Professional 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.

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.

A USE LOOKING FOR A SITE

Who Becomes Developers? How Do They Start?

ULI members who were identified as development professionals were surveyed about their experiences as beginning developers in August 2010. The following summary, based on the 239 completed surveys, gives an idea of the background of people in the development industry who are active in community development.

A PROFILE OF DEVELOPERS

All respondents are actively engaged in real estate development. Figure A shows the breakdown of the types of firms represented.

Figure B breaks down respondents’ developments over the previous ten years by property type.

In addition to development activities, respondents had also been involved in the purchase of land and completed residential, office, retail, and industrial projects (figure C).

CAREER PATH TO DEVELOPMENT

Those surveyed identified their previous three positions. Respondents represented a broad range of experiences, including accounting, brokerage, construction, lending, real estate consulting, and law, among others (figure D). Other than development, project management was the most common step on the development career path. First jobs showed a wide range, indicating that brokerage and construction, among others, offer good entry points to development. Many respondents had spent time furthering their education, with 15 percent identifying it as a first step. Approximately 7 percent of respondents have held only one job on the way to their career, as indicated by the drop in responses as one moved from the first to the second job on the table.

The most popular product type for respondents’ initial project was residential development (figure E). Their second and third projects were more evenly split among land development, residential, retail, and office development. The most popular product type for the developer’s third project was evenly split between residential and office development. The increase in office development involvement likely occurred in part because by their third project, respondents had gained the greater experience required for office development.

In running their businesses, respondents devoted their primary attention to the front end of the development process: site acquisition, procurement of regulatory approvals, market analysis, and design (figure F). Site acquisition, the regulatory and approval process, and design and planning were most identified as the development phases developers had concentrated on.

LESSONS LEARNED

If they had the opportunity to redo their projects, most respondents would have done certain things differently. Many respondents highlighted mistakes made at the front end of their projects that came back to haunt them, such as team selection, due diligence, and the entitlement process. During planning and construction, the majority cited the importance of selecting competent, experienced team members and of effectively coordinating them. As James Ellison, cofounder of Mode Development, LLC, wrote: “Projects are very complex and are comprised of a very eclectic cast of characters. Your job as the developer is essentially the same as the director of a movie. You have to make the best of your location, get the best out of your actors, and stay within the budget of the studio all in a short period of time. Organization, accounting, relationships are all key.” Having partners that understand your operations and vision is essential, and many respondents highlighted the importance of thoroughly vetting team members and joint venture partners.

Another major concern was being skilled at the intricate details of the approval process to avoid resource-draining delays. Many spoke of the importance of forming strong relationships with local regulatory bodies and bringing in the community early in the process. Brian McCarl, vice president of acquisitions for Newland Communities, echoed this sentiment: “Real estate is a unique endeavor that often engages community and political structures in decision making about how to deploy private capital for private ownership. All real estate is in essence a public/private partnership. Failure to factor in the public decision-making process and values into decision making is a good recipe for failure. Do your homework at the neighborhood, city, and state level before you invest and start spending money.”

Another dominant concern was thorough due diligence in acquisitions. Many agreed that a bad acquisition is almost impossible to rectify, although many successful deals made their profits in the acquisition and entitlement phases. Land value comes through entitlements so developers should ensure that their acquisitions have approval strings attached. Understanding the market through extensive preliminary study will alleviate the risk of getting stuck with an unworkable project. As Michael Brodsky, CEO of Hamlet Companies, summed it up, “Time spent planning lessens time spent fixing.” Many highlighted that developers should use the market to shape their decisions, think about the end user, and not seek to impose a use on a site. “Focus on what the market is and wants, not what you want or what zoning allows,” wrote George Casey, president of Stockbridge Associates.

It is crucial to recognize which obstacles are immediate, short term, and temporary, and which ones are deal breakers. Many respondents addressed the importance of maintaining a critical distance from the project and allowing research and a conservative pro forma to generate a commitment to the deal—not an emotional excitement for building or site. As Chris Squier, vice president of mixed-use development for Crosland Development, LLC, wrote, “Don’t fall into the trap of entering into a project with a ‘best case’ pro forma that only gets worse as time goes on.”

Many discussed the importance of knowing when to walk away. Although it is difficult to let go of a project, knowing when to cut losses differentiates successful developers. Stephen Arms, managing member of Marthasville Development, LLC, gave the following advice: “Don’t be afraid to walk away from a project if conditions change. Believe in ‘sunk cost’ accounting (also known as the more common phrase ‘don’t throw good money after bad’).”

Looking forward, a number of those surveyed commented on the increased importance of urban, mixed-use, and infill projects, as well as sustainable development. “Sustainable development practices are not optional. A balance between economic, environmental, and social objectives must be planned into every 21st-century project,” advised Elias Deeb, president and owner of Cedrus, LLC.

FIGURE A | Firm Characterization

FIGURE B | Projects Built by Respondents, Past Ten Years

FIGURE C | Projects Purchased by Respondents, Past Ten Years

FIGURE D | Most Typical Career Paths to Development

FIGURE E | First Three Projects (%)

FIGURE F | Primary Areas of Focus (%)

One exception is that smaller “problem” deals may offer an opportunity that experienced developers have passed over. For example, larger developers may decide that a site requiring special attention to curing problems with easements, boundaries, or flooding is not worth the necessary time and effort. A beginner, however, might be able to tie up the property at little cost while working out the problems. Another opportunity can be found with sites owned by local and state governments and redevelopment agencies, because large developers may prefer to avoid government red tape. Unless the site is simply put up for auction, however, the beginner might need to demonstrate a track record to convince government officials to work with him. Nonetheless, keeping officials aware of continuing interest in a project as the government works through various procedures and public hearings can give the beginner an edge when the agency finally issues a request for proposals or advertises the property for sale.

The Concept of Present Value

An understanding of present value is essential for developers.a Present value analysis equalizes the time value of money. Because one can earn interest on money, $100 today will be worth $110 in one year at 10 percent interest and $121 in two years with annual compounding. Ten percent interest represents the opportunity cost if one receives the money in, say, two years rather than now, and meaningful comparison of sums accruing at different times requires discounting each to comparable present values.

The present value of $121, received in two years, is $100. That is, the discounted value of $121 at a 10 percent discount rate, received in two years, is $100 today. If the discount rate (opportunity cost rate) is 10 percent, then it makes no difference whether one receives $100 today or $121 in two years.

The formula for calculating present value is as follows:

where PV is present value; FV is future value; r is the discount rate; and n is the number of years. Thus, the present value of $121 received in two years at a 10 percent discount rate is

The landowner’s dilemma about developing the land immediately into single-family lots or waiting for five years to develop a shopping center is solved by applying present value analysis. Suppose, for example, that land for single-family development today is worth $100,000 per acre ($1,076,400/ha), whereas land for a shopping center would be worth $200,000 per acre ($2,152,800/ha) in five years. If the personal discount rate is 10 percent, then $200,000 to be received in five years is worth $124,184 today—clearly more than the value of the land if it is developed for single-family houses. The best option is to wait. In this example, if the discount rate is 20 percent rather than 10 percent, then the present value of $200,000 is only $80,375. At the higher discount rate, the best decision is to develop the land for single-family lots today.

Which discount rate—10 percent or 20 percent—is appropriate? The answer depends on risk. Generally, land development (except for single-family houses) is considered the riskiest form of development because of uncertainties about entitlements and market absorption, which are exacerbated by the length of the approval process. Development risk for buildings depends on local market conditions. Office development is considered riskier than industrial or apartment development because the lead time is longer and space has been oversupplied in many markets.

Because of the high rates of return and high risk associated with development, most developers have personal discount rates of at least 20 percent.^b That is, they expect to earn at least 20 percent per year on their investment.

Discount rates consist of three components:

Real return rate + Inflation + Risk = Discount rate premium

If inflation increases to 10 percent, then a developer’s required return increases to 25 percent. The risk premium depends on the particular property and might range from as low as 4 percent for a completed office building to 15 to 20 percent for a recreational land development.

^aFor further discussion of present value, see Mike E. Miles, et al., Real Estate Development: Principles and Process, 4th Ed., Washington, D.C.: Urban Land Institute, 2007, pp. 207–209.

^bTechnically, the target discount rate is the rate for which the net present value of a project is greater than or equal to zero. When the NPV => 0, then it delivers a rate of return on equity that is => the discount rate. This discount rate is also known as the target internal rate of return.

In the final analysis, a developer’s strongest assets are a reputation for integrity and an ability to deal in good faith with a multitude of players. A large developer may be able to outlast the opposition in a contentious deal, but the best advice for a beginning developer is to avoid such situations altogether.

Managing the Development Process

Development is distinct from investment in income-producing properties, because it involves much more risk. Many firms and individuals invest in operating properties, buying existing properties and managing them for investment purposes. Investors often incur some risk in leasing and may make minor renovations that entail some construction risk. Developers, on the other hand, take on a set of additional development risks. Most developers also hold on to properties, at least until liquidity is required, after they are developed—that is, during the operating phase—thus incurring the ongoing risks associated with operations.

Developers may take on different degrees of ownership and risk depending on their ownership structure and the complexity of the project. Developers who operate alone and invest only their own money are said to be 100 percent owner/developers. They furnish all the cash equity, accept all the risk and liability, and receive all the benefits. The concept of a 100 percent owner/developer is useful for quickly analyzing development opportunities, because if a project does not make economic sense in its entirety (as viewed by someone who has all the risks and rewards), it will make even less sense as a joint venture or other form of partnership.

No generally accepted definition exists to determine who is a developer and who is not, but a developer can be defined as the person or firm that is actively involved in the development process and takes the risks and receives the rewards of development.⁴

Many people involved in a development project incur risk. Those who design, build, and lease a building for a fee are agents of the owner and are developers insofar as they are engaged in the processes of development, but they incur no risk if the fee is fixed. If, however, the fee depends on the project’s success, the individual accepts some performance risk associated with development. Development risk is associated with delivery of the entire project and thus may be distinguished from performance risk associated with individual tasks (such as contractors who accept construction risk when they have a fixed-price contract). Most rewards in development are proportional to the risk one takes on. Experienced developers are able to transfer some or most of the risk to others by using other people’s money or by finding a lender who will give them nonrecourse financing (lending without personal liability). They still carry the burden of delivering a successful project, however. In almost all cases, developers will have something at risk, such as front money for feasibility studies, investment in preliminary designs, earnest money, or personal liability on construction financing.

Development companies increasingly serve as development managers for major institutions. In this role, they perform all the normal functions of developers except that they bear little or no risk. The institution—a bank, an investment group, an insurance company, a foreign corporation, or a major landowner—bears the risk. The developer works for a management fee and usually a percentage of the profits (10 to 20 percent) if the project is successful.

Historically, developers have preferred to own real estate rather than to manage it for others, because ownership has enabled them to leverage completed projects into new deals as they amass wealth. Nevertheless, major developers have increasingly accepted roles as managers, either to keep their staffs busy during slow periods or to enter new markets with minimal risk. Firms that succeeded in finding these scarce roles in the Great Recession of 2007–2009⁵ have benefited from steady, though modest, cash flow.

Property management, brokerage, tenant representation, construction management, and other tasks in the skill set of developers can become, at any time, valuable, or at least sustainable, as service businesses. Developers building an organization should know, however, that in times of distress, competition for these service contracts increases dramatically, and banks and other property owners will find themselves in excellent bargaining positions for these services. Truly outstanding or niche businesses stand a better chance of providing cash flow in these periods.

How Four Developers Got Started

CHICKIE GRAYSON

Chickie Grayson is the president and CEO of Enterprise Homes, Inc., where she has been for 23 years. Her interests in problem solving and “seeing something happen” originally attracted her to the profession. She says, “Seeing ‘sticks and bricks’ and knowing you’re providing people with a great place to live, but also seeing homeowners and renters and how meaningful the development or new home is to them,” are all very rewarding aspects to her job. She describes developments as “one big puzzle” and relates the need to have a lot of balls in the air; she enjoys keeping them moving in the right direction. Developers are the ones who coordinate all the players and really make the communities happen, she notes. She defines a good developer as someone who knows “a little about everything, not a lot about anything, but knows where to get it.” Her secret to success is to constantly move things forward and not let any problems stop her.

Grayson’s first development was four communities in Baltimore City, Maryland, for a total of 176 for-sale homes. The development and construction schedule was aggressive. The interest level was so high that the company was able to presell all the homes. The homes were modular and constructed in a factory, which helped with the fast-paced construction timeline. The funding for the development was a mix of federal (one of the last Urban Development Action Grants), state, city, and other resources. This mix remains typical of Enterprise’s approach to financing developments today. Grayson has received many compliments from homebuyers. “I didn’t buy a home; I bought a community,” said one resident, reflecting the pride felt by both owners and renters, and the energy and hard work that the residents contributed to making a great place to live. Grayson feels that this is a sign of a successful partnership: “Enterprise provides the material; the community provides the pride. Enterprise works hard with the community beforehand to make sure they’re providing the right product, then follows up afterward to learn about what the residents liked and what could be improved for the next project.”

Typically, Enterprise’s projects come in under budget. The staff works hard in the beginning to make sure that they have the numbers right; 50 percent of the work they do is up front, before they even close on a property. Grayson keeps a list of lessons learned and opportunities for future projects and shares advice from this experience. She says that utility companies can be challenging to coordinate but are essential to the project, so building good relationships with them is key for future developments. Soil problems can also slow projects down—they had significant problems in the Baltimore City development—and she recommends performing as many advance soils tests as possible.

Grayson offers advice for those starting out: “You don’t need a lot of expertise; that will come on the job. You do need to be really curious and always learning.” She identifies the challenge of always having enough capital as the most difficult part of getting started. “It typically takes two to four years to see revenue; meanwhile, you need to make money to stay in business, which requires capacity and expertise.” Her approach to developing housing is twofold: “To develop, you need land, money, will, and perseverance. For success, you need a great product at a very competitive price.”

TARA HERNANDEZ

Tara Hernandez is president of New Orleans–based JCH Development where she specializes in adaptive use of historic buildings for mixed-income and mixed-use projects. Public/private partnerships and complex financial structures are part of her expertise and competitive advantage.

After earning her master of science in real estate development from MIT in 1992, she returned home to New Orleans and began her own real estate development and consulting firm. She assisted the community development departments of several financial institutions and local nonprofits with their redevelopment efforts. Their primary mission was to redevelop blighted housing and restore neighborhoods in many historic districts in the city, through homeownership initiatives. Many of these efforts focused on Community Reinvestment Act goals. Additionally, she developed her own projects, with a similar strategy of restoring blighted housing into homeownership opportunities for market-rate households. She redeveloped in several neighborhoods throughout the city. The strategy was based on the results of her graduate thesis work on redeveloping neighborhoods. She was hired by a financial institution whose strategy included the redevelopment of a historic neighborhood adjacent to a credit union it had recently acquired. They targeted a 16-square-block area and acquired all the vacant and blighted residential buildings for redevelopment as single-family homes for first-time homebuyers. A pool of people were waiting to move in, she recalls, so the homeowners were actually able to participate in certain decisions, such as color selections for their units. These buildings were laid out in a “double-shotgun style” with one room adjacent to another and little privacy. She converted the old layout into single-family dwellings and created privacy for the future owners.

Hernandez looked for ways to collaborate with HRI Properties, whose owners she met while in school. On breaks from MIT, she would return to New Orleans and meet with members of the real estate community—from all aspects of the profession, including development, finance, and consulting. In this way, she began building relationships within the New Orleans real estate community that still continue today. The principals at HRI continued to reach out to her for an opportunity to work together. Timing worked out well with an opportunity to redevelop a project in Shreveport that HRI was starting. That was a transitional time for her as she was expecting her first child and had an increasing desire to work on larger projects. She went on to redevelop several large conversions of historic industrial buildings into mixed-income lofts in Shreveport and New Orleans, Louisiana, as well as in St. Louis, Missouri. She also became a member of the executive team and worked at the firm for almost eight years.

After Hurricane Katrina, Hernandez decided to capitalize on opportunities for creative redevelopment. Creativity is one of the top traits that a developer must possess, she asserts, along with patience, persistence, and attention to detail. Above all, she believes the two keys to successful development are teamwork and communication. Her strategy has been to involve all team members early in the process (including investors, architects, and contractors) and to take a collaborative approach. Often, this approach manages time, minimizes errors, and provides an outlook of potential obstacles or challenges that the team may face.

As a result, all her projects have been completed on or ahead of schedule and on or under budget. On one project, a particularly effective aspect of this collaborative approach involved bringing in a facilitator every three months to mediate with key people on the team (including subcontractors) and to keep clear, honest communication. This process raised issues that may have otherwise gone unmentioned. “The culture and environment are better if you lay the cards on the table and keep everyone’s interests aligned,” she explains.

Another key element to her success is being proactive. She tries to anticipate as many unforeseen conditions as possible, and historic buildings often have many. “You’re not going to think of everything,” she cautions, “but if there’s anything you’re uncomfortable about, look into it and minimize the risk as soon as possible. You will never cover everything, but trying will help.”

The most difficult part of starting a development company is the uncertainty. Funding predevelopment for an uncertain amount of time can be challenging, and nothing ever goes as anticipated. “There are usually one to two years of predevelopment; then you break ground and need time to lease it up,” she explains. These prolonged periods can add up before one realizes any revenue. Often a new developer is required to pay out of pocket for all aspects of the predevelopment process, including funding approvals.

JCH Development has incorporated many sustainable aspects into its practice. The focus on historic adaptive reuse is a major element, since no demolition is required. One current example is the redevelopment of a former mayonnaise-manufacturing facility into Blue Plate Artist Lofts, comprising 72 mixed-income residences. The lofts will offer a preference for artists and will be built with sustainability in mind. JCH is also working with the local university to provide faculty housing close to campus, to place a priority on energy efficiency, and to sponsor a central recycling program for all its properties, helping to minimize waste, reuse materials, and recycle materials, such as extra wood and mulch. Through these commitments, JCH is able to implement some component of sustainability into every property. In addition, it is working on several retail projects that will help create urban mixed-use districts that employ innovative aspects of the urban environment. From the beginning, the team considers everything. “We build to a standard: would I want to live there and shop there myself?” Hernandez notes. Beyond that, they consider what might make each property a unique experience and a standout from other developments. She concludes, “Historic buildings create opportunities to take advantage of things that are already in place…. You have to think through the future.”

DON KILLOREN

A founding principal of Celebration Associates, based in Virginia, Don Killoren has been involved in the development of master-planned communities since 1979. He has served as general manager of award-winning communities throughout the Southeast and has been chair of ULI’s Community Development Council.

After graduating from Georgia State University in 1972, Killoren began as an assistant property manager for John Portman in Atlanta and transitioned to the company’s development team, focusing for four years on the development of Atlanta’s Peachtree Center. Killoren counsels those entering development to work first for someone else, seeking out a capable and inspiring individual, and to worry about the specific job later. “Find a leader, someone who is nurturing and who lights a fire under people. It helps if the organization is small … allowing the beginner exposure to all aspects of the business, rather than to a limited administrative, analytical, or marketing role.”

Having gained property and project management skills, Killoren left to work with Thomas E. Lewis, former legal counsel of Portman Properties, managing a 2,500-acre (1,012 ha) community in Florida and broadening his expertise to residential land development and homebuilding. As president of Lewis-Killoren Properties, Killoren says he began to discover his real talent for process management, organization, and coordination of the entitlement, development, and construction process. “Many people in the real estate business misdiagnose their skills,” says Killoren. He counsels beginning developers to consider their strengths and weaknesses, as the diversity of project types and job descriptions in real estate means there are lots of opportunities for individuals to do jobs they are only mediocre at. He advises young developers to focus on the parts of development where they excel and to find partners, staff, and consultants to do an equally good job on the tasks outside your “sweet spot.”

Joining community developer Erling Speer, Killoren helped develop the ULI-award-winning Mariner Sands golf course community and country club, where he began to understand the increasing importance of “software,” or community organizations and programming. Increasingly integrated and sophisticated structures for clubs, community governance, and educational functions have grown from their beginnings in golf course development to become a part of most master-planned communities, and Killoren foresees the trend continuing. “Education, health care, and community-based volunteerism are all becoming a more integrated part of the community development toolkit, and real estate project managers must manage these entities with the same intensity they apply to physical planning and construction. We’re moving from building stuff to building community.”

Following his tenure at E. Speer & Associates, Killoren joined the Walt Disney Company as director of community development. As part of Disney’s expansion from core entertainment and hospitality businesses into community development, Killoren was tapped for a leading role in the development of large retail and mixed-use residential projects, including the new town of Celebration, Crossroads Shopping Center, and the Magnolia Creek community. Celebration, particularly, served as a laboratory for refinement of new urbanist ideas, and the architectural precedents and controls there have informed Killoren’s efforts to shape identity in subsequent projects. Lessons learned on these Florida projects were exported, as Killoren assisted in the shaping of residential development strategy for EuroDisney, near Paris.

In addition to development projects, Killoren spearheaded a company-wide environmental strategy, culminating in the creation of the Disney Wilderness Preserve. This 12,000-acre (4,856 ha) preserve is essentially a giant wetland mitigation project, offsetting impacts from Disney’s and other entities’ development activities, which has been managed according to state-of-the-art resource management plans. The result is a national model for ecological restoration and sustainable land management and a crown jewel in the Florida Nature Conservancy.

With several major projects under their belt, Don Killoren and Charles Adams left Disney in 1997 to found Celebration Associates (CA), a development and advisory firm. The decision to strike out on their own was difficult, but Killoren recalls, “Development at Celebration was winding down, several of the key players in the division had left, and we found ourselves knowing a lot about building the types of projects others wanted to build, and wanted to see built in their communities.” CA’s first client was its former employer, the Walt Disney Company.

Assembling a partnership, CA assessed its strengths and divided tasks into financial (primarily Adams), planning and development (primarily Killoren), and sales and marketing (shared responsibility). Building a team, the partners looked for “smart, energetic, and intelligent utility players” who could manage many different kinds of activities. In the early years of the partnership, they focused on consulting, requiring less capital investment, and structured deals to work toward sweat equity positions. To maintain a lean structure, they depended on consultants for virtually all nonexecutive functions. They still prefer to staff projects, rather than the central office, but have expanded to a group of partners that oversees particular areas of expertise, such as sales and marketing or design, in all CA projects, even as these individuals may take a particular role within one or more project teams.

The firm has built strategic alliances with a major landowner-investor and developed several linked communities in Clear Springs, South Carolina, as well as the Governor’s Club community in Chapel Hill, North Carolina. It has also partnered with Crosland, Inc., a diversified development and construction firm in Charlotte, to develop the award-winning Homestead Preserve and Bundoran Farm communities in Virginia, and more recently the redevelopment of the Mount Washington Resort in New Hampshire.

As the extended recession has slowed development projects across the Southeast, Killoren has come to appreciate the lessons learned in prior downturns over his career. CA’s early and necessary emphasis on consulting, which the partners have maintained over the years as a means of “keeping sharp,” has become an essential strategy of survival for firms like Celebration Associates. The company’s relatively lean corporate structure and dependence on consultants and strategic partners have enabled it to adapt more nimbly than most, and its facility with financial reporting and investor communication, honed in a large organization, has preserved its reputation in a time when all developers are having unpleasant conversations with lenders and investors.

Reflecting on his nearly 40-year career, Killoren says his most important lesson has been that for an individual to succeed in development over the long haul, his interest cannot be solely financial. “It has to be about more than money. A good developer is giving an enduring gift to the community. Find something you like, do it well, and make that amount of money adequate.”

JAIR LYNCH

Jair Lynch is the president and CEO of JAIR LYNCH Development Partners, “an urban regeneration company that specializes in the responsible transformation of urban markets.” His career inspiration began at Stanford during his undergraduate years, where he studied urban design and civil engineering. He started there two months before a significant earthquake shook San Francisco. Lynch recalls that this event turned the city “into a laboratory for urban designers and civil engineers. Questions arose, such as what happens when you remove a highway from a city? Highways had been dividing the community for years, and it was fascinating to watch the city rebuild.” Travel also influenced Lynch’s passion for urban environments. As a world-class athlete (his impressive résumé includes winning a silver medal on the parallel bars as captain of the U.S. Olympic gymnastics team in 1996), he has enjoyed traveling to many cities across the globe. What fascinates him most? “How cities and places have evolved over time, and how things work,” he shares.

After graduation from Stanford, Lynch’s first job in the development world was for Silicon Graphics, Inc., as a project engineer/manager in its Real Estate and Development Department. The company was a manufacturer of high-performance computing solutions, and its business strategy was to attract the best talent by providing new amenities and developing facilities around the country and the world. Because the company was accustomed to young people in positions of leadership, Lynch was allowed much more responsibility than he might have had elsewhere as a 24-year-old without much experience. As he says, “They gave me a tremendous amount of latitude and allowed me to make decisions beyond my level of experience. On the other hand, I had a 24-year-old’s perspective and knew what kinds of things young programmers would want in their work environment.” Lynch assisted in creating innovative workplaces with amenities such as juice bars and yoga studios that are now considered standard in the high-tech industry. The Mountain View Campus was later sold to Google for its headquarters.

He worked at Silicon Graphics for only four years, but gained an extraordinary amount of experience since development in the Silicon Valley moves so quickly. He says that the most critical aspects of his first experiences were the latitude and responsibility that he was given, the speed of the decision-making process in Silicon Valley, and his desire to learn.

The next stage that significantly influenced Lynch’s career path occurred at Harvard University, where he focused on his ideas about development and created a hierarchy approach to urban regeneration. His framework blossomed into a structure that he calls “The Five Stages of Development.” The five-stage progression is categorized as “1: Neglect; 2: Hope; 3: Rebirth; 4: Awareness; 5: They’re there” and represents a perspective that is central to the way he approaches projects today.

In 1998, Lynch moved back home to Washington, D.C., but not many developers there were convinced that opportunities existed in the urban neighborhoods. He opened his own firm out of necessity and a drive to have a positive effect on neighborhoods. His company’s first project was the Thurgood Marshall Center—a rehabilitation of the first African American YMCA, repurposed as a mixed-use complex of offices, a conference center, and a school. The project had financing and construction issues, but the most challenging part was making the deal bankable. “It languished for a long time with the grand idea of being one use—a museum. It needed to be mixed-use, but getting people used to that idea was challenging.” In addition, the zoning had to change in order for mixed use to even be an option, and many minds had to be convinced for that to happen. Lynch finally knew that the project would materialize when the financing was secure. Bringing in an anchor tenant was key to obtaining the financing; until that point, it could have not happened. As part of the financing structure, the firm received federal funding through a Community Development Block Grant.

This project set the stage for Lynch’s business model and led to a more robust thesis on the reimagining of places. His firm focuses on places, not just buildings. It is committed to taking care of endangered places so they don’t get swept away by market swings. Regeneration typically takes 10 to 20 years for the whole process; as a young firm, the partners have not been able to follow one neighborhood from Stage 1 through Stage 5 yet, but that is the goal. Lynch asserts that defining these stages and positioning themselves to follow a neighborhood through each are one way to hurdle the high barrier of entry in the field of development. He elaborates, “Often, complex financing is involved. If we can provide a visioning and a master plan, later come back with a library, and later with a hotel, we can build a longstanding relationship with the neighborhood and develop a level of trust that it would take other developers longer to earn.”

Lynch attributes his success to his ability to evolve and not to get stuck in particular formats. “Being someone who creates new environments, you have to be willing to change dramatically. This involves recognizing new definitions of urban conditions.” His desire to be part of that change is one of the reasons he is so resilient. His primary advice for emerging developers is to recognize the value of getting access to processes and systems very early and learning the basics. “There is a lot of leakage in real estate, and trying to do things on your own too early can cause inefficiencies.”

At each stage, certain items must be completed before moving to the next stage. For example, before lenders consider a mortgage application, the developer usually must provide conceptual drawings, a boundary survey, title information, information about the site’s feasibility, market surveys, personal financial information, and an appraisal. (Because different lenders have different requirements for appraisals, however, it may be wise not to order an appraisal until a promising lender has been identified. Otherwise, another appraisal might be necessary.) The sequence of steps to be taken and even the steps themselves change frequently in development. The rate of change in the development world is one of its major sources of excitement. It also gives beginning developers a better chance to compete with experienced developers, because all developers must adapt to, and keep up with, changing conditions or they will fail.

Advice for Beginning Developers

Three themes emerge from the advice given by members of ULI’s Small-Scale Development Council: (1) be well prepared at all times; (2) work with experienced people, even if they are more expensive; and (3) anticipate delays throughout the development process.

SITE ACQUISITION

• Correctly analyze the purchase price of a site to include usable, not total, square footage.

• Anticipate problems with sellers who are not familiar with real estate and delays while a disputed estate is being settled.

• Analyze the site’s physical constraints, including the availability of utilities.

• Conduct a soils test and check for hazardous waste.

• Identify the site’s legal and political constraints, such as the availability of the required zoning or the existence of a moratorium on building.

• Research the market before purchasing the site.

REGULATORY PROCESS, OBTAINING APPROVALS

• Be prepared to work with the community to resolve concerns and challenges to the project.

• Take time to understand the local political climate.

• Prepare for the local regulatory process and public hearings.

• Use qualified and experienced consultants, lawyers, and architects to give your project added credibility.

• Anticipate and do not underestimate delays in the approval process.

PRODUCT SELECTION, MARKET, AND ECONOMIC FEASIBILITY

• Remember that when an opportunity is obvious, it is obvious to everyone—resulting in a great deal of competition.

• Develop toward the higher end of the market for your product type, where there is more margin for error. Low-end projects typically have slimmer profit margins.

• Choose a respected market consultant with a strong reputation in the city where your project is located.

• Decide how much time to allocate for the feasibility study. Some developers consider this step to be vital and maintain that the study should be thorough; others feel it should not be belabored.

• Make sure that extensive primary research accurately identifies all competition, whether under construction or still on the drawing boards.

DESIGN, SITE PLANNING, ENGINEERING, AND CONSTRUCTION

• Do not complete the design without paying attention to the market study.

• Work closely with the architect and the contractor.

• Be careful not to ignore important information, even if it requires redesign or additional approvals.

• Use a flexible design that can be easily adapted to different tenants’ needs.

• Accept the design and recognize that it will never be perfect.

• Spend sufficient time and money to check all references before retaining contractors and subcontractors.

CONSTRUCTION AND DEVELOPMENT FINANCING

• Establish relationships with several lenders to eliminate lengthy delays.

• Deal with experienced lenders.

• Make adequate allowances for contingencies.

• Remember that it could take three to four months to process a $10 million loan—even if the lender says that it will take only six weeks.

• If the market softens, be able to cover interest out of your own pocket until the market comes back.

PERMANENT FINANCING

• Establish good communications with the lender.

• Prepare a detailed, professional presentation package for the lender.

• Secure the permanent loan before beginning construction. (Beginning developers might be forced to do so, even if they would prefer to wait until after the project is built and leased.)

• Be aware of trends in interest rates.

EQUITY FINANCING

• Investigate the financial records of sources of equity.

• Find two or three compatible partners who can provide or raise equity for the project.

• Do not give away too much equity position to secure funds, because nothing may be left to give if you come up short.

JOINT VENTURES AND PARTNERSHIPS

• Structure a fair deal so that no partner is burdened with excessive risk and meager profits.

• Make clear who is in charge of the project.

• Avoid establishing goals that conflict with those pursued by other partners.

• Have agreements ready to cover dissolution of the partnership.

• Monitor changes in tax legislation that could affect returns.

• Establish a record of regular, honest communications with partners.

MARKETING AND LEASING

• Be prepared for unanticipated changes or a weakening market.

• Find a broker you trust and can work with.

• Understand the importance of marketing the project yourself.

• Create a suitable tenant mix for commercial projects.

• Be specific about tenant improvements and tenants’ responsibilities in the lease, and include escape clauses for your own protection.

• Be creative about concessions. Consider buying stock in a tenant’s startup company, paying moving expenses, or providing furnishings.

• Understand the implications of leasing versus sales on tenants’ earnings and balance sheets.

• Advertise that you have made a deal or signed a lease.

• Recognize brokers with incentives, such as dinners and awards.

OPERATIONS, MANAGEMENT, AND MAINTENANCE

• Pay close attention to building management and operations. Find a first-rate building manager.

• Budget properly for postconstruction maintenance.

IN GENERAL

• Stick to geographic areas and product types with which you are familiar.

• Think small. Find a first project that is within your financial capabilities and can be developed in a reasonable amount of time.

• Never begin a project just because you have financing available.

• During the feasibility stage, keep investment in the project low to maximize your flexibility

• Do your homework. Know what the holes in the market are and how to plug them—quickly.

• Never enter a negotiation that you are not prepared to leave.

• Attend to details. Whether you are designing a building or negotiating a lease, you personally must be on top of every detail. You must rely on your professional consultants, but if you do not understand the details, you should arrange for someone else to help you.

• Do not be afraid to make a nuisance of yourself. The people you are dealing with are usually very busy and hard to reach. You may have to make several telephone calls or personal visits before you talk to them. Learn to be tenacious—nicely.

• Do not deceive yourself by ignoring facts and warning signs as they are presented to you. Be aware that self-deception occurs most often with evaluation of the market.

• Increase the time you think you need to develop a project—perhaps by twice as much. Do not promise cash payments to investors by a certain date. Be neither overly optimistic nor overly conservative in your assumptions.

• Be able to turn on a dime and switch your strategy instantly.

• Follow up on everything. Never assume that something has been done just because you ordered it.

• If you promise something to a lender, a professional consultant, a tenant, or a purchaser, deliver.

• Communicate honestly and often with your lenders and investors. Avoid deals that show early signs of being contentious.

• Recognize that the buck stops with you. A million excuses can be found for things that go wrong in a development project, but you have the ultimate responsibility for ensuring that they go right.

The key to successful development is serving the needs of a particular segment of the market in a particular location. In almost every instance, it also means serving the needs of a particular individual (whether a mayor, corporate president, business owner, landowner, or homebuyer), who must have his or her needs met in a particular manner. Above all, it requires an understanding of what the local market is missing. No one—not even the most experienced developer—has a monopoly on this knowledge. Beginning developers succeed by identifying an opportunity and pressing ahead. They will face obstacles that they cannot envision in advance, but perseverance, hard work, and integrity will enable them to succeed.

1. Phil Hughes, president of Hughes Investments, Inc., Greenville, South Carolina, reviewed this chapter and many of his comments were integrated into the text.

2. See ULI’s Directory of Real Estate Development and Related Education Programs (10th ed.) for a list of more than 60 undergraduate and advanced degree programs.

3. Operating risk may be higher for smaller projects than for larger projects, however, because the loss of one tenant can jeopardize the project’s cash flow. Further, a small apartment or small office project costs more to operate per dwelling unit or per square foot. Nevertheless, total development risk is lower for a smaller project.

4. Phil Hughes adds that the definition of a developer ought to include the ability to control the process. He distinguishes between a full developer and a fee developer, who faces many of the same risks and rewards but does not control the project because he works for somebody else. “This is also true for ‘corporate developers,’ who are not satisfying themselves personally but satisfying committees and others. The whole of the corporate committee and the development manager make up the ‘developer.’ A developer has risk/reward and control. Otherwise, he is someone’s employee.”

5. See www.nber.org/cycles/sept2010.html for information regarding the periods referred to throughout this book as the Great Recession and the financial crisis.

6. Accuracy is measured by how narrow the range is around an estimate. Statistically, it is defined by the standard deviation of the estimate. For example, a construction cost estimate of $100,000 with a standard deviation of $10,000 means that 68 percent of the time the actual costs should range from $90,000 to $110,000. A standard deviation of $20,000 means that 68 percent of the time the costs should range from $80,000 to $120,000.

7. “Under the Radar Screen: Success Strategies for Small-Scale Developers,” ULI Spring Meeting, May 11, 2000, Miami, Florida.

1

Introduction

What Is a Developer?

The Book’s Approach and Objectives

Requirements for Success

Paths for Entering the Development Field

Finding the First Deal

A USE LOOKING FOR A SITE

A SITE LOOKING FOR A USE

IMPROVING THE CHANCES OF SUCCESSFUL DEVELOPMENT

Managing the Development Process

REAL ESTATE CYCLES

GETTING STARTED

STAGES OF DEVELOPMENT

Conclusion