When Projects Stall and Fees Rise: The Dilemma of Developer Fees

Introduction

Understanding the role of a developer in a commercial construction project can be complicated, but it is critical knowledge to have for all parties involved in the adjustment of a Builders Risk claim.  Policyholders will often include increased developer fees in their soft costs claims when they experience project delays.  The concept of developer fees is often misunderstood, but this article will provide some clarity and understanding that can be used to properly evaluate claims for developer fees by covering who a developer is, what they do, and how their fees are impacted in the event of a project delay.

Parties to a Construction Project

The development and construction of a commercial project is a large and complex effort that involves many stakeholders.  The following is a list of some of the key parties to a project along with a description of their respective roles:

Developer

• Initiates the idea for a project
• Conducts feasibility studies
• Secures project financing, both equity and debt
• Selects the general contractor to construct the project
• Manages the entire construction process
• Will charge a fee to the project / project owner for their services
• May stay on after construction is complete and operations commence to manage operations on behalf of the project owner

Investors

• Becomes the project owner and establishes a separate operating entity from the developer
• Invests capital into project to provide partial funding for construction
• Owns and operates the completed project
• May include individuals, institutional entities, private equity firms, or other
• Developers may also be investors in the project

 Banks

• Provide loans to project owner to fund construction
• Reviews monthly construction progress and draw requests and issues loan proceeds

General Contractor

• Responsible for the construction of the project
• Will generally hire subcontractors for trade work (earthwork, concrete, steel, roofing, painting, interior finishes, electrical…)
• Charges can be based on fixed fee, guaranteed maximum price, cost plus, or other method
• The general contractor may be wholly owned by the Developer, but under a separate company

Other Parties

• Architects – Designs project and monitors construction is in accordance with plans
• Engineers – Also part of project design and ongoing monitoring of construction
• Owner and Lender Representatives – Works for project owner or bank to monitor project progress
• Attorneys and Accountants – Provide professional advice to stakeholders within their area of expertise

What A Developer Does

Developers are generally responsible for identifying a need for a project, which they do by relying on their experience, extensive market research, study of economic trends, knowledge of changes in city zoning, and collaboration with other professionals such as brokers, architects and investors.  Once a need is identified (for example, hotel, apartment building, shopping center, industrial building…), the developer will conduct an extensive feasibility study to confirm that a project is viable.  This can include environmental studies, traffic impact studies, utility access review and pro-forma financial analysis.  When the study is complete and it is determined that a project is viable, the developer will then seek funding to construct the project from a variety of sources, such as investors and banks.

Naturally, there is a considerable cost involved with the above activities, and this is even before any land has been purchased or construction has commenced.  Developers will hire many third-party companies to provide specific services to be used in the feasibility study, and they also carry their own internal costs.  Development companies have many employees on staff covering a variety of necessary disciplines such as real estate, construction, marketing, finance and accounting.  All of the costs incurred to bring a project to fruition (both direct out-of-pocket cost and allocation of internal costs), along with project management costs as discussed in more detail below, will ultimately be charged to the project as developer fees on a fixed fee, percentage of project value, or other basis.

Developer Vs. Project Owner

At this point, it is important to understand that the developer is generally not the end-user of the project, or the project owner, although they may have an equity interest in a project.  As an example, let’s take an apartment building that is being developed.  Once the developer, we will call them Century Developers, LLC, completes the feasibility study and has determined that the project is viable, they will seek funding for the project, which will likely be some combination of equity via investors and construction loans from a bank.  Once investors are secured, a separate operating company will be established on their behalf, which we will call Lone Star Housing Group, LLC in this example.  This will become the “ownership group” or “project owner” of the actual completed apartment building.  As a reminder, this newly established entity may include some equity investment from Century Developers, LLC, but it is a distinct and completely separate legal entity from the developer.  With funding now in place, the land for the project is purchased, and construction begins.  Century Developers, LLC selects the general contractor that will construct the project, and manages the construction process through to completion.  As soon as construction is complete and certificates of occupancy are received, Lone Star Housing Group, LLC will pay off the construction loan via the proceeds from a separate and permanent mortgage, and rental operations will commence and tenants will begin taking occupancy of apartment units.

Generally speaking, at this point in the project, the developer’s involvement is complete and they will fall out of the picture.  However, in many cases, developers also provide property management services to project owners, and may stay involved to manage the operations of the ownership group’s entity, but they will charge a fee to do so, often in the form of a management fee based on a percentage of revenue.

Project Details and Builders Risk Coverage

Now that we have established the various parties to a construction project and defined who the developer is and what they do, let’s discuss what happens if our apartment community was damaged by a covered casualty event during construction, leading to a delay in completion.  For discussion, we will assume that the project owner’s company, Lone Star Housing Group, LLC, was established in January 2024 at the time they made an equity investment in the project and, thus, construction began.  Construction of the project was scheduled to be completed at the end of December 2025, for a 24-month period.  The project had a total budget of $42,000,000 broken down as follows:

• $7,000,000 for land acquisition
• $29,000,000 for site work and vertical construction
• $2,500,000 for accrued interest for construction loans
• $2,000,000 for other project soft costs such as insurance, taxes, permits and fees
• $1,500,000 for Developer Fees charged by Century Developers, LLC

However, due to covered damages that occurred during construction that resulted in delays, construction was not completed until the end of June 2026, or six months later than scheduled.  As a result of the delay, in addition to hard costs to repair damages as well as other soft costs, the developer charged the project for an additional $375,000 in developer fees during the delay period.

In a typical Builders Risk policy, the Named Insured and / or Additional Insured generally includes the developer, the project owner, the general contractor, and all subcontractors.  For this project, we will assume the Named Insured includes Century Developers, LLC, Lone Star Housing Group, LLC, the general contractor and all subcontractors and $42,000,000 in coverage was purchased, which includes $1,500,000 in developer fees.

Soft Costs

Builders Risk policies generally provide coverage for increased Soft Costs incurred as a result of a project delay.  Most policies provide coverage only for specifically listed Soft Costs, which typically include the following.  Furthermore, Soft Costs are often subject to an overall sublimit of coverage, or sometimes each specific Soft Cost is subject to a separate sublimit:

• Interest Expense on Construction Loans
• Realty Taxes / Ground Rents
• Insurance Premiums
• Advertising Expense
• Commission Expense
• Architect / Engineer Fees
• Legal / Accounting Fees
• Project Administration Expense

Although developer fees are usually not specifically listed as a covered Soft Cost in most policies, it seems the only logical line-item they may fall under would be Project Administration Expense.  Additionally, some policies specifically exclude developer fees as part of Soft Costs within the line item of Project Administration Expense.

Things to Consider In Handling Claims For Developer Fees

The developer and project owner will typically enter into a development contract, which will include a complete project budget with line-item detail, including the amount to be charged for developer fees.  Remember that the developer incurs costs to conduct the feasibility study, to set up and manage the project and to oversee the construction process and will recover those costs via the developer fee charged to the project.  Since a developer is usually a for-profit entity, they will endeavor to profit from a project via fees they charge for their services.  Except for the initial feasibility study, most of the developer’s costs will be generated from their own internal costs, as opposed to third-party vendor costs.  The specific costs associated with the development company include occupancy, insurance, marketing, general and administrative expenses, direct payroll wages and salaries (those involved directly in the projects), management salaries, and payroll burden, all of which would generally be considered fixed in nature (in other words, the developer’s total cost of operations will not vary whether they are managing three projects versus seven projects).

When we run into a delay scenario, it extends the amount of time that a developer spends on a project.  In our example above, our project was scheduled to last 24 months and the budget for developer fees was $1,500,000.  Since the project now took 30 months to complete because of a delay, the developer charged an additional $375,000 in developer fees to the project.

What are some of the considerations that should be taken into account when handling a claim for developer fees:

• First and foremost, one should evaluate whether the policy covers developer fees at all. As discussed above, Project Administration Expense may be the only Soft Cost line-item that they may fall under.  Also, the policy may specifically exclude developer fees.  An evaluation whether any sublimits are applicable should also be done.
• Did the developer actually spend more time on the project than originally scheduled? If not, it may be difficult to support that additional developer fees were incurred.  This can be particularly challenging when dealing with a phased or multi-building project where concurrent construction activities are ongoing while covered damages are being repaired, to the point that the overall project may not have even experienced a delay.
• What was the arrangement between the developer and project owner in terms of charging developer fees. Some examples of how a developer charges fees include percent of the project costs, fixed fee or monthly rate.  An analysis should be done to verify the amount of additional developer fees charged to the project because of the delay, and that fees were charged in a manner consistent with the methodology used on the base project.  Again, since the developer and project owner are two completely separate legal entities, additional charges to the project for developer fees truly are an out-of-pocket cost to the project owner.
• Did the developer actually incur higher costs because of a delay, given that the majority of their costs are fixed in nature (salaries, occupancy costs, administrative expenses…). Even in the event of a confirmed project delay, the developer may not spend any more money than they actually were committed to had the loss not occurred.  However, we have seen where the developer argues that the additional time they spent on a project due to a delay caused them to forego or delay other projects, thereby becoming a lost opportunity.  This can be illustrated using a simple example as follows;
  • Assume that in a typical year, a developer generates $10,000,000 in revenue and closes six projects. If one project is delayed due to damage and the developer spends additional weeks or months on the project, while employees continue working 40-hour weeks, and they do not charge additional fees to the delayed project, they may only generate $9,500,000 in revenue in that particular year.
  • Alternatively, under the same scenario, if a developer had all its employees work 50-hour weeks to manage the one delayed project, but they were able to remain on schedule with all other projects, they may still be able to earn their $10,000,000 in revenue. As long as the developer does not pay additional wages (assuming employees are salaried), then there may not be any financial impact to the developer in this case.

To summarize, it is important to 1) verify if the project was actually charged additional developer fees, 2) evaluate the developer’s actual costs and determine if they incurred additional costs above normal, and 3) determine whether the developer can document impacts to other projects.  Just be aware that, in practice, it is fairly straightforward to document additional developer fees charged to a project due to a delay, but not so straightforward to verify financial impacts to the developer as a result of a delay.

• Be mindful of the conundrum that if both the developer and the project owner are Named Insureds under the policy, then charging of developer fees by the developer to the owner is simply moving money from one insured pocket to another insured pocket. In other words, do we need to offset the developer fee charged to the owner for revenue gained by the developer, since they are both insured under the same policy?

Unfortunately, there is not one single answer on how to deal with all situations involving developer fees because fact patterns change from project to project and policy to policy.  All claims should be handled in accordance with their own set of facts.  The discussion above is somewhat general in nature and is not intended to cover every possible scenario, however, it does provide some fundamental guidance on areas to consider when handling claims for developer fees.

By George Uhl.

The statements or comments contained within this article are based on the author’s own knowledge and experience and do not necessarily represent those of the firm, other partners, our clients, or other business partners.