Development — building from the ground up

Development takes a piece of land and turns it into an income-producing building. Done well it is the highest-return slice of real estate investing; done badly it is the highest-loss slice. The same forces — leverage, illiquidity, location — that shape the operating side of property are concentrated and amplified during development, when there is no rent coming in, the building doesn't yet exist, and every cost overrun lands on the equity slice.

Development as two projects

It helps to think of a development as two projects stitched together. Project A — construction — runs from land acquisition through certificate of occupancy. Duration 12–36 months for typical residential and commercial. No rental income; all cash is going out. The risks are concentrated, lumpy, and binary: the building is either delivered on time and on budget or it isn't. Project B — operations — starts at lease-up and runs through the eventual sale or refinance. Everything covered in modules 1–6. The handover between A and B is the moment the certificate of occupancy is issued; the model splits there.

The development pro forma

TYPICAL DEVELOPMENT BUDGET BREAKDOWN (residential, 24-unit Nairobi block)

  Land acquisition                                                15-25%
      Land cost + transaction costs + holding cost during planning

  Hard cost                                                       50-60%
      Foundation, structure, finishes, MEP (mechanical/electrical/plumbing),
      contractor markup, insurance during construction, retention

  Soft cost                                                       12-18%
      Architect (3-6% of hard cost), engineering (1-3%), permits & approvals
      (local authority, KEBS, NEMA, water, fire), legal, accounting,
      property tax during construction, marketing & branding

  Financing cost                                                   5-10%
      Construction loan interest (capitalised), lender fees, mortgage
      origination at takeout, equity-line interest

  Contingency                                                      5-10%
      Reserves for cost overrun, scope change, latent site conditions
      (the line that distinguishes amateur from experienced developers)

• Land acquisition — the cash spent buying the development site, plus stamp duty, legal, due-diligence, and the carrying cost of holding the land through the planning phase (which often takes 6-18 months in Kenya). The land cost itself is non-recoverable if the project fails; you cannot sell unbuilt land back at the price you paid for it during a downturn.
• Hard cost — the physical building. Foundations, columns, slabs, walls, roof, MEP (mechanical, electrical, plumbing), interior finishes, external works. The contractor's contract value plus retention (typically 5-10% held back until practical completion). The single largest cost category in most developments.
• Soft cost — every cost that is real but not physical. The architect designs the building (3-6% of hard cost). The structural engineer, MEP engineer, and quantity surveyor each take 1-3%. Permits — building approval, NEMA environmental, KEBS standards, water connection, fire-safety certification, electricity-connection deposit. Legal — title diligence, sale-of-plot transactions, contracts with the contractor and the architect. Accounting and tax compliance during the build. Marketing budget for off-plan sales or pre-leasing.
• Financing cost — interest on the construction loan, capitalised (not paid in cash) because there's no operating revenue yet. Lender fees (commitment, drawing, monitoring). Mortgage origination at takeout (when the construction loan rolls into the permanent operating mortgage). For a 24-month build at 14% interest on KES 200m drawn pro rata, financing cost can easily reach KES 30m.
• Contingency — the reserve for what goes wrong. Cost overrun on the contractor, scope changes the buyer didn't anticipate, latent site conditions (rock, water table, soft soil) that the geotech survey missed. 5-10% on the hard cost. Developments without an explicit contingency line are amateur or aggressive; experienced developers price it in and consider it part of the cost of doing business.

Construction lending and the draw schedule

Construction loans don't pay out as a lump sum. They pay out in 'draws' against verified construction progress. The lender appoints a site inspector (a quantity surveyor or a project monitor) who visits monthly, signs off that the work claimed has actually been done to the standard contracted, and authorises the next draw. The typical draw schedule mirrors the construction milestones: 10% on foundations, 20% on structure to slab level, 25% on superstructure complete, 25% on roof + walls + windows, 15% on finishes + MEP, 5% on practical completion. The lender controls disbursement; the developer cannot just draw the full loan against the project value.

This protects the lender from the most common construction-loan failure mode: the developer drawing the full loan upfront and then under-delivering or absconding. The draw schedule is itself a control against fraud as much as against execution risk.

Lease-up risk and the stabilisation curve

The development isn't over when the certificate of occupancy issues. There's still no NOI because there are no tenants yet. The lease-up phase — typically 6-18 months for residential, 12-24 months for commercial — is where the building moves from zero occupancy to stabilised. During this period the developer is paying full operating expenses on a partially-occupied building and the construction loan is rolling over to a (more expensive) operating mortgage. Lease-up is the second-most-common reason developments fail: the building is delivered on time and on budget, then sits half-empty for two years longer than projected because the local market has more supply than the developer modelled.

The four common failure modes

• Cost overrun. Contractor goes 15-30% over budget on hard cost, often because of scope creep, weak procurement, or genuine cost inflation between contracting and execution. The contingency absorbs some; the rest comes out of the equity slice.
• Lease-up delay. The market is softer than the model assumed. Concessions (free months, fit-out contributions) used to fill space erode the effective rent, and the stabilised NOI lands 20-30% below model.
• Capital-market shift. Interest rates rise between when the construction loan was sized and when the permanent mortgage is sized; the takeout loan is smaller (DSCR-limited) and the developer has to inject additional equity at the worst possible moment.
• Regulatory or title problem. NEMA refuses the certificate. The local authority discovers an encroachment dispute on the neighbour's land. A latent title claim surfaces during lender due diligence at takeout. Each of these can pause or kill a project that was otherwise on track.

In practice, developments rarely fail from one of these alone. They fail when two arrive at once — cost overrun while the capital-market shifts, or lease-up delay while a permit dispute escalates. The job of the development sponsor is to build sufficient cushion (in budget, in time, in lender goodwill) to absorb any single shock and survive the simultaneous occurrence of any two.