A New Policy Paradigm
KDI series in Economic Policy and Development
Edited by Susan Wachter, Man Cho and Moon Joong Tcha
Chapter 7: Financing real estate development: a case study of the US real estate market in the 2000s
Real estate development is a creative process that combines multiple disciplines. Like most creative work, real estate development is also risky. A real estate property under development is subject to market risk as a seasoned property is; a collapse of the real estate lease market or crash in the capital market imposes substantial risks for any real estate investors, regardless of their investments in seasoned properties or new development projects. In addition, a development project is also subject to idiosyncratic project risks that can lead to cost overrun or delay in construction completion resulting in higher carrying costs, shortfalls in funding or even incompletion. This chapter presents various arrangements made by developers, investors and lenders to manage those risks. Risk management efforts in real estate development range over development entity choice, cash flow allocations, construction loan underwriting process and various monitoring procedures used by lenders. The current financial crisis appears to offer an ultimate testing ground for such risk management efforts in the real estate development industry and real estate capital markets. Since the current financial crisis started in 2008, there have been numerous reports and research papers on various problems in residential mortgage markets during the credit boom period in the 2000s.
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