Real Estate Development and Investment E-Book

S. P. Peca

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Wiley Finance Editions
• Sprache: Englisch

Seitenzahl: 385

Veröffentlichungsjahr: 2009

Beschreibung

Real Estate Development and Investment

A Comprehensive Approach

Written by real estate industry veteran Stephen Peca, this timely guide skillfully outlines the various phases of the real estate development process and addresses some of the most important issues associated with this discipline.

Using numerous illustrations and anecdotes, this book takes you through the development process, from historical considerations and idea formulation to financial feasibility and asset disposition, while covering the entire cycle of real estate development for various property types. Topics touched upon throughout these pages include:

• The key factors affecting demand for different land uses and development
• The interaction of market research, financing, planning, contract negotiation, marketing, leasing, and property management
• The need for universal, current, and broad knowledge
• The importance of ethics in the development process
• The role of different professionals and companies involved in the development process
• Environmental considerations in real estate development
• And much more

Filled with in-depth insights and practical advice, this reliable resource will help you gain a firm understanding of the functional skills necessary to be successful in this field and familiarize you with several often-overlooked-but essential aspects of commercial real estate development.

Leseprobe

Table of Contents

Title Page

Copyright Page

Preface

Acknowledgements

CHAPTER 1 - Overview of the Development Process

ECONOMIC PERSPECTIVE

RELEVANCY OF UNIVERSAL KNOWLEDGE

GROUND-UP DEVELOPMENT VERSUS REDEVELOPMENT

THE SIX PHASES OF DEVELOPMENT

CHAPTER 2 - Business Ethics

RELEVANCY TO THE REAL ESTATE INDUSTRY

LEGISLATED ETHICS

CHAPTER 3 - Project and Development Teams

TYPES OF DEVELOPERS

FUNCTIONAL DISCIPLINES IN THE DEVELOPMENT PROCESS

FACTORS TO CONSIDER WHEN FORMING A DEVELOPMENT TEAM

CHAPTER 4 - Historical Perspective of Real Estate Development

THE BEGINNINGS OF REAL ESTATE DEVELOPMENT

MAJOR EVENTS CAUSING CHANGE IN THE UNITED STATES

CHAPTER 5 - Market Research

INCEPTION OF THE IDEA

MARKETS, MARKET RESEARCH, AND MARKETING (ANALYSIS OF DEVELOPMENT POTENTIAL)

CONCEPTS THAT DEFINE MARKETING (AND MARKETS)

USING MARKET STUDIES AND PREPARING FOR MARKETABILITY STUDIES

SOURCES OF AND METHODS FOR GATHERING INFORMATION

FLAWS OF A STUDY

VALIDATE THE DATA AND THE IMPORTANCE OF REVISIONS AND UPDATES

CHAPTER 6 - Marketability Studies

SHOWING THAT YOUR DEVELOPMENT CONCEPT COULD AND SHOULD BE BUILT

IMPORTANCE OF MARKETABILITY STUDIES REVISITED

IDEA REFINEMENT AND THE APPLICATION OF THE MARKETABILITY STUDY

THE PROCESS OF IDEA REFINEMENT

CHAPTER 7 - Land Acquisition and Control

NONSPATIAL AND SPATIAL MARKETS

ELEMENTS OF DESIGN

TARGET MARKETS AND MARKET SHARE

SITE CONTROL AND ACQUISITION

PUBLIC AND PRIVATE RESTRICTIONS ON LAND USE

CHAPTER 8 - Land Planning and Siting

VALUE CREATION

PROJECT PROGRAMMING AND DESIGN

ELEMENTS OF DESIGN—AGAIN

TALKING TO END USERS

TENANT MIX AND MARKETABILITY

A BRIEF WORD ABOUT ARCHITECTURAL DRAWINGS

CHAPTER 9 - Entitlement Process and Public-Private Partnerships

TYPICAL COMMUNITY APPROVAL PROCESS

PUBLIC-PRIVATE PARTNERSHIPS

CHAPTER 10 - Budgeting, Financial Analysis, and Capital Structure

PREPARING FOR THE FINANCIAL ANALYSIS AND PRO FORMA

THE DEVELOPMENT BUDGET

THE OPERATING PRO FORMA

REVIEW OF COMMON ANALYTICAL MEASUREMENTS

FINANCING AND THE CAPITAL MARKETS

SHORT - AND LONG-TERM FINANCING

FINANCING CYCLE—ANTICIPATING REQUIREMENTS

ELEMENTS OF A FEASIBILITY STUDY OR DEAL BOOK

GUARANTEES

CHAPTER 11 - Contractors, Consultants, and Construction Contracts

BUDGETING AND SCHEDULING

CONTRACTORS AND CONSTRUCTION CONTRACTS

RISK MANAGEMENT DURING CONSTRUCTION

PREPARING FOR CONSTRUCTION: BID PROPOSALS AND REVIEW

CONSTRUCTION DOCUMENTS AND CONSTRUCTION AGREEMENTS

RISK MANAGEMENT: PART 2

SCHEDULING

BONDING AND INSURANCE

CONSTRUCTION MONITORING: DRAW MEETINGS, MANAGING CHANGE ORDERS

TENANT IMPROVEMENTS AND COORDINATION

CONSTRUCTION CLOSEOUT

CHAPTER 12 - Leases and How They Are Used

VALUE CREATION

WHAT IS A LEASE?

COMMON LEASE STRUCTURES

LEASE MANAGEMENT AND ANALYSIS

CHAPTER 13 - Marketing Focus of Development

KNOW YOUR TARGET AUDIENCE

YOUR ESSENTIAL VISION

THE IMPORTANCE OF BRANDING

IMAGE, IDENTITY, AND COMMUNICATION

COMPONENTS OF MARKETING CENTERS

CHAPTER 14 - Investment Management

FUNCTION AND GOAL OF PROPERTY MANAGEMENT

FUNCTION AND GOAL OF ASSET MANAGEMENT

FUNCTION AND GOAL OF PORTFOLIO MANAGEMENT

PROPERTY LIFE CYCLE

CHAPTER 15 - The Future

RECENT HISTORY—WHERE WE LEFT OFF

APPARENT FUTURE TRENDS

GREEN DEVELOPMENT AND SMART GROWTH

SOCIAL RESPONSIBILITY AND ETHICS

Glossary

Index

Founded in 1807, John Wiley & Sons is the oldest independent publishing company in the United States. With offices in North America, Europe, Australia and Asia, Wiley is globally committed to developing and marketing print and electronic products and services for our customers’ professional and personal knowledge and understanding.

The Wiley Finance series contains books written specifically for finance and investment professionals as well as sophisticated individual investors and their financial advisors. Book topics range from portfolio management to e-commerce, risk management, financial engineering, valuation and financial instrument analysis, as well as much more.

For a list of available titles, please visit our Web site at www.WileyFinance.com.

Copyright # 2009 by Stephen P. Peca. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, [phone], fax [phone], or on the web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, [phone], fax [phone], or online at http://www.wiley.com/go/permissions.

Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.

For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at [phone], outside the United States at [phone] or fax [phone].

Wiley also publishes its books in a variety of electronic formats. Some content that appears in print may not be available in electronic books. For more information about Wiley products, visit our web site at www.wiley.com.

Library of Congress Cataloging-in-Publication Data:

Peca, Stephen P.

Real estate development and investment: a comprehensive approach/Stephen P. Peca. p. cm.—(Wiley finance series)

Includes index.

eISBN : 978-0-470-48027-4

1. Real estate development. 2. Real estate investment. II. Title.

HD1390.P43 2009

333.33—dc22 2008047052

Preface

I have been involved in the real estate industry and development business in one aspect or another now for 30 years. I was trained as a CPA, went to law school for a year, was an accountant, was a chief financial officer, have been part of several development teams, was a commercial banker, was an investment banker, and now am an entrepreneur and a teacher. While these roles seem to be disjointed and unrelated, they are not. Virtually all of my roles have been focused on the real estate industry, with a brief departure into corporate banking and project finance. When I started in real estate development, very few academic programs were available to teach people about the business. I was trained, just like everyone else in the industry, by on-the-job training. Today, there are many more academic programs—even internationally—proving the demand for the knowledge.

This book provides a systematic and practical analysis of the phases of the real estate development process, including conceptualization, site acquisition, planning and design, the construction process, financing, and leasing and marketing, followed by investment management. The linear process I have outlined for you, the reader, will help you pursue your first real estate development or redevelopment project, or help the experienced person refine the process he or she has been using. This book, at the very least, will perhaps help you look at real estate development from an entirely different perspective. The book addresses details of the development process, but does not get so detailed as to address the fine points of each area of the development process, and, as a result, is highly readable.

Being a developer, the leader of the development process, requires experience and thought. I try to scatter the book with quotes from famous and not-so-famous people that should help the reader gain a philosophic understanding of the topics.

I have been teaching a course on the real estate development process for more than five years at a major university. This book offers an all-inclusive approach; that is, many developers simply focus on the financial or construction aspects of development and give only passing reference to the other—and no less important—aspects of the development process, such as idea refinement, branding, or investment management.

Frankly, real estate development and investment, while exciting and sexy, is still viewed as an odd investment type. Major changes have occurred over the years, such as institutional investors directly investing in real estate development projects in the 1990s. So, real estate is now considered a solid alternative investment. Hedge funds are investing in real estate projects. Private equity firms are investing in real estate. So real estate has finally come into its own. But many still think there is a mysterious element to the business and process. I think the mystery is because the essential way to obtain the knowledge is still by on-the-job training and experience. Even as students complete my course on the subject, they have the motivation, they have the knowledge, and now they have to actually go do it.

What I hope to accomplish in this book is to impart my knowledge and experience to the reader. I will try to get you to think differently when approaching a real estate development. Let me point out here that when I am saying real estate development, I am talking about ground-up development, renovation, brownfield development, and everything in between. Thus, this book should be of interest not only to the active real estate developer—new or experienced—but also to the institutional investors, hedge funds, private equity firms, commercial banks, and investment banks that are trying to understand the industry so they can make better investments or understand their clients’ activities.

Leadership, management and control of the development team, and public-private partnerships are featured issues. The book will take readers through the development process from historical considerations to financial feasibility to asset disposition by using a number of illustrations and anecdotes. Each chapter finishes with a section on learning points, things that you should understand after reading each chapter.

Useful to all readers is that once you understand the overall development process, you can pursue development anywhere in the world. Yes, the laws are different, but the laws are different everywhere—New York, Des Moines, Beijing, or Kabul—yet the development process is exactly the same. So my aim is for you to learn the entire development process, learn a way of thinking, and use this book as a reference as you pursue your exciting career or business in real estate development anywhere in the world. Additionally, no matter what the state of the economy might be in a given geographic location, following the development process as I have outlined it will almost always result in a successful development project.

Overall, this book has the following learning objectives for readers:

• Understand the key steps in the development process: A key to successful development is following a standard path from the beginning to the end. A developer faces many tangential issues that need to be addressed, but a developer must have this set path in mind throughout the development process to be successful.

• Appreciate factors affecting the demand for different land uses and development: Demand does not arise from studying and interpreting marketing data. Demand often starts as subjective beliefs derived from intuition and common sense.

• Appreciate the need for universal, current, and broad knowledge: Everything a developer reads, hears, or sees is relevant to the development process. It is this universal, current information that gives a developer hints or suggestions for a planned real estate project.

• Appreciate key legal issues that must be considered by real estate developers: Everything—everything—a developer does involves a contract: buying property, selling property, leasing property, financing property, everything.

• Appreciate the importance of environmental considerations in real estate development: Environmental consideration here is not limited to environmental contamination. It is true that environmental contamination must be addressed, but real estate development also causes change to the surrounding community environment. That is, when any project is developed—ground-up or regeneration—that development causes change to the surrounding community or environment. It is important to understand what that change is and address it proactively, just as a developer would address environmental contamination proactively.

• Understand the role of the different professionals and companies involved in the development process: Myriad professionals and companies get involved in a real estate development project. The specific types and numbers vary greatly, but a key responsibility of developers is to identify requisite professionals and companies to assist them in the development process.

• Develop an appreciation for the importance of ethics in the development process: Ethics is critical in real estate development. A developer’s reputation is paramount for becoming successful in this field. Having a reputation for practicing good ethics often helps a developer through the entire development process. We have all heard about six degrees of separation; I believe that in the real estate industry, it’s more like two degrees of separation.

• Learn the interaction of market research, financing, planning, legal considerations, contract negotiation, design, construction, marketing, leasing, and property management: This point describes the difficulty of being a developer. Being a developer does not require substantial knowledge or education; it is not rocket science. What is exceedingly difficult, however, is keeping everyone on your development team on track, doing what they are supposed to do when they are supposed to be doing it. This coordination or project management can be very difficult.

Acknowledgments

Many people and experiences have contributed to my overall background in the commercial real estate industry. I suppose it all started in the late 1970s, when I joined Urban Investment & Development Co. The company no longer exists, but it was then a prominent national developer and operator of many trophy properties. Many of the people who worked at Urban now hold positions in prominent real estate companies. Urban had a thorough methodology of how to pursue real estate development and investment that I carry with me today.

I also want to thank Bob Morgenstern at New York University, who incessantly encouraged me to write this book. Bob reviewed initial drafts of the manuscript and prepared some of the figures in the book. Similarly, I want to thank the many people at the New York University Real Estate Institute who allowed me to teach at the school and gave me the opportunity to refine much of the information I learned over my career.

I additionally want to thank my daughter, Victoria (Torie), who helped me with the editing of this book by highlighting areas that needed further explanation.

CHAPTER 1

Overview of the Development Process

Where does the real estate development process begin? It begins with an idea. It does not begin with crunching numbers. It does not necessarily begin with a site. It begins with an idea. Real estate development is a highly creative endeavor, as the reader will see. Frankly, those in the creative arts, such as movie or television production, often do very well transitioning into the real estate development industry.

ECONOMIC PERSPECTIVE

Before we delve too deeply into the development process, it is important to gain a perspective on its role in the U.S. economy. (Do not focus on the absolute numbers in the list below; instead, focus on the relative magnitude of the numbers as you read them.)

Real Estate Development1

• Is more than a US$5 trillion U.S. market segment

• Generates about a third of U.S. GDP

• Creates jobs for more than 9 million Americans

• Is responsible for nearly 70 percent of local property tax revenue, which pays for schools, roads, police, and other essential public services

Clearly, the real estate industry has a major impact on the U.S. economy, and on the world economy as well. I cannot think of any business or activity that does not directly or indirectly use real estate or is not a supplier of the real estate industry. Most important, focus on that last bullet point. If a municipality gets 70 percent of its revenue from property taxes, it is logical and true that municipalities are in favor of real estate development, that is, real estate development improves values and hence the tax base and thus generates increased property tax revenues. Therefore, municipalities inherently are positively inclined toward new property development and regeneration. Yes, there are municipalities that say they do not want new development, but eventually they all come around because property tax revenue has such a significant impact.

Figure 1.1a 200X REIT Transactions: Total Acquisitions US$9.7 Billion

I mentioned earlier that the real estate industry has a major impact on the U.S. and world economy. Every business, every person, uses a building or real estate every day. Even the homeless person sitting in a cardboard box has his piece of real estate. Hence, the balance sheet of every company and every person in this world has real estate as a major line item. Municipalities know this. Hence, over the years, governments have provided many financial and legal subsidies to enable additional real estate development and investment.

Figure 1.1b 200X REIT Transactions: Total Dispositions US$3.8 Billion

Let’s look at Figures 1.1a and 1.1b.

Figures 1.1a and 1.1b were derived from information from public real estate investment trusts (REITs). The information is labeled as coming from 200X because the specific year is not important for this discussion. In Figure 1.1a, we see that REITs acquired US$9.7 billion of property. (The top pie charts indicate distribution of property types, and the bottom pie charts indicate geographic distribution.) In Figure 1.1b, we see that REITs in this year disposed of or sold US$3.8 billion of property. So, what do we learn by studying these pie charts? Well, we see that the REITs in this year are net holders of property. We see that the REITs concentrated their preferences in property type and concentrated their geography where the properties are located. So again, what do we learn from these pie charts? The correct answer is, as a developer, nothing; the information is useless. It is interesting but useless. Some might say that the information would be better presented as a trend over several years. Again, I would still say the information is useless to a developer. Primarily, when was this information gathered and presented? The data is from the end of a year. It probably took several weeks to compile the information into these nice pie charts. So, the information is outdated. A development project takes on average three to five years before construction begins, maybe another year or two for construction to finish, and perhaps another year before the building is fully occupied. So if a developer had a site today and started planning, before a building is completed and operating, five years or more will pass. What will the markets be like in five years? What will be the demands of any particular city or town five years from now? No one knows. So performing a trend analysis is barely a beginning. What a developer needs to do is establish the trend beyond the trend. Once a trend has been determined, the trend is old and common. A developer cannot gain an advantage by using known trend information. To be successful, a developer needs to perceive what is next to come. Now this is not easy to do, but this skill distinguishes successful developers from very successful developers.

Consider a group I worked with several years ago. The group presented an idea to me for creating a suite hotel project in New York City, seeking an opinion. The central idea was that the project would attract families. Currently, families had to secure multiple rooms to accommodate family members. A suite hotel would contain individual hotel rooms, but each room would contain two bedrooms, a sofa bed, and perhaps a folding cot. The group’s concept included a children’s museum on the ground floor, open to nonguests, and provided child care, should parents want to attend a Broad-way show or go to dinner some evening. I thought this was a good idea. The next day, I received an e-mail newsletter that highlighted the fact that the concept was already being used in Germany. A week letter, I received another e-mail newsletter with an article discussing the concept in use in South Africa. Ideas, good ideas, are everywhere. Just because a developer has an idea rarely means he or she is the only person with that idea. There are many people in this world with good ideas. The key is to act quickly or to devise an idea that is the next step, or the trend beyond the trend.

A useful tip in trying to determine the trend beyond the trend is to look for the negative in a circumstance. That is, what is it that is not happening? You will find that focusing on what is not happening is far easier than focusing on what is happening. Consider this example: Imagine you are with a friend, colleague, or spouse. There often comes a point when you might be a little hungry. So, what does one person say to the other? “I’m hungry. Where do you want to go to grab a bite?” What does the other person say? “I don’t know. Where do you want to go?” And this questioning goes back and forth without immediate resolution. On the other hand, imagine if the dialogue went as follows: “I’m hungry. Where don’t you want to go?” The answer usually comes quickly. “Well, I don’t want Italian food because I just had Italian food last evening” (and so on). It is far easier to determine the negative because most people have definite ideas of the negative. A developer should do the same. Don’t ask a city, “How about we build a shopping center here?” A developer should instead ask what the city does not want built. The answer often comes quickly.

Essentially, we are following demographic—that is, people—trends when we plan a real estate development. What are the population trends? What regional population or development shifts are occurring? Are there any specific city development trends discernible? In short, real estate development is about people. What is it that people are doing or, more important, not doing? If a developer becomes a student of people and how people go about their daily lives, that developer will become adept at formulating the trend beyond the trend.

The State of New Jersey created a number of years ago the Blueprint for Intelligent Growth (B.I.G.) Map. The color-coded map indicated where in the state the government would encourage development or regeneration, where in the state the government would discourage development or regeneration, and where in the state the government would be open to argument. These areas were depicted by the use of three colors: green, red, and yellow, respectively. (If you would like to look at the B.I.G. map, then go to the New Jersey Department of Environmental Protection web site.) To my knowledge, this is the only map of its kind created by any state in the country. It is a very creative and progressive effort for a state to exercise control on a statewide basis.

If you look closely at the B.I.G. Map, you will see a clear concentration of the green-colored areas. They are located across from the major cities of New York and Philadelphia. So why did New Jersey concentrate on these areas to encourage development? Well, what is physically in these areas? What is the condition of those improvements? The areas are built-up, but old. Infrastructure is inadequate and in need of repair. The state, in essence, has unproductive assets in these green areas. Unproductive assets from the government’s viewpoint are assets that have low or nonexistent value for tax purposes. (Remember, 70 percent of property tax revenue supports the local municipality’s efforts at maintaining roads, schools, and the like.) Therefore, it is easy to picture that where there is a concentration of nonproductive assets, the government would like new development or regeneration. Conversely, the red-colored areas are already built, but the state would like to promote the preservation of open, green space and hence discourages additional development.

As I said, this is a creative and progressive effort. However, as of the writing of this book, the B.I.G. Map has been tabled indefinitely. That is, the purpose and execution of the B.I.G. Map will not be pursued for the foreseeable future. This is not to say that the concept was stopped. What happened? Well, what do you think would happen to elected officials in the red areas of the map? They would lose political power. How would this happen? Since new development would be discouraged in the red areas, the population would probably move to areas where they would find newer development (buildings). Thus the population in the red areas would probably decline. Along with reduced population and older buildings, property tax revenues would decline. With reduced property tax revenues, the town’s basic and essential services would not be funded. Without the funding, politicians such as the mayor would initially be without purpose and eventually not have a town to govern.

In addition, New York and Pennsylvania were not too happy with the B.I.G. Map. The two states clearly understand that they would lose population to adjacent, newly rebuilt towns across the rivers in New Jersey, and as a result, the two states would lose tax revenue to New Jersey.

So, developers have to always address two factors when pursuing a development anywhere: What political changes will occur, and what property tax revenue changes will occur as a result of new development? Every town will ask this question, so be prepared with a logical answer.

RELEVANCY OF UNIVERSAL KNOWLEDGE

Everything you see, everything you hear, and everything you read is relevant to real estate development. Let me offer a couple of scenarios and take you through the thinking process of why universal knowledge is so important. Gasoline prices seem to be going higher, for a time they seemed to be going lower, but no one really knows what the trend is going to be. Recently, gasoline prices were at historically high prices, placing pressures on the population. What kind of pressures am I speaking about? Well, consider people who drive 30 minutes or more to get to their workplace or to a local train station to get to their workplace. When gasoline prices doubled or more, personal budgets were extended to pay for gasoline. These people who drive in many cases do not have a choice about driving because public commuter services are limited or nonexistent in the areas in which they live. Thus, they had to pay the higher gasoline prices. While many of these people were willing to bear the higher cost of gasoline, other expenses, particularly discretionary expenses, were reduced or eliminated. Perhaps people have become frustrated as a result of having to cut back on their luxuries or even their necessities of life as a result of the high gasoline prices. So what might be a commonsense solution? I suppose one possible solution might mean moving closer to the workplace or to the urban center. Very well; if people start moving closer to or into the city, what do they need? Where is the opportunity for a real estate developer? Well, the answer is quite simple. More housing has to be built in these urban centers.

One day you read in the newspaper that a foreign car manufacturer is moving into a southern U.S. state. What does that foreign car manufacturer need? Some argue that the foreign car manufacturer needs to move to a specific location that has a job pool of qualified employees for the manufacturing plant. Extending this thought, that means that perhaps new housing needs to be built to house the new employees. In addition to the new housing, perhaps some retail of various types has to be developed to service the people who are moving into the area. And of course, the foreign car manufacturer needs a building to establish the plant. Does this building exist currently? Does this building have to be built? On what site? If this building has to be built, what are the foreign car manufacturer’s requirements? Again, another opportunity for a real estate developer.

Universal knowledge is critical. Always be aware of everything that is going on around you, whether you read about it in a newspaper, hear it on the radio, see it on television, or catch it on the Internet. This universal knowledge is an application of what I referred to earlier as the trend beyond the trend. If you, as a real estate developer, want to be successful, you will be aware of everything and be thinking about what opportunity is presenting itself to you.

“Don’t forget nothing.”

—Rogers’ Standing Orders for Rangers, 1739

So, what is the development process? Let me offer a comprehensive, and somewhat lengthy, definition of the development process: The improvement of raw land or property through the development process is a highly creative process in which physical ingredients such as land and buildings are effectively combined with financial and marketing resources to create an environment in which people live, work, and play.

Let’s dissect this definition, so you have a thorough understanding of what the development process is really about.

The improvement of raw land or property. As a real estate developer, you improve things, whether you are starting a development from the ground up or renovating an existing property. When we say we are improving raw land or property, what we really are saying is that we are creating value. Many people who get involved with real estate development think they want to get involved to make money. The reality is that a real estate developer cannot make money without first creating value. Once value is created, then money or profit can be made. This is a basic concept that I will refer to many times: The main goal of a real estate developer is to create value.

A highly creative process. One characteristic that attracts many people to real estate development is that it is highly creative. In my experience, some of the most successful people transitioning to real estate development are those who come from the creative industries, such as film and television production and the like. Frankly, I have learned that film and television production is actually very similar in its processes to real estate development. The only thing that’s really different is the jargon. As a real estate developer, you can do just about anything you wish to do. Of course, you have limitations such as zoning, and you must meet all of the building codes and other requirements. However, you can build or design anything you wish. Your imagination and the imagination of your project team are your limitations.

Physical ingredients such as land and buildings are effectively combined. The fact that real estate development involves physicality is very attractive to many people. People can actually see and touch what it is that they do. They can point out to friends and relatives a building that they themselves built. At one point in my career, I was a commercial banker. When I was a real estate banker, and I lent, say, US$100 million to a developer, I could see how the US$100 million was used. I could touch a foundation, touch a wall, or touch windows. Later in my career as a banker, I lent to major corporations. I would lend, say, US$100 million to a Fortune 100 company. Where did that money go? Did it go to pay payroll? Was it used to pay administrative expenses? Could I touch something that the US$100 million was used to pay for? Most likely not. As a banker, I had a lot of confidence lending money to a developer because I knew I could see how the money was being spent. My consultants would tell me whether work was in place. When I was a corporate banker, I could only rely on auditors to tell me that the money was spent appropriately.

Financial and marketing resources. These two resources are essential to real estate developers. Clearly, financial resources are needed; otherwise, the developer would not have the money to build. But as this book explains, marketing and market research and the resources associated with the real estate development process are both essential.

Now, there are two things that I want everyone reading this book to adopt into their psyche. If there is nothing else that you learn by reading this book, there are two things that you must understand. The first is the last phrase in the definition of the development process: “to create an environment in which people live, work, and play.” Some people new to the real estate development business still think that real estate is an anomaly. Some people think real estate is something that is highly specialized and doesn’t involve the majority of people in the world. Well, think about it. Where are you now? Perhaps you are at home, at work, at school, in a park? All of these things involve real estate development. Perhaps they are buildings. Perhaps they are green space. All were created by a real estate developer. Everything that you do as a developer involves people and how they live, work, and play. When you go before a city board or a community group and they ask you, inevitably, “Why are you doing this development?” your answer should be immediate: “I am creating an environment by which people live, work, and play.” If you say, as some inexperienced developers say, “I am here to make some money,” you will fail to obtain the necessary approvals. Everyone knows that you would not, as a developer, be doing a development unless you made money. But you shouldn’t be so crass as to say that’s your sole purpose. The reality is that you are creating an environment by which people live, work, and play.

The second thing that is essential to your understanding of real estate development is the enterprise concept, as summarized by Jim Grasskamp of the University of Wisconsin at Madison. The enterprise concept portrays real estate development and its operations as a business, and it requires active, aggressive management. Consider, what is a business? A business has revenues, expenses, income, employees, and taxes. What does a real estate project have? A real estate project has revenues, expenses, income, employees, and taxes. They are essentially the same thing. What do both require to succeed and create value? They both require active and aggressive management. If you decide to passively monitor your business or real estate project, it will fail or, at the very least, be mediocre. So it is essential for a real estate developer to follow the enterprise concept.

Grasskamp said that you should perpetually ask yourself four questions:

1. What is it that we are doing? What are you building? A hotel, a multifamily building, an office building, a retail complex? How big or small? How will it be designed? If real estate developers do not have a clear vision of what the market needs and what exactly they are building for the market, they will have difficulty.

2. For whom are we doing it? Why is a real estate developer building a building? A developer doesn’t build the building just for fun. A developer builds a building for a specific target market. Constantly ask yourself, For whom am I building this building? In reality, it doesn’t matter what you think. What matters is what your target market thinks because it is your target market that is actually going to buy or lease space in your building.

3. To whom are we doing it (whom are we affecting)? The reality is that a real estate developer who builds a building is causing change. That change could be increased traffic, noise, odors, or just the reality that something has changed. If a developer does not think about and identify those groups or individuals who will be affected by the real estate development, those groups or individuals will become that developer’s NIMBYs (Not in My Backyard people).

4. Will it economically fly? Is your project financially feasible? Note that the financial analysis is the fourth thing that Grasskamp asked about, not the first thing, as many people think. While it’s true that financial feasibility is important, as far as a real estate development project is concerned, it is clearly not the first consideration and can be irrelevant if the first three questions are not sufficiently answered.

If real estate developers do not know what they are doing, if real estate developers do not know for whom they are building, if real estate developers do not know whom their project is affecting, then the financial feasibility is absolutely useless information. I have interacted with a number of real estate developers who have proudly announced that their project has a projected return on investment of 50 percent or more but really did not understand the ideal or desired project they should be building for their target market or how the surrounding community and government would be affected by their new real estate development. Unfortunately, in many cases, developers do not ask themselves these four questions. They do not apply the enterprise concept, and as a result, they have mediocre projects. Oftentimes, they wonder why their project is not leasing or selling. The answer is simple: They did not apply the enterprise concept.

Grasskamp goes on to talk about the highest and best use versus the most fitting use and the highest and best use versus the most fitting use versus the most probable use. What does this mean? Let me offer a hypothetical situation. Let’s say that you have acquired a strip of land between a light industrial area and a residential single-family home area. The concept of highest and best use would argue that you should build another industrial plant—a property type that likely creates the highest value for the site in this situation. Do you think the single-family homeowners would appreciate having an industrial plant in their backyard? If you built single-family homes on the strip of land, would anybody buy these homes next to an industrial plant? You could build a retail building. Single-family homeowners would probably appreciate having retail and similar services close by. But would the single-family homeowners appreciate the delivery trucks coming and going at 6:30 in the morning? So what should be built? Try to answer the first three questions that Grasskamp says you should be asking yourself in this hypothetical.

Grasskamp further said that there are three types of development approaches or concepts: the traditional development concept, the idealistic development concept, and the pragmatic development concept.

The traditional development concept is quite successfully used every day by many people. Under the traditional development concept, a developer finds a site, comes up with an idea, pulls together a team, signs contracts, builds the building, leases it, and sells it. Again, the traditional development concept is used every day by many developers, and there is absolutely nothing wrong with the approach.

The idealistic development concept is perhaps what you the reader will be using. The idealistic approach suggests optimization of consumer satisfaction. That is, you know the target market’s needs and wants, and you, as a developer, try to maximize the satisfaction of your target market’s needs and wants. Next, you try to minimize your cost of production, you try to minimize the impact on third parties (NIMBYs), and last, you try to maximize the profit to the investors (including your profit).

But Grasskamp said that a developer is likely to use the pragmatic development concept. The pragmatic development concept says that a real estate development results in having less than the most fitting use, which is constrained by political factors, short-term solvency, and the state of real estate technology. Let’s look at each one of these individual aspects of the definition of pragmatic development concept. Let’s consider these point by point:

Less than most fitting use. It often arises when a site is available but cannot have the maximum highest and best use because of the needs and wants of the surrounding neighbors, as in the hypothetical of a strip of land between a light industrial park and a single-family housing development.

Constrained by political factors. What is one of the most common political factors that constrains real estate? It is zoning. Zoning requires a developer to include certain aspects and elements into his future project. There are many other political constraints, such as political elections, but zoning is the most common.

Short-term solvency. Short-term solvency is probably the most important aspect of development. Short-term solvency asks whether you have the money to bring the development project to fruition, where fruition is defined as the point at which you are able to get a construction loan for your project. For example, do you have the money to pay for attorneys, accountants, soil-testing consultants, environmental testing consultants, and so on? Short-term solvency is very much like the old adage about investing in the stock market, spend only the money that you can afford to lose. Until you reach the point that you actually are able to get a construction loan for your project, all the money that you spend will come out of your own personal savings account. Perhaps you will be able to raise money from friends and family, but it is still money that comes from your own savings or out of your own pocket. There is no standard for how much a developer will spend on a proposed project to bring it to the point of obtaining a construction loan. It could be a small amount because the developer has a lot of experience in building a particular type of property in a particular location. It could be a large amount because of various difficulties or the sheer scale of the project. I mentioned that the time to bring a project to the point of obtaining a construction loan could be 2 to 3 years or could be 10, 15, 20, or 30 years. A rough, rough rule of thumb I often use is that the predevelopment costs (the amount of money that will be spent before a construction loan is obtained) is about 3 percent of the eventual total development cost for the project. With that in mind, I often use the amount of US$200,000 to US$300,000 given the size of projects I have worked on. (The amount could be lower or significantly higher.) Short-term solvency asks whether you as the developer have US$200,000 to US$300,000 readily available to spend on the predevelopment costs of a proposed project, money that you can afford to lose and not have a significant change in your lifestyle if you cannot bring the project to fruition. Many beginning developers have a simple answer to this question: no. So a developer who thought of building a US$30 million office building in the suburbs somewhere is often forced to revise the plan to renovating a two-story walk-up building in the city.

The state of real estate technology. This is not about technology as in computers. I am addressing building technology, design technology, and the like. With all due respect to design architects, they often design a building that cannot be built. Thus the question here is what technology will allow the efficient and cost-effective construction of a building that is attractively designed by your design architects?

All of this is the concept of pragmatic development. Pragmatic development is more than likely the approach that you and everyone else will use toward the development of a new project.

Figure 1.2 The Development Process

I like Figure 1.2 because of its simplicity, yet the simplicity quite effectively shows how a developer brings together a variety of resources to create a development plan. For example, when a developer takes the universe of physical things and combines it with the universe of the market, the developer has the design of the project. When the developer takes the universe of physical things and combines it with the financial tools, the developer has the costs of the project. When the developer takes market information and resources and combines it with the financial resources, the developer has the revenues for the project. When all three things are combined—physical, market, financial—then the developer has created the development plan.

GROUND-UP DEVELOPMENTVERSUS REDEVELOPMENT

There are three basic types of development: greenfield development, brownfield development, and grayfield development.

Greenfield development takes place on a site where nothing has ever been built previously. The sites may be old farmland or forest areas. Greenfield development once was the most common type of development, as suburbanization continued out from the central business districts (CBDs). Today, greenfield development is probably the most difficult type of property development to execute.

Brownfield development has two definitions. The first, or technical, definition is a site that has environmental contamination. The common or day-to-day definition of brownfield development is basically a site that has been built on before. The site could be improved with a structure or structures or the site could be vacant. So, for example, this could be an abandoned industrial plant or manufacturing site. Brownfield development sites are of high interest to most municipalities because they are nonproductive assets; that is, they produce little or no property tax revenue. As a result, municipalities welcome developers and their efforts toward renovating or reclaiming brownfield sites.

“Education is all you have left when all the facts are gone.”

—Brigadier General Daniel Kaufman, Dean, U.S. Military Academy

Grayfield development is a relatively new term that is being used more frequently today. There is nothing really wrong with a grayfield site. It is often improved with a building, the building is fully leased, and the property is cash flowing; that is, there is sufficient cash flow for the property to pay all of its expenses, taxes, and the like. What distinguishes a grayfield property is that it is in need of renovation or is currently being physically underutilized. So, for example, let’s say we have a 10,000-square-foot convenience center. The convenience center is fully leased with the typical tenants of a dry cleaner, video store, take-out food, and so on and pays all of its expenses and taxes. However, the 10,000-square-foot convenience center is located on 100 acres of land. Clearly, the property is being underutilized. The property could be greatly expanded to create higher value through highest and best use. Most developers acquire grayfield properties. Without question, all beginning developers should focus all of their efforts toward acquiring grayfield properties. Why?

It is not unusual that a new developer who acquires a grayfield property begins a redevelopment effort. Somewhere during the process, the new developer perhaps feels overwhelmed, perhaps thinks that he or she has gotten involved in something that is beyond his or her capabilities. Frustrated and frightened, the new developer decides to sell the grayfield property. Can a sale be made? Absolutely. The property is cash flowing, has value, and can be readily sold to another party. Let’s say the new developer decides to help his community by purchasing a brownfield property. Again, somewhere in the process, the new developer feels overwhelmed. Can the developer sell the brownfield site? Sure. But when? How much is the property worth? The biggest distinction between a brownfield development site and a grayfield development site is that the grayfield development site has cash flow.

THE SIX PHASES OF DEVELOPMENT