Where development projects get money

Last Reviewed: June 11, 2024

Visitor Question: How do real estate developments get the money they need? Do all of the funds come from people's pocketbooks, or does every development fleece the taxpayer?

Editors Reply: Real estate development relies on a variety of funding sources, including these:

1. Developer's own working capital (with this usually being only a temporary state of affairs until other financing can be secured)

2. Both short-term construction loans and long-term financing borrowed from banks or non-traditional sources, often using the developer's other real estate as collateral

3. Sometimes public sector money, including local government, county or state government, and occasionally even federal programs. This could include tax credits or tax abatement (which means forgiving real estate taxes that otherwise would be due).

At least in normal economic times, when banks are lending money, it may e possible for a development company with good credit to borrow against a future revenue stream if and when the developer had a credible plan.

Obviously, some types of real estate development are much riskier than others. Multi-family development and single-family subdivisions behave reasonably predictably, and if the lender can be convinced that there is a real market, financing often can be secured.

An example of riskier development, from the financial standpoint, would be speculative commercial space where there are no tenants located.

Any type of development that is overbuilt in a particular market, or nearing that saturation point, should be harder to finance. Here again we are being perhaps too optimistic that financial institutions actually are acting in a rational fashion rather than based on some outmoded customs of their industry.

In terms of government financing for development, usually there are no outright grants. Instead, one of the common ways that governments assist is by giving tax credits for certain desirable types of development (such as historic preservation, low-income housing, energy efficient structures, and a whole host of other particulars that a certain government may want to encourage). These are relatively prevalent at the state level.

Local governments often favor tax increment financing or a variation of this technique for commercial developments and even some types of residential development.

Also in some locations, government housing assistance of various types is prevalent.

So to summarize, a variety of public and private financing arrangements are used to enable real estate development. It's very rare that a developer just wants to see something happen so badly that he, she, or it will fund a development directly. Usually development occurs with borrowed money, with whatever supplements from governments can be acquired.

We hope this helps with your basic understanding of real estate development finance. Poke around on the site more if you need additional details.

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