In one multi-family transaction, investors can own and manage a much larger asset, increasing their overall net worth and growing their real estate portfolios much faster than with single-family real estate. Just imagine — building a small portfolio of 10 single-family homes means funding 10 purchases, managing 10 individual assets, and a much larger amount of time to find and close on all these deals, not to mention how spread out geographically these 10 properties might be. By buying multi-family properties, investors can achieve the benefits of real estate investing more quickly, including building wealth and increasing cash flow, with the investment in one easy location, with one transaction and one asset to manage. Hoping to double or triple the number of units? Adding an additional multifamily property to your portfolio compounds the rate of growth without the inefficiency and effort of building it all off of single-family properties.

3. Semi-Passive Investment Potential

While some real estate investors may enjoy being involved in the day-to-day management of their properties, many would rather focus on building their investment business. But with many smaller properties sprinkled throughout a market, management of single-family homes can be a headache that doesn’t cash flow enough to afford a management company.

Multi-family investments, however, offer the potential for an investor to be “semi-passive,” meaning they will be required to ensure the positive management of the investment, but they will not need to take every call and handle every lease. Because multi-family properties produce a higher income, they are better positioned to afford an excellent property management company that will allow the investor to get out of the daily management of the property and back into building their business.

To learn more about Investor Loan Source, visit our website or follow us on LinkedIn, Facebook, and Twitter. To apply for a loan, click HERE.Categories

The Capital Stack: How It Works in Commercial Real Estate Investing

When it comes to real estate investing, a thorough understanding of the capital stack is essential for success. The capital stack is the collective term for the various sources of capital used to finance a commercial real estate project. Understanding the different parts of the capital stack and how they work together can help you make informed decisions when investing in commercial real estate. In this blog post, we’ll discuss the components of the capital stack and how they come together to fund a development or redevelopment project.

What is a Capital Stack?

The “capital stack” refers to the different types of financing used to fund a given CRE (Commercial Real Estate) investment. It is the combined set of all financing instruments that investors use to acquire and develop CRE investments with mention to their risk and return profile. The capital stack for any real estate transaction typically involves numerous parties and a variety of structures, offering investors creativity and freedom in how they structure the deal. The instruments used in the capital stack are commonly referred to as common equity, preferred equity, mezzanine debt, and senior debt. Understanding the potential and risks for each layer can help investors understand how to build wealth by adequately funding their commercial real estate deals.

Senior Debt

Senior debt is a critical component of the capital stack in commercial real estate investing, with secured debt providing lenders a sense of security and investors an opportunity to build wealth. Senior debt is secured by a mortgage or deed of trust on the property itself, making it the base of the capital stack. If the borrower fails to pay, the senior debt holder can take over the property and recoup their investment by selling the property or selling the non-performing loan. However, this lower level of risk comes with a lower yield than all other positions on the capital stack.

Mezzanine Debt

Mezzanine debt comprises the next layer of the capital stack and follows the senior debt in payment priority. After the developer has paid operating expenses and senior debt, the borrower must pay the mezzanine debt. Because mezzanine debt sits above the old debt in priority of payment, this higher risk to lenders leads to higher returns, as borrowers typically pay higher interest rates for mezzanine loans.

For mezzanine loans, if a borrower fails to pay and defaults, the lender can also take possession of the property, typically agreeing with the senior debt holder on how each entity’s rights will be protected.

Preferred Equity

Because of the creative potential of preferred equity investments in the capital stack, it is impossible to define one shape it may take. Preferred equity is very flexible, allowing investors to take different positions. For example, a “hard” preferred equity position functions similarly to a mezzanine loan with a fixed maturity date and payment schedule. A “soft” position will likely include returns based on the project’s performance. Understandably, hard preferred returns range similarly to mezzanine loans and share similar rights in case of default. In contrast, soft preferred equity holders have fewer rights but the potential for higher returns –especially for projects that perform better than anticipated because this equity is “preferred.” It is paid before any common equity distributions can be made.

Common Equity

At the top of the stack and the riskiest position, common equity is the most profitable position on the stack. Typically, the lender or other equity investors require the borrower to invest some portion of their own capital in the project, thereby having skin in the game and a vested interest in seeing the project succeed. In addition, common equity positions also require that every other capital investment be repaid before common equity sees returns. However, if the property performs well, common equity investors often have no limit to potential returns. Common equity returns can also be creatively divided between investors, but often the developer or sponsor of the project sees considerable common equity returns.

To learn more about Investor Loan Source, visit our website or follow us on LinkedIn, Facebook, and Twitter. To apply for a loan, click HERE.Categories