Professional Real Estate Development

The ULI Guide to the Business

Richard B. Peiser, David Hamilton

• Publisher: Urban Land Institute
• Year: 2013
• ISBN:
  9780874202779
• Edition: 3
• Topic: Commerce
• Subtopic: Immobilier

This basic primer covers the nuts and bolts of developing all types of real estate, including multifamily, office, retail, and industrial projects. Thoroughly updated, this new edition includes numerous case studies of actual projects as well as small-scale examples that are ideal for anyone new to real estate development.

In La Quinta, California, Wolff Waters Place provides rental housing for low-income families. The project is certified LEED Silver and Gold.

Mark Davidson Photography

1

Introduction

What Is a Developer?

Few job descriptions are as varied as that of real estate developer. Development is a multifaceted business that encompasses activities ranging from the acquisition, renovation, and re-lease of existing buildings to the purchase of raw land and the sale of improved parcels to others. Developers initiate and coordinate those activities, convert ideas on paper into real property, and transform real property into urban fabric. They create, imagine, finance, and orchestrate the process of development from beginning to end. Developers often take the greatest risks in the creation or renovation of real estate—and they can receive the greatest rewards.

Developers must think big, but development is a detail business. Successful developers know that they must double- and triple-check everything. The clause overlooked in a title policy or the poorly done soils test can have serious consequences. Developers are ultimately responsible for their projects, and even if someone else is negligent, developers must deal with the consequences of an error or omission. A good developer is flexible, ready for the unexpected, and adaptable to rapidly changing conditions. During the approval process, for example, a developer must often negotiate with neighborhood groups that seek major changes to a proposed project. If the developer is unwilling to compromise or if the project has been conceived in a way that does not allow flexibility, the group could have the power to kill the project altogether. A developer must be able to address all stakeholders’ concerns without compromising the project’s economic viability.

Managing the development process requires special talents—not the least of which is common sense. Developers must have a clear vision of what they want to do; they must also demonstrate leadership to communicate and deliver that vision. Successful developers by nature often have strong opinions, but they must be good listeners and collaborators. They cannot possibly be authorities on the myriad fields of expertise involved in a project, so their success depends on their ability to coordinate the performance of many other parties—and on their judgment and skill in putting those inputs together in a coherent way.

Developers work with a variety of people and groups: most obviously, building professionals, including surveyors, planners, architects, and other designers; specialized consultants, contractors, and tradespeople; and tenants and customers hailing from many different businesses—sometimes with divergent goals. Developers must work closely with attorneys; bankers and investors; planners; elected and appointed officials at the city, regional, and state levels; and an increasingly complex network of regulators and inspectors. In addition to professionals, the developer must communicate effectively with citizens groups, homeowners associations, and community organizers with varying degrees of sophistication. Success comes from knowing the questions to ask and whom to ask, having a familiarity with best practices and rules of thumb, and being able to sift and evaluate conflicting advice and information.

The spark of creativity—in designing, financing, and marketing—can distinguish successful developers from their competitors. Management of an innovative project team is a balancing act. Too much guidance may stifle creativity; too little may lead to a chaotic process and unmanageable results. obtaining creative, cutting-edge work from the team without exceeding the budget is one of the fundamental challenges of managing the development process, and it requires the combination of a rigorous overall process along with room for flexible exploratory work within this regimen.

Real estate development is an organic, evolutionary process. No two developments are exactly alike, and circumstances in a project change constantly. For beginners, development often appears easier than it is. Most beginning developers have to work harder than seasoned professionals to keep a project moving in the right direction.

Solving problems as they occur is the essence of day-to-day development, but anticipating the unexpected and managing the risks are the keys to a satisfying career. Laying the necessary groundwork before an important meeting, arranging an introduction to the best prospective lender, creating the best possible setting for negotiations, and knowing as much as possible about the prospective tenant’s or lender’s needs and concerns before meeting with them will help ensure success.

Many developers say that it is better to be lucky than good. According to Phil Hughes, president of Hughes Investments, Inc., “In this business you’d better be lucky and good. Luck may be where opportunity meets preparation, but in our business the developer makes his own preparations and his own opportunities, and it is up to the developer to introduce the two.”¹

The Book’s Approach and Objectives

This book is directed to beginning developers and other professionals who work in or around the real estate industry. Readers are assumed to be familiar with at least one or two segments of this industry, through their daily activities, academic training, or personal investment. Even seasoned professionals may gain a better understanding of the role they play in the development process: What are the rules of thumb concerning the way developers do business with them? What are the critical elements affecting the success of the development? Why does the developer, for example, care about the concrete contractor’s slump test? What type of certification enables a developer to close a permanent mortgage? In short, how does the detailed business of development make great places?

This book addresses in detail five major types of development that beginning developers are most likely to undertake: land subdivision, multifamily residential, office, industrial, and retail. Single-family housing is not addressed except insofar as land developers sell subdivided lots to homebuilders. Each of the five product types is described from start to finish: selecting sites; performing feasibility studies; evaluating alternative approaches; identifying markets and tailoring products to them; financing the project; working with contractors; and marketing, managing, and selling the completed project.

Understanding the Real Estate Industry

The real estate industry is divided into five main product types: residential, office, commercial, industrial, and land. The market for each product type can differ dramatically by region and by location relative to employment centers, transit stops, or other location factors. Interestingly, such historic correlations of value and location no longer necessarily hold across the board. Some suburban nodes, for example, boast office rents higher than their center cities, and examples abound of formerly blighted neighborhoods rapidly gentrifying as they become appealing to changing residential preferences. These kinds of shifting parameters illustrate the successful developer’s need for intellectual curiosity and openness to continuing improvement and education.

Building design and site density represent two other primary dimensions for categorizing different segments of the property market. Each combination represents a different building type, cost structure, and end-user profile. For example, high-rise apartments with structured parking cost much more to build and operate than do garden apartments. Rents must be higher, and to be successful, the market study must demonstrate sufficient unmet demand for units from higher-income people who want high-rise rental apartments in a given location. Choices made in development must continually balance market demands with project economics.

The development process, although similar for each product, is different in detail and emphasis. For example, preleasing is not necessary for apartment development and has no meaning for land development, yet it is critical for office and retail development. Likewise, market analysis for industrial buildings is highly specialized, versus residential or other commercial uses.

The book contains three main parts: an introduction to the development process, discussions of individual product types, and a look at trends in the industry. Chapters 1 and 2 contain an overview of the development process, paths of entry into the business, and strategies for selecting and managing the development team. Chapters 3 through 7 describe development of the five main product types. Chapters 3 and 4 also provide detailed step-by-step summaries of the core processes for development analysis and will serve as references for the other product types. Because many steps are the same for all income property types, chapter 4 describes in detail certain steps common to all product types, such as how to calculate financial returns for the overall project and for individual joint venture partners. After reading chapters 3 and 4, readers should then turn to the sections of the book that concern the particular product type in which they are interested. A final chapter discusses industry trends, emerging issues, and the developer’s social responsibility. Case studies at the ends of chapters 4, 5, 6, and 7 show how the principles discussed in the chapters are used to develop actual projects.

The breadth and detail of this book should not be considered a substitute for remaining up-to-date with market and regulatory conditions. No two communities, and no two projects, are alike, and despite the long history of real estate development, nearly everything is subject to change. New regulatory approaches, construction innovation, even Supreme Court cases can upend longstanding best practices and standards presented in this book. Although this book is intended to be a primer covering all aspects of development, it is no substitute for expert local advice from experienced developers and professionals involved in the process.

A wealth of information is available online to facilitate every step of development—from real-time market analysis and local demographics to government approvals and financing. Indeed, one of the most important trends today is the impact of technology on the conduct of the development process.

Requirements for Success

Developers take risks. At the low extreme of the risk spectrum, developers may work for a fee, managing the development process for other owners or investors. In this role, they might incur a small degree of risk from investing some of their own money in the venture or having an incentive fee that depends on their bringing the project in under budget or with faster leasing at higher rents. At the other extreme, developers can undertake all the risk, investing the first money in the project, taking the last money out, and accepting full personal liability. Failure could mean bankruptcy.

Developers also manage risk. They minimize, share, hedge, or eliminate risk at each phase of the development process before moving forward. They attempt to minimize the risk at an early stage to make sure that the risk of investment for upfront costs—when a project’s prospects are most uncertain—is balanced with the likelihood of success. Beginning developers must usually accept greater risk than experienced developers do, because beginners lack a strong bargaining position to transfer risk to others. They must often begin with projects that experienced developers have passed over. Beyond this basic truism, though, Phil Hughes argues that beginning developers often take on more risk than they have to. They need to look harder to find the right opportunity, but every project includes opportunities to reduce risk.

Many people are attracted to development because of the perceived wealth and glamour associated with the most successful developers. To be sure, development can offer enormous rewards, tangible and intangible. Besides the economic considerations, many developers relish the role of creating lasting contributions to the built environment. The feeling of accomplishment that comes from seeing the result of several years of effort is, for this type of person, worth the trouble and sleepless nights along the way.

Development’s risks, however, require a certain kind of personality. Individuals must be able to wait a relatively long time for rewards. Three or more years often pass before the developer sees the initial risk money again, not to mention profit. Generally, this delay is growing as projects and approvals become more complicated. Developers risk losing everything they have invested at least once, and sometimes several times during the course of a project. Events almost never go exactly as planned, especially for beginners or those moving into new product types or markets. Developers must be able to live with some level of constant risk.

Development can be extremely frustrating. Developers depend on a variety of people outside their own organization to get things done, and many events, such as public approvals, are not under the developer’s control. one developer recalls that when he started developing single-family houses, he often became frustrated when work crews failed to show up as promised. only after he learned to expect them not to show up and was pleasantly surprised when they did, did building become fun. The public approval process has become much more time-consuming and costly over the last two decades, greatly reducing the developer’s control over the process and adding considerably to risk, especially in the early stages when risk is already highest.

The impact of local politics on real estate development cannot be overstated, especially for a beginner. A project’s feasibility is a function not just of market demand but also of what the local jurisdiction demands. A project might work financially but if local officials, or neighborhood activists, don’t agree, approvals will not be granted, and the project will not go forward. It is crucial for the developer to build a good relationship with local officials and the community and to understand their interests.

Until beginners develop sufficient skill and self-confidence, they should probably work for another developer and learn about the process without incurring the risk. Even with experience, developers often start with a financial partner who bears most of the financial risk. one way to limit risk is to start on projects that involve leasing or construction risk but do not involve all the risks in a completely new development: an apartment ...