Accounting for the Hidden Costs of Development

By Jeff Bennett and Justin D. Gericke

The true cost of a development project is often underestimated by everyone but the most sophisticated developer. Except for the simplest, cookie-cutter project, unanticipated costs can cause project budgets to far exceed a basic budget proposal. Developers can minimize the unwelcome surprise of these extra costs by performing a comprehensive cost-analysis (the pro forma) at the beginning of a project, ensuring that the true costs of a project are accounted for in the budget. While some unexpected costs may still arise, the final costs will be much less likely to break the project.

The key to successful cost analysis rests with the development of a comprehensive pro forma that accounts for as many potential costs as possible. The pro forma should analyze the following commonly overlooked aspects of a proposed project:

1. Architectural Costs. Architectural costs should contemplate not only conceptual and schematic design elements, but also interim and final design review, as well as costs associated with building permits, modification of initial plans, and simple construction administration as the owners' representative.
2. Special Inspections. Usually dictated by the proposed site, these costs can include soils and hydrogeologic testing; regulatory agency overview; and costs associated with lab work, analysis, and further inspection of the site.
3. Appraisal Fees. These are often overlooked but always required by your lender.
4. Soils Reports. These are required by most permitting agencies and are a must for ensuring proper foundation design.
5. Level 1 and Level 2 Environmental Reports. These costly reports are almost always required when acquiring property for a proposed development. Results often involve multiple layers of technical consultants, an attorney, specialty contractors, and governmental oversight. During construction, hazardous materials testing and contamination abatement costs may be incurred.
6. Arborist. This expert is often required if trees are present on the proposed site and a project requires their removal.
7. Wetlands Consulting. Wetlands issues are an increasingly important issue for proposed developments. They always affect early site-design considerations, require coordination with project stormwater facility design, and can contribute significantly to the overall cost of a proposed project. You may need to engage a wetlands consultant in some cases.
8. Traffic Studies. In an urban project, a traffic study is always required. It often addresses issues that can make or break a project during the land use approval process. It also identifies most transportation-related improvements to be constructed with the project, a major financial component.
9. Title Insurance. No longer simple, title insurance can add significant cost, particularly if you are dealing with a lender that is unaccustomed to Oregon development projects. Many out-of-state lenders attempt to require an "early issue" endorsement, which is quite expensive.
10. Survey. Determining boundaries and easements at the beginning of a project can eliminate or minimize additional costs later. A lender's review of a survey can often generate one or more revisions.
11. Legal Fees. Depending on the complexity of the project, legal fees can be incurred during many aspects of a project, including documenting the transaction, forming the project business entity, negotiating permitting requirements and development approvals associated with environmental and other land use approval criteria required by local jurisdictions, and paying the lender's legal fees.
12. Closing Costs. Understanding the project's cash requirements at closing helps avoid last-minute financial demands.
13. All-Risk Insurance. Every project requires fairly sophisticated insurance coverage. Depending on the nature of the project, this can be a significant cost item.
14. Construction Inspection. Some lenders require the developer to pay for various inspections. Working with the lender to avoid duplicate expense will minimize these costs.
15. Bonding. At the very least, the local government will require a performance bond to ensure construction of infrastructure required by the project's land use approvals (e.g., streets, storm sewer, water lines.)
16. Marketing Materials, Advertising. The ultimate success of a project often depends on a successful marketing campaign, which can add significant cost.
17. Construction Loan Interest Fees. These vary considerably from lender to lender. Some loans include penalty fees if loan proceeds are not taken down on a predetermined schedule. Interest, of course, will accrue until the construction loan is paid, so knowing and hitting your market will minimize interest costs.
18. Permits. These numbers go up every year as local governments look for creative ways to finance public infrastructure. It is not uncommon for these fees to double or triple from one year to the next.
19. Water Meters and Sewer System Development Charges (SDCs). Jurisdictions are increasingly relying on SDCs to fund improvements. SDCs can be imposed for water, sewer, transportation, storm water, and parks. If the project jurisdiction has not adopted an SDC for each, expect it to do so soon. Find out the projected fee and budget for it.
20. Broker Commissions. These fees normally are negotiated up front and become a known fixed cost.
21. Indirect Contingency. While every project has its own unique fee structure, sometimes local jurisdictions will not estimate the fees correctly and developers will be required to pay a corrected amount.

Consideration of these suggested aspects of a project at the beginning of the development process can significantly minimize the impact of the unexpected. In addition to the general considerations outlined above, developers should customize a pro forma to meet the needs of their specific development. A customized pro forma might include items specific to certain local jurisdictions, recurring or common environmental or natural resource issues present in the area of the project, or even unique financial considerations regarding project funding. Because almost every aspect of a project can add to its overall cost, the goal in creating a pro forma is to proactively consider as many identifiable elements of a project as possible. It is to be hoped that this process will result in fewer unanticipated costs and a project budget that more closely resembles the true project cost and anticipated profit.

This article is intended to inform the reader of general legal principles applicable to the subject area. It is not intended to provide legal advice regarding specific problems or circumstances. Readers should consult with competent counsel with regard to specific situations.

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