Professional Real Estate Development

Downtown @ 700 2nd is a transit-oriented single-resident-occupancy development in Albuquerque, New Mexico. A rooftop solar array provides 30 percent of the heating and 80 percent of the water heating for the building.

Trends and Issues

This chapter explores ongoing structural changes in the real estate industry, emerging demographic and technological changes affecting developers, current planning and development issues, and the changing social responsibilities of developers. This snapshot of current issues, across many markets and product types, emphasizes the larger picture of real estate development, and its role in society. This review is intended to give beginning developers an understanding of long-term changes afoot in the field and to highlight opportunities and pitfalls developers will likely encounter over their careers. The chapter concludes with a discussion of the developer’s social responsibilities to the community at large. ULI and the many contributors to this book are dedicated to the idea that the development of land represents a civic responsibility. To maintain the public’s trust, developers must create products and developments that make a positive contribution to their communities and to the urban environment.

Changing Market Factors

The industry has changed dramatically since the 1970s and 1980s, when many of today’s major developers started their firms. A formative experience for many developers is their first recession. Along with land use regulations, tax incentives, and demographic changes, the cycle of expansion and recession is an important driver of the development business. And for those that survive these cyclical changes, the lessons learned refine developers’ approaches to their work. As Don Killoren of Celebration Associates puts it, “Each time we think we’ll learn, and each time seems to be just different enough.”¹

Double-digit inflation of the late 1970s and early 1980s made real estate a preferred investment, relative to stocks or bonds, because of the perception that it provides an inflation hedge. This thinking led to an increase in investor demand for the tax advantages of real property, and development outpaced absorption often to accommodate investment rather than to follow market demand. The subsequent real estate crash of the late 1980s through the early 1990s catalyzed the most dramatic structural changes in the real estate industry since the Great Depression, some of which are still reverberating today. A number of factors led up to that crash:

In 1989, public concern about damage to the financial sector led to the creation of the Resolution Trust Corporation (RTC), a government institution established to take over bankrupt S&Ls and to recycle their assets back into the market. The RTC marks one of the great success stories of government intervention in the real estate market. Criticized at first for selling assets too cheaply, it succeeded in rechanneling nearly $400 billion in failing assets back into private possession between 1991 and 1995. The speedy sell-off allowed properties to quickly reenter the market, forced lenders to take losses early, and set the stage for recovery. New development would not occur until troubled properties were leased and prices returned to normal. As an ancillary benefit, it has also been argued that cheap commercial space assisted the economic recovery in the early to mid-1990s. In fact, prices and property values did quickly increase, as the incipient economic boom led to rapid absorption of vacant office and industrial space.

Still, there was debate over the success or necessity of the RTC’s actions: Kenneth Leventhal argues that the government caused a 40 percent decline in value during the RTC sell-off, whereas the decline should have been only 10 to 15 percent. “In hindsight, if they had not been so draconian, more of the owners would have stayed in place, the losses would not have been so severe, and we would not have had this whole new breed of buyers—the vulture funds.”² Debate over public sector involvement in real estate investment markets is far from over, as the financial crisis of 2008–2009 has renewed questions about whether banks should hold on to bad assets in hopes that prices recover or sell them off quickly.

INDUSTRY RESTRUCTURING IN THE 1990S

The early 1990s’ crash and recovery led to several fundamental changes in the development industry:

Pearl Qatar occupies an Island In Doha, Qatar. The project Includes single-family and multifamily residential units, industrial space, and retail and entertainment uses.

THE CRISIS OF 2008–2009

As of this writing, several competing explanations exist for the spectacular boom and bust witnessed between 2003 and 2010. Although debate over causes will no doubt continue for years, it is sufficient to say that this crisis has supplanted the S&L episode as the greatest challenge to the real estate industry since the Great Depression, and at least a few points are agreed on by nearly all observers:

Much remains uncertain about the recovery of national economic growth, and of the real estate development business. Markets are far from understanding the long-term effect of this crisis’s equivalents to the 1990s’ RTC: TARP (Troubled Asset Relief Program), the Term Asset-Backed Securities Loan Facility program, and the Public-Private Investment Program. All these programs have allocated Treasury funds to purchase illiquid, so-called toxic assets, and in combination with easing of monetary policy and increased support for government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac have been intended to shore up the financial underpinnings of residential and commercial real estate. The enormous losses to the taxpayer from the bad debts of Fannie Mae and Freddie Mac leave the future of GSEs in grave doubt.

Buzz McCoy calls 2010 “not the beginning of the end, but the end of the beginning.” McCoy points out that as commercial debt matures, a “state of high anxiety” is certain to persist in capital markets for more than a few years, with speculation about the nature of financial regulatory reform and tax changes only adding to already bewildering market risks: “Put yourself in the investors’ shoes; they haven’t been able to write a business plan for two years!” These uncertainties will clearly reinforce conservatism in project finance, including modest leverage, enhanced underwriting standards, increasing recourse requirements for debt, and an implicit reduction in real returns over the next five to ten years.³

Although uncertainty has always been a part of this industry, real estate investors and developers have faced nearly unprecedented stresses as a result of the Great Recession. Though it is difficult to prognosticate, it is certainly possible to look back at some key lessons learned or relearned by developers in recent years:

The business of development will continue, but the terms of “the new normal,” and the future relationships among government, banking, investors, and buyers, are far from clear. John Knott, president of the Noisette Company, suggests that developers over the next ten years will likely offer lower returns, but with more direct relationships to capital. “No more three to four layers of management, fund-of-funds. Instead, the incentive of equity investors will be to drive a hard bargain for control, direct ownership, and accountability of on-the-ground management.”⁶

THE DEMISE OF SMALL DEVELOPERS?

In the wake of the 2008–2009 financial crisis, small developers are finding it even more difficult to obtain financing than after the S&L crisis of the late 1980s. Although it is generally understood that Wall Street capital is seldom the lowest-cost capital available, other economies of scale and barriers to entry increasIngly favor larger developer-owners. The largest property managers can achieve substantial cost savings on supplies, utilities, and services. They can also frequently amortize overhead or spread personnel over more projects than smaller competitors. New technology has historically favored large owners who could make the sizable capital investments required for productivity-enhancing software and network upgrades for their properties. This trend appears to be reversing, though, as increasingly decentralized forms of communication, like social media (see chapter 4, “Marketing”), can level the playing field. Today, the most substantive advantages for the large firm are, generally, a lower cost of capital, giving them “first look” at deals, and, perhaps most important, the resources to withstand the uncertainty, delay, and potential legal action that can impede development projects.

Pursuing these efficiencies and economies of scale, the last ten years have seen a consolidation of large development firms. Regional homebuilders and medium-sized developers have found themselves targets for acquisition, allowing the purchasing firm the ability to grow its business and expand into new markets without a three- to five-year startup. Most of the targets have been builders of at least 100 homes per year, leaving the smaller builders alone. Developers’ experience of the recent economic turmoil may be clarifying this trend, as the “survivors” of this episode appear, so far, to include both small and large firms, and some of the most spectacular failures have so far involved regional and medium-sized developers.

Although the challenges they face are real, small developers are not likely to disappear. In fact, small developers will likely benefit from future demographic changes. A world of increasing demographic and cultural diversity means more opportunity in niche markets that favor small local developers. The large organization typically requires a certain deal size to justify involvement, and the relative availability of infill sites, as well as the increasing interest in secondary and tertiary markets, preserves a landscape of opportunity for the nimble, disciplined, small firm. As long as personal relationships remain central to doing business, small developers will continue to thrive.

As Gerald Hines observes, “Real estate in the U.S. today is a mature industry. Starting today is very different from starting when I did after World War II. Then, there was no infrastructure in place, a lot of need for builders, and the whole concept of investment building was new. Today, there is a lot of competition in every field. You have to find a specialty and a niche where you can have some expertise above someone else.”⁷

FINANCING

REITs, securitization, and commercial mortgage-backed securities all have revolutionized real estate finance. These changes have rested on conflicting assumptions: the historic perception of real estate as a low-volatility, inflation-hedged, steady cash flow asset class, and the perceived ability to dramatically improve returns on these assets with leverage. As Emerging Trends in Real Estate 2010 states, “Real estate’s touted attributes—low volatility and steady income—require reevaluation.” Over the past 20 years, real estate has been highly volatile, and the “steady” cash flows of the underlying assets have recently become anything but.⁸ Simultaneously, some of the financial structures overlaid on assets have, by their complexity, made understanding risk allocation more difficult than ever. Although financial markets are still being shaped by this crisis, a solid understanding of the players, and their roles relative to projects, will serve a developer well. There is no indication that any of the major players outlined below will not exist ten years hence, and parties involved in the financing of smaller projects are likely to remain the steadiest of all.

Although beginning developers’ initial projects will probably be financed through small banks and local lenders, they should understand the bigger picture of financing real estate deals. Opportunities for cheap permanent mortgage money may come from different sources at any given time: from insurance companies or banks, or through mortgage brokers representing conduit loans (prepackaged pools of mortgages that Wall Street sells to investors).

And although they will need to find equity for their initial projects from friends and family, they should position themselves to be able to find institutional equity partners as soon as their track record permits. Robert Larson, past chair of Lazard Frères Real Estate and past vice chair of Taubman Centers, Inc., emphasized alignment of interests when Wall Street and other institutional investors work with developers. “Any investment of size needs to be made so that the interests of the company and its management are very closely aligned with interests of the investor.”⁹

The Rathaus-Galerie Leverkusen is located in the heart of Leverkusen, Germany. The development includes a 120-store shopping center and a two-story town hall rotunda that houses office space for city officials.

Larson observed that investors would like a preferential position, but whether they can get one depends on the company’s need for capital and the competitive market at the time. To the extent that the investor ends up with a preferred security, the possibility of divergent interests may increase.

When private companies deal with Wall Street investors, they naturally want any new investor of size to be a passive partner. This position, however, runs counter to the needs of the investor. Larson notes that structural problems exist when investors own more than 50 percent of a publicly traded company but do not have board control. If the company runs into problems, the investors need to be able to change the strategic direction of the company to protect their interests. Lazard Frères looks for opportunities to invest in whole businesses rather than individual properties, but other investors, out of concern for hidden liabilities, prefer strategic partnership with the developer, allowing equity investments directly into project assets. Two decades of consolidation have transformed the development industry from a game for small entrepreneurs to a sophisticated capital market favoring public companies. Larson believes this trend actually increases the opportunities for certain entrepreneurs because development is very specific to local circumstances. Large institutions in general are less flexible, have high pursuit costs, and are less able to respond to market opportunities, leaving opportunities for smaller players. Taking advantage of these opportunities, however, is more difficult than ever. Opportunities for leverage are more meager, and only well-capitalized entrepreneurs will succeed. To be able to compete, developers must have a strong balance sheet, a substantial track record, or a working alliance with a capital source.

PAYING FOR INFRASTRUCTURE

Fiscal problems have increasingly forced localities to rely on real estate development to balance local budgets and help pay for new infrastructure. Before 1980, most municipal services and infrastructure, such as schools, public safety, roads, and utilities, were paid for out of general revenues and general obligation bonds. Today, residents view crowded roads and schools as negative results of growth, and the costs of growth have become a contentious issue. Virtually every major city and many small cities across the country have adopted comprehensive systems that include impact fees, exactions (payments made to receive a permit to develop),¹⁰ community facilities districts, and adequate public facilities, or “concurrency,” ordinances (requirements that facilities or plans for new facilities be in place before new development is approved)¹¹ to address these issues. Based on the theory that development should pay its own way, communities impose impact fees—usually charged per dwelling unit or per square foot—on developers to fund roads, intersections, schools, and public safety improvements. In many jurisdictions, the rezoning process includes evaluation of “proffers,” specific off-site improvements like parks or roads, which may be “voluntarily” performed by the developer, with benefit to both the development and to the larger community.

The trend toward higher impact fees and exactions is likely to continue as cities try to maximize revenue without raising taxes. Developers have turned to the legal system to resist exorbitant charges, and court rulings have limited the types and purposes of these fees, but the trend is inescapable.

Developers have much at stake when it comes to municipal finances, and they need to understand local financing sources almost as well as city officials do. Local fiscal problems affect developers in several ways. First, higher fees raise the cost of development and make new construction less cost competitive with existing stock. They often worsen the issue of affordable housing, which is already at crisis levels in some major cities. Further, these fiscal problems lead to cutbacks in local budgets for maintaining public facilities, causing deteriorating neighborhoods and falling real estate values. In predominately lower- and middle-class communities, these issues can cause a vicious cycle where inadequate infrastructure and service funding deters the investments needed to revitalize the community and renew its building stock and tax base.

On the other hand, fiscal problems often give cities stronger incentives to work with the development community. Some of the best opportunities for beginning developers lie in working with cities on government-owned land or in targeted redevelopment areas. If developers are willing to tolerate red tape and bureaucratic delays, cities and their redevelopment agencies can support, and sometimes streamline, the approvals process. These types of deals, sometimes with explicit public/private partnership, are increasingly available to smaller developers, as cities motivated by “smart growth” ideas push development toward more complicated infill sites.

REGULATORY CHANGE AND THE EROSION OF DEVELOPMENT RIGHTS

The increasing cost of approvals has been accompanied by a reevaluation of government’s role in development in many jurisdictions. For most landowners, this reevaluation can be read as an erosion of development rights. As concerns about fiscal health and quality-of-life issues have become tied (in many cases unfairly) to development, pressure has built for increased regulatory control. Municipal strategies range from the blunt instrument of comprehensive downzoning (reduction of allowed density across a zoned area) to a set of more finely tuned incentives to locate and shape allowable development where political opposition will allow it, or where infrastructure better supports it.

Developers can do little to influence broad regulatory action like moratoriums, so it becomes very important to understand exactly the process by which development rights (typically outlined in zoning as a set of allowed uses and a density) become vested (the moment at which these rights cannot be taken away by regulatory change). This process determines how many years, and how many millions, a developer might be forced to spend before losing all right to develop. The moment of vesting can be radically different, and the consequences of misunderstanding are usually catastrophic. In California, for example, vesting protection from moratorium may be defined as erection of a foundation and structural frame, while in some states, density and use are arguably vested at the approval stage of the general plan, and certainly at the specific or final plan stage, before construction has even been bid. The difference in risk between these scenarios is stark.

One way for developers to hedge against the risk of losing development rights is to buy land subject to an “entitlement contingency.” Developers pay for this consideration, but the higher price is often worth the reduced risk. Aside from the obvious benefit of delaying payment for the land, most developers find the alignment of sellers’ and developers’ interests to be advantageous, particularly because sellers of desirable tracts often have deep roots in the community, and sometimes political power. It is worth noting that, in extremely hot markets, often such contingencies will be off the table. Also, in some cases smaller developers with good local relationships feel they can make an offer without such a clause to outbid others with deeper pockets, by taking on more entitlement risk. Developers of larger projects can deal with the risks of vesting by negotiating “development agreements” that require them to build certain facilities in exchange for a city’s locking in existing zoning and development rights.¹²

The pace of government involvement has quickened, and its scope expanded, as the environmental movement has gained strength since the 1980s. In addition to basic considerations such as density and setbacks, developers now must navigate a web of rules for water rights, stormwater, wildlife habitat, traffic, and other issues, some of them subjective items like “viewshed” and “neighborhood character.” As society better understands the impacts of growth, new rules will necessarily follow. As of this writing, carbon emissions appear to be the new regulatory topic, and California is just beginning to implement policies that hold developers accountable for emissions tied to land use change. Still, the blanket disgust expressed by some developers toward regulation is misplaced. Zoning and other forms of regulation have historically been initiated or supported by developers as a means of protecting long-term property values. Value lies both in the protection of areas surrounding and serving a project and also in the barrier to entry that an approvals process applies to competitors. From the developer’s point of view, it is sometimes better to struggle in a growth-averse jurisdiction, and to be one of the few that makes it through to market, than to compete on price in a wide-open and commodified market.

It is not regulation per se but the uncertainty about new regulation that can be the greatest risk to developers. With this in mind, recent trends are troubling. Matt Kiefer of Goulston & Storrs suggests, “As the public sector pulls back, financially … we are entering a period of regulatory experimentation. Rather than issue commands, or regulate simple metrics like density, the trend is toward setting goals and performance standards, and leaving it to the developer to figure out how to get there.”¹³ This trend is particularly apparent in green building, where a third-party standard, such as LEED, may be required, but the approach to meeting the standard allows an à la carte selection of construction practices. Although this approach can preserve owner flexibility, it can also lead to confusion, to poor operating performance, and to a more subjective determination of compliance. It can also lead to unanticipated costs, as the burden of proof of compliance increasingly shifts to the applicant. Still, the opportunities of market-driven growth control are considerable for the developer willing to invest the time to understand them. Tax increment financing districts have introduced essentially a new way to finance infill development, and transfer of development rights markets, which allow shifting of density to targeted growth areas, bring a whole new set of tradable real estate assets to the market. Kiefer notes that “changes in regulation lag social change,” so developers with long project timelines need to watch today’s hot-button issue because it may be a condition of a building permit in a few years. Just as zoning can benefit the conscientious developer, so can new conditions serve as a bar that ultimately supports projects that contribute to a desirable shaping of the urban fabric.

THE TECHNOLOGICAL REVOLUTION

The implications of technology for real estate are dramatic, and new tools have transformed how real estate professionals conduct many areas of the business, from acquisition, design, and construction to marketing, brokerage, property management, community operations, and financing. Over the coming decade, it is nearly impossible to predict the outcome of any given technology, but it is possible to analyze some of the changes currently afoot.

ACQUISITION AND DUE DILIGENCE. The spread of GIS-based technologies, Web-based property tax databases, real estate listing services, and even free aerial mapping databases like Google Earth have revolutionized the “pursuit” phase of development. An initial investigation of a property can now be performed quickly, remotely, and with virtual anonymity using such tools. In this way, developers are able to move quickly toward the acquisition of properties (and discard unsuitable candidates) while delaying involvement of consultants like surveyors and planners. Under development today are stand-alone software packages that offer the ability to generate preliminary yield plans and criteria for valuation, from the most basic of available data sets. Already, it has become nearly as easy for a developer three states away to take a first pass at a property as it is for an in-town professional.

DESIGN AND CONSTRUCTION. Like the PC revolution before it, the Internet is changing how property is developed. Extranets—networks that facilitate the exchange of all forms of information, including plans, specifications, and financial data—are widely used in the design phase of development and are increasingly used during construction.¹⁴ New techniques, such as BIM (Building Information Modeling), allow team members, clients, and contractors to manipulate and reference the same base drawings. Extensive use of 3-D imaging allows clients to visualize the project. Over the past decade, visualization has gone from an expensive design presentation technique to a nearly mandatory component of most public approval processes. Real-time design enables value engineering to occur concurrently with design, compressing the process. General connectivity of team members has shortened the time required to revise drawings and other documents and has greatly expanded the geographic range of participants in the development process. Local consultants are now used because they bring value by their expertise, no longer simply because of their location near the project. In fact, substantial international outsourcing is already occurring in many design firms.

In addition to changes in the development process, smart developers and landlords anticipate future technology needs and plan accordingly to install the most advanced wiring, cables, and backup generators that might “future-proof” the asset.¹⁵ End-user demand for high-performance data infrastructure may be a simple enough request in urban areas, but for exurban sites, incumbent telecommunications providers may represent a virtual monopoly, and provision of fiber service may require substantial upfront cost or the involvement of third-party network operators with long-term service contracts.¹⁶

MARKETING. Great advances have been made in the use of technology for marketing and sales. Multiple Listing Service (MLS) and its commercial equivalents, such as CoStar, allow brokers, buyers, and tenants to almost instantly aggregate, sort, and virtually tour most available properties in a given market. Threatening this broker-controlled model are scores of for-sale-by-owner sites, with offers of flat-fee, discount, or free listings and search services applying tremendous pressure to agent commissions in many markets, both residential and commercial.

The Internet is now the medium for most buyers’ or tenants’ first experience of a property, and its importance is magnified in international sales or geographically remote sales of retirement or second-home communities. The project website—which in turn receives inbound traffic from traditional media and advertising, marketing blasts, social media, blogs, or word of mouth—has also become a central receiving point for information on potential buyers and tenants. Numerous free services exist to collect and analyze this traffic, allowing managers to more precisely understand the effectiveness of various marketing approaches and investments. Contact management software packages have evolved from simple “lead lists” to complex platforms for managing flow of information between sales agents and individual prospects or groups. Emerging applications point toward a future where sales professionals are armed with detailed real-time information on any call.¹⁷ Given the relative cost of digital approaches, versus printed collateral, on-site staffing, and event marketing, there is little doubt that the coming decade will offer more of these tools to developers.

Innovation in this area has its limits, though, and even a downside. As services like MLS aggregate listings, they tend to commodify noncomparable products, and buyers may browse right past an offering that does not fit standard price points or amenity packages. As Zvi Barzilay of Toll Brothers points out, “The Web is, for us, and for customers, a screening tool. There’s still, and always will be, a lot of walking. The model home is where buyers make the big decision, and they must touch what they’re evaluating.”¹⁸

PROPERTY MANAGEMENT. Dozens of software packages are available to assist in increasing the productivity of individuals managing ever-larger portfolios. These software packages can be tailored for any type of property and are available for tenant records, lease management, maintenance scheduling, checks, taxes, profit and loss reports for one unit or an entire portfolio, payroll, and work orders. In addition to office tasks, innovative technology is causing rapid change in security, access control, and building-systems monitoring, any of which might now be as easily handled from Bangalore as from the boiler room. As in any business, owners should understand that technology represents an initial investment, not just in products, but in training personnel, and in replacement and maintenance of systems. Owners should understand both sides of these investments and should ensure that the “cool factor” does not supplant a real cost-benefit analysis.

FINANCING. The real estate and construction industries were notoriously slow to adopt new technology. In the 1990s, the industry watched from the sidelines as Internet startups grabbed a significant share of the mortgage origination business, and many developers were purposely late to the game, as they depended on captive mortgage originators to service their communities. Not surprisingly, the greatest penetration of technology in real estate finance has been in those areas serving the largest number of consumers—home mortgage originations and servicing. Still, with Web portals taking over substantial portions of Americans’ financial lives, purely digital real estate transactions—digital transaction processing, information disclosure, financing, and closing transactions—are coming soon. The number of mortgages, equities, leases, and sales transactions is increasing dramatically, and Web-based appraisal services are edging into an important transactional role. If one lesson has been learned over the past decade, it is to avoid being the first to adopt an innovation, as many new tools fail or are supplanted as industry standards shake out. A successful developer will, however, stay abreast of technological development and will be ready to invest in appropriate tools when they offer improvement to productivity, marketing success, and profitability of the enterprise.

Trends

Opportunities abound for developers that are able to capitalize on the many changes taking place. Demographic trends, such as the aging of the American population, the influx of immigrants, and the impact of new technology on work and leisure, are creating demand for innovative types of living environments. Some developers will find success providing these new kinds of places for work, home, and leisure pursuits. Historically, though, the safest bet on the future is usually that it will look rather like the recent past. Developers must be cautious not to innovate beyond their target.

NEW DEMOGRAPHICS

Results of the 2010 Census show that demographic factors will have a profound effect on the nation’s economy and population distribution over the next 50 years. The combined growth rate for both cities and suburbs in the 100 largest metropolitan areas dropped to little more than half that of the 1990s, due to an aging population and sluggish economy. As the white population continued to age, racial and ethnic minorities accounted for an astonishing 91 percent of U.S. population growth in the 2000s.¹⁹ As the baby boom generation enters retirement, the United States is moving toward a population with a roughly equal number of people in each major age group. At the same time, Americans are becoming a substantially more diverse group. By 2042, “non-Hispanic whites” will no longer be a simple majority. As planner Elizabeth Plater-Zyberk points out, relative increases in single-parent households, blended households, and singles mean that two-parent households with their own children, the historical driving force behind U.S. housing markets, now make up only a quarter of all households.²⁰ Developers must consider a variety of housing types in order to attract these diverse buyer types.

According to demographer William H. Frey, new regional demographic divisions will be created that will be as important as our current distinctions between cities and suburbs, rural and urban. These divisions will encompass entire metropolitan areas and states, distinguishing “multiple melting pot regions,” “suburban-like new Sunbelts,” “heartland regions,” and “new minority frontiers.”²¹ The multiple melting pots—California, Texas, southern Florida, the Eastern Seaboard, and Chicago—will become increasingly younger, multiethnic, and culturally vibrant. Heartland regions will become older, more staid, and less ethnically diverse, encompassing growing parts of the Sunbelt, economically healthy states of the new West, and declining areas of the Farm Belt and Rust Belt.

The new immigrants and their children, primarily Latinos and Asians, will contribute 1 million people annually to the U.S. population, accounting for more than half of the 50 million additional residents during the next 25 years. As a result of current immigration laws, it is expected that incoming immigrants will choose to live in a handful of metropolitan areas spread from California to Texas to Florida. Two key constituencies continue to drive expansion in some of the fastest-growing cities: the young, particularly those professionals author Richard Florida calls “the Creative Class,” and the old (empty nesters and early retirees).

CHANGING LIFESTYLES

Driving demographics since the 1950s, the aging baby boom generation continues to dominate market trends. The oldest cohort of this generation is already redefining retirement and semiretirement and making substantially different market choices from those of their parents’ generation. With increased life span and good health, baby boomers expect to have an active lifestyle and to spend greater amounts on experiences rather than goods. Higher wealth accumulation and fewer children than previous generations will permit many to define retirement on new terms, allowing them to stay busy with volunteerism, second careers, and travel. Their demographics will determine where they retire and their preference for different types of housing. To cater to this market, more homes will offer accessible features such as first-floor master suites and accessible or convertible fixtures to facilitate aging in place.

Ten years ago, much was made of the potential reurbanization of baby boom retirees. Although preference surveys indicate that a portion of this cohort might be interested in a downtown area with ample amenities, so far the data show that these people largely remain in suburbs, with roughly equal proportions moving into city centers and moving out to exurban locales. Many of this generation chose to live their working lives in suburban metropolitan areas, and most can be expected to retire in those locations, or similar locations in other states. As with previous generations, their retirement choices will be influenced by the quality of nearby health care facilities, and a greater share of new housing construction will likely be nontraditional types of smaller single- and multifamily residences, following a consistently expressed preference for minimizing home maintenance and upkeep.

Continued full- or part-time involvement in the workforce and diverse lifestyles are likely to make the traditional “active adult” communities less attractive to seniors than more connected and authentic environments. Unlike in past decades, seniors are not expected to relocate in large numbers to the Sunbelt. Except for the wealthiest elderly boomers, who can search the country and select high-amenity locations, most are expected to age and retire near their families and other lifelong connections. Although many age-restricted communities remain focused on physical fitness, new ones are being developed around access to lifelong learning opportunities or outdoor amenities with an environmental theme. In an interesting shift, in recent years, survey respondents have raised “walking/hiking trails” to the top preferred amenity in new community construction, far outstripping the desire for golf or tennis.

White Provision is an adaptive use of a meatpacking plant as 94 condominium units, office space, shops, and restaurants on a 4.7-acre (1.9 ha) site in midtown Atlanta.

CITIES VERSUS SUBURBS

The extent to which cities are on the rebound is entering the third decade of a fiery debate. Urban history during the last half of the 20th century was largely about the migration of people from cities to suburbs and the decentralization of residences and, later, workplaces. Census data for 2010 indicate that the draw of recent immigrants to urban cores is weakening. Preferences are shifting, as particularly Latino and Asian immigrants increasingly choose suburbs.²² Suburbs are becoming much more like central cities, with larger nonwhite populations, higher percentages of retired residents, and greater poverty. Crime has been dropping throughout metropolitan areas since the 1990s. Ironically, crime in central cities fell more quickly than in suburbs. Affordable housing will be an important issue for all immigrant populations, especially Latino immigrants, who are projected to be drivers of growth, as they cluster in areas where land and housing costs are rising and developers have difficulty providing new housing at an affordable price.

Although immigrants are increasingly moving to the suburbs, urban living appears to be on the upswing, in some cities. Conversion of older downtown and near-downtown offices and warehouses to loft housing, apartments, and condominiums signals the resurgence of urban life. This trend received its first serious confirmation in an EPA-funded study of core and surrounding county building permits and population change.²³ While a statistically significant increase in building in center cities is documented for some of the nation’s largest MSAs, this shift is uneven. The trend is undetectable, or even reversed, in many second-tier cities. Demand for urban living is fueled by three main groups: (1) aging baby boomers, approximately 15 percent of whom are moving back to the city in early retirement years; (2) young high-tech and creative workers who are interested in the walkability, shopping, restaurants, and entertainment of a 24-hour downtown; and (3) certain groups of immigrants. To maintain this interest in urban living, cities need successful downtown housing programs with several elements: committed public officials, aggressive marketing, creative financing, a flexible regulatory environment, a developer-friendly business climate, parking, amenities, and, most important, good product and urban design. Renting is the key for young professionals and minority householders to live in the city, as most renters continue to have annual incomes of under $50,000. More than 40 percent of householders ages 25 to 44 are renters, compared with around 20 percent of householders ages 45 to 64 and fewer than 20 percent age 65 and older.²⁴ The majority of center-city minority householders are renters.

Development Issues

A number of issues will continue to be of concern to developers in the coming years. More sustainable development will be a way to address environmental, economic, and social problems.

SMART GROWTH

Although growth has benefits, it is widely recognized that it can result in unintentional fiscal, environmental, health, and lifestyle consequences for the larger community, and for regional and national interests. As Matt Kiefer describes it, “The postwar view was of development as an engine of growth. The 21st-century view is of development as a generator of impacts.”²⁵ Recent census and other data indicate strong growth will continue, and the challenge for many municipalities is how best to accommodate development while maintaining community identity and protecting the environment. Stepping into the unproductive “economic development versus no growth” debate is a powerful and simple concept: smart growth, also referred to as “sustainable growth,” or “quality growth.” It refers not to a single solution but to a set of principles promulgated by organizations like Smart Growth America. Smart growth has gained national attention as a framework for limiting, and in some cases reversing, sprawl.

As its ten basic principles—discussed in detail in chapter 3—have gained popularity and have been folded into many municipalities’ comprehensive plans, they have received the endorsement of unlikely supporters: staunch environmentalists and downtown business associations, land use attorneys, and biologists. Unlike the rigid mechanisms used under earlier growth management strategies, smart growth strives to promote a higher quality of growth that accommodates and directs development activity in a way that supports the economy, by encouraging investment and job creation, raising property and tax values, providing incentives for a variety of housing and transportation alternatives, preserving the environment, and enhancing quality of life and a sense of place. The Smart Growth America organization, in concert with planners and architects associated with the Congress for New Urbanism and with the active support of ULI, has contributed to the dissemination of these ideas.

Policies derived from smart growth principles have been promoted by states, and recently the federal government has taken steps to promote similar goals through interagency partnerships between EPA, the Department of Transportation, and the Department of Housing and Urban Development. With this kind of support, it is likely that smart growth will continue to have a strong influence over development decisions, and developers should be able to frame their proposals in terms of these goals. Smart growth seems at times to be a movement more solidly supported than it is understood, and there remain those who are skeptical of its benefits to the environment, the building industry, housing provision, and transit policy. To help developers navigate these issues, ULI has published reports such as the annual series “Climate Change, Land Use, and Energy” and books, including The Green Quotient: Insights from Leading Experts on Sustainability.

Despite planners’ and policy makers’ efforts, the job of implementing better growth ultimately falls to developers, who introduce proposals and invest capital to do the actual place making. As such, in the hands of entrepreneurs, these models must satisfy not just civic ambition but also financial metrics, and the underlying principles must be able to survive the “sausage-making” process of public approvals and regulatory review. Public opposition to growth in general can deter even high-quality projects that incorporate smart growth principles, and the “smarter” plan often exacerbates the rancor of abutters and environmental groups, because these principles when applied to a given site typically result in higher densities and mixed uses where growth is desired, in order to minimize sprawl, impact, and infrastructure provision in other areas designated for protection. Advocates for these projects should not expect an easier ride through approvals, unless the jurisdiction offers an explicit fast track or public partnership for appropriate projects. Developers should, however, heed one of the key principles: planning should involve community stakeholders. At the mercy of local politics, developers may be loathe to admit outside voices into project planning, but when these plans succeed, they do so with coalitions behind them.²⁶

Conceiving a project, developers must not conflate desires of the public at large with individual buyer decision making. A well-conceived smart growth project may put all the parts together in an innovative way, but demand for individual product types should be well established in the market.

PLACE MAKING

Nearly everyone agrees on the need to preserve a sense of place. A sense of place gives residents and workers in a community a feeling of belonging. It is achieved through a combination of policy, planning, design, marketing, and the evolution of a set of social structures and local organizations over time. Design plays a critical role, helping define boundaries, public spaces, places where people meet and have fun, character, and landmarks that people identify with that community. It does not happen overnight, though thoughtful development can accelerate the process, and thoughtless building can undermine it quickly. Classic examples are the town centers of Sienna, Italy, and Cambridge, England. More recent examples are found in San Antonio’s River Walk and downtown Boulder, Colorado. Neisen Kasdin, mayor of Miami Beach, and developer Peter Rummell echo the importance of this ineffable quality in Miami Beach: “The challenge is to determine how to meet future demands while preserving the sense of place that currently makes it so attractive to residents and visitors.”²⁷

According to Tom Lee, former chair of Newhall Land and Farming Company, “places” take many forms—from old-fashioned main streets and town squares to traditional big-city downtowns to newly developed town centers. Each creates a public realm that gives a community its heart, character, identity, and, most important, a place where all kinds of people can come for a wide variety of everyday activities from early in the morning until late at night, seven days a week.²⁸ Even the absence of development, where it is not appropriate, contributes to a community’s sense of itself.

Why should developers care about streetscapes and public places? Such concern is part of good citizenship, but it also translates into long-term value. Streets and plazas that are pleasant to experience, durable and accommodating of change, rather than requiring demolition, will appreciate more and hold their value over time more than less desirable neighborhoods. Developers, however, cannot improve streetscapes by themselves. They are often constrained by zoning and engineering standards that mandate the width of streets, setbacks, and building heights, and by lenders’ impulses, such as mandating front-door rather than backdoor parking, or that require overbuilt roadways in pedestrian districts. On the other hand, early 20th-century planning principles favoring the separation of uses have recently begun to give way to new trends favoring mixed-use development. Many planning commissions now actively encourage mixed-use development with offices, shopping, and residences on the same or adjacent sites. And new mechanisms such as business improvement districts can help provide funding for urban design improvements and coordination of disparate property owners.

ENVIRONMENTAL CONCERNS

Environmental concerns are of central importance to the general public, to policy makers, and as a result to real estate developers who must work with all these parties. Increasingly, developers recognize that a sensitive approach to the environment is good not only for the community but also for business. Site contamination is a major problem for developers, but the industry has adopted methods for dealing with it. Both developers and lenders are slowly becoming more accustomed to dealing with brownfield sites, partly because the majority of urban sites—and even undeveloped farmland—have some contamination that must be mitigated, or at least suspected problems that must be investigated.

As always, new problems generate new opportunities. Some investment and development firms now specialize in rehabilitating properties contaminated, or suspected of contamination, by toxic materials. Because the properties can usually be purchased at significant discounts, careful analysis of the removal costs and appropriate actions can generate large profits. Although lenders have been extremely wary of loans on such properties, federal and state governments have established grant and loan programs to partially underwrite remediation costs, and knowledge of the intricacies of these programs can improve the profitability of a project. Nonetheless, developers that fail to perform adequate due diligence before purchasing new properties risk financial disaster.

Water availability and quality issues increasingly determine where and how much development can occur. In addition, communities are increasingly concerned about the preservation of hillsides, wetlands, canyons, forests, and other environmentally fragile areas. Developers that address these concerns in planning and designing their buildings will find communities more receptive to their projects. A related matter, habitat preservation, can touch nearly any land development project and can trigger unsustainable delays as field science is scoped and as preservation and mitigation plans are prepared and approved. Of considerable frustration to landowners is the perception that time, the enemy of the developer, often seems to hold little interest for the regulator, whose goal is to prevent a detrimental project from being developed, not just to approve good projects. As in so many other areas, the best defense against uncertainties is twofold: negotiating appropriate approval contingencies in acquisition and performing solid due diligence. Modest, early expenditures with reputable and experienced consultants can help owners foresee, if not forestall, such problems.

Stormwater management is one of the most common pitfalls facing developers, particularly in suburban and exurban settings. As environmental science has advanced understanding of nonpoint source pollution of waterways, regulatory attention has shifted from the stereotypical factory pipe discharging PCBs into a river to a focus on limiting sedimentation and the low-level but constant runoff of nutrient- and contaminant-laden stormwater. One manifestation has been state or regional plans for impaired waterways, such as the Chesapeake Bay Act(s). Following interstate agreements forged in the 1980s, the states of Virginia, Maryland, and Pennsylvania have passed laws requiring local governments and other regulatory agencies to delineate impact areas and to enforce rules toward the preservation of a massive macroregional watershed. Compliance is overseen by state agencies, and penalties for noncompliance can be costly.

The experience of landowners over the 20 years of incremental implementation has been bewilderment and confusion over who is in charge, laced with occasional panic at what might happen if every possible interpretation of the law was enforced. These fears result from years of “mission creep” by the U.S. Army Corps of Engineers, which, though originally tasked with regulating navigable waters, has gradually established regulatory jurisdiction over quarter-acre wetlands miles from even canoe-scale rivers. Matt Kiefer describes the ongoing evolution of stormwater regulations as part of a larger regulatory regime change: “We’re going from designing out nature to design with nature, and new performance criteria for stream crossings, for site permeability, and on-site retention and discharge are all of a piece.”²⁹ The coming decade will likely resolve many of these regulatory uncertainties, and for the better, as best practices that mimic natural watershed function and other low-impact development strategies become commonplace and join the well-understood vocabulary of site development.

Over the coming decade, many land use and environmental professionals expect climate change to increasingly drive planning decisions. Greenhouse gas (GHG) emissions are clearly moving the planet toward irreversible climate change, with impacts that cannot yet be reliably predicted. European nations have begun voluntary trading of GHG credits, and in the United States, while national policy is being negotiated, California has passed a potentially revolutionary regulatory scheme to rein in emissions. This scheme, likely to become a model for other states, directly addresses GHG and energy impacts deriving from land use change, which puts developers in the driver’s seat. This leadership role is appropriate, as the largest sinks and sources (forests, farms, utilities, industry, and building construction and operation) are all touched by real estate development, though few developers active today would consider themselves qualified to make decisions in the field of planetary energy balance.

Judi Schweitzer advises developers of long-timeline projects to jump into energy-related issues, with appropriate consultants to help navigate. “These constraints are coming, and they will be complex, and it will pay to be familiar with the terms and players early…. In addition to regulation, funding sources increasingly have portfolio requirements that will further motivate developers following capital to address these issues.” Rather than recoil at the thought of accounting for carbon and methane in a land use plan, developers should delineate the constituencies that must be satisfied, and treat energy like any other approvals issue. “A checklist, or even a series of checklists, is insufficient. Rather than tick off points toward LEED or other certification, developers will, over the coming years, have to become familiar with the emissions profile of various land use decisions they make, in the aggregate, and working as a system.”³⁰ Steve Kellenberg, principal of AECOM, states it differently: “What’s happening now, and going forward, is a shift from qualitative (add bike lanes, preserve a wetland) to quantitative (carbon accounting, energy modeling) understanding of environmental impacts. This is good. It means, with the right tools, we are going to start making smarter and more informed decisions…. We think we can knock 25 percent off carbon emissions, just by using models and adjusting land uses accordingly.”³¹

Separate from carbon and a tax on vehicle miles traveled is the trend of real estate as an energy producer. Increasingly, as the costs of renewable energy sources come down, and nonrenewables go up, real estate can have an important asset in the ground (geothermal heat) or on the roof (solar or wind power). Fortunately for the bewildered developer, many of the recommended—or legislated—land use solutions to climate change already closely follow principles of smart growth: colocation of jobs and housing, transit orientation, and compact and efficient buildings. As is often the case, developers that pay attention to areas of concern today will have a leg up on the issues of the future.

THE NEED FOR OPEN SPACE

Preservation of open space consistently ranks among the top concerns of both urban and suburban residents. The increasing interest in ecological function of even highly urbanized areas portends only greater focus on this issue in the coming decades. Open space comes in many different forms, from manicured golf courses to permanently wild forests and wetlands. These spaces might allow a wide range of uses, from farming and passive recreation to structured facilities, such as ball fields. Ownership and protection of these spaces can range from public ownership, in the case of city parks, to quasi–public service districts within planned communities, to privately held easements across individually owned land, or public/private funding initiatives to rent or ease specific assets of ecological or cultural value. Each type of open space is critical for the enjoyment of different people who make up a community, and many of these spaces perform important—and sometimes economically valuable—ecological functions, such as filtering runoff and carbon sequestration. One trend worth watching is the attempt to monetize these “ecosystem services” and to establish markets that will pay landowners for their stewardship of these values by mechanisms like credit trading. Although municipal parks and other small-scale breaks in the dense urban fabric often generate the most intense public feeling and interest, environmental science has prioritized the protection of large, unfragmented spaces, where water and wildlife can more closely approximate their predevelopment functions.

Open space must be specifically protected, either by zoning, tax policy, or rolling rent payments on a long-term agreement or by a permanent legal reduction of development potential. If it is not, incremental urban development will eventually consume potential sites and cut up habitat areas. Since a landmark Supreme Court case in 1979, developers have been able to generate charitable tax deductions by donation of land, or by donation of an easement reducing development potential to a nonprofit easement holder. These returns can be attractive to investors and have spawned their own niche product: conservation development. States have responded to this relatively inexpensive method of conservation by offering their own suite of credits, which in some states are tradable on open markets for cash, to sweeten conservation deals. This response has greatly accelerated land conservation and has created an infrastructure of local and national land trusts qualified to accept and monitor these easements, and to develop plans that prioritize parcels for conservation.

At the national level, organizations like the Nature Conservancy and the Trust for Public Land provide mechanisms for developers and communities to set aside land for open space. The organizations serve as stewards of such land, providing various levels of access to the public while preserving natural amenities and wildlife habitats. Such organizations are needed because the timeline of preservation covenants is extremely long, often “perpetual.” In some states, easements held by these groups are “backstopped” by state-chartered corporations, such as the Virginia Outdoors Foundation, which receive easements on their own, and when small land trusts can no longer serve as conservators.

For developers, a familiarity with local land trusts is critical, as they are often key stakeholders in community decision making. A working knowledge of the mechanisms of open space preservation will increasingly become part of the necessary toolkit for many developers, as municipalities respond to the contradictory challenge of constituents who want open space but cannot or will not pay for it from general funds.

TRANSPORTATION AND CONGESTION

Transportation has always been a major source of real estate value because of its effect on location, but solving the problem of overburdened roads continues to be one of the development industry’s principal concerns. Congestion—or merely the perception of congestion—can undermine a property’s value and motivate new and existing development to continue its move outward to more accessible locations. Traffic delays in some large cities increased by 500 percent or more between 1982 and 2007,³² but lost time is only one measure of congestion’s cost. Idling and inefficient operation waste tremendous fuel resources and contribute to GHG emissions, airborne particulates, and ozone.

The most direct method of reducing traffic congestion is to decrease the length and number of vehicle trips. Developers can assist in achieving these reductions by offering development in a dense, compact form with a mix of land uses accessible to mass transit. The inclusion of residential development, offices, retail uses, and entertainment venues in a convenient and accessible location reduces vehicle trips, spreads peak-hour flows on arterial roads, makes transit more feasible, and allows more people to live closer to employment and services. To achieve this scenario, federal and state agencies must work with the cities and counties that control land use. Developers, which will shoulder much of the burden for improving inadequate transportation in the suburbs, would be well advised to support coordinated, collective efforts to plan transportation in their communities. Otherwise, they will be forced to pay a disproportionate share of the cost, and what they do provide will be inadequate to hold congestion constant, let alone reduce it.

Greenbelt 5 is a four-level shopping center in the central business district of Manila, Philippines. It is surrounded by lush gardens, emphasizing the developer’s commitment to preserving open space.

Social Responsibility

Developers hold special responsibilities because their activities involve large public commitments. In many communities, developers actually build most of the urban infrastructure, including roads, sewers, water treatment facilities, and drainage channels. They may also provide civic facilities, such as schools, hospitals, and police and fire stations. And as the public sector pulls back from financial commitments, this trend is likely to continue.

Communities have a right to expect the highest possible quality of design, construction, and implementation from developers. They should expect developers to be sensitive to community concerns, to the streetscape and landscape, traffic, and other dimensions of development that affect the civic environment. Developers should uphold their promises—delivering buildings on time and with appropriate attention to quality. Developers are also expected to be ethical citizens of the community, concerned with protecting its long-term interests.

What do developers have a right to expect from communities? They have a right to be treated fairly and consistently and for decisions to be made on the basis of merit and law. The community should honor its commitments to build promised infrastructure on time and to properly maintain public facilities and services. They have a right to expect the community to exercise foresight and good planning judgment in setting public policy—to ensure that new regulations are handled efficiently and do not impose unnecessary costs or delays on the development process.

THE DEVELOPER’S PUBLIC IMAGE

Developers as a group suffer from a negative public image. As the authors of Suburban Nation point out, “It was not always thus. When George Merrick built Coral Gables … he was regarded not as a developer, but as a town founder. A bust in his likeness still presides proudly over City Hall.”³³ The public image of developers today is more often of a self-interested actor who profits from degradation of the environment and quality of life. That image is often undeserved—as when developers are mistakenly identified as causes of, rather than responders to, demographic and economic change. Sometimes, however, the image is deserved—when they build shoddy products, when they have been insensitive to community needs, or when they have imposed costs on the community for which they should have taken responsibility.

In expanding communities where economic growth is desired, developers can more easily overcome negative stereotypes. In communities with strong antigrowth sentiments, however, the distrust with which community members view developers in general makes conditions more difficult for even the best developers. Developers should understand the sources of the distrust that they will encounter. Many communities and neighborhood groups have relied on developers’ promises that were never kept or on inaccurate predictions, such as a new office building that would not increase congestion. Developers are the standard-bearers for the real estate industry as a whole, even though real estate brokers, property managers, and even public planners may also be to blame for these failings. The public approval process for development provides the sole opportunity for most people to complain about the full array of urban ills.

GAINING COMMUNITY SUPPORT

Community opposition to growth can be one of the most difficult challenges developers face. Debates often begin with the question of how the land is currently used. Although vacant land choked with weeds may seem to builders like a prime opportunity for development, surrounding neighbors may consider this open space a recreational area, dog park, parking area, or view corridor. Failing to acknowledge these existing, very low intensity uses can make it difficult for a developer to reach consensus with neighbors about future land uses. The situation is different when the land is already intensively used. Then parties must explore the more complex question of whether the proposed land use is more or less desirable than the existing uses.

The analysis of citizen opposition to development proposals has spawned its own vocabulary, with terms like NIMBY (not in my backyard) and LULU (locally unwanted land use) often used interchangeably. A significant amount of opposition to development proposals is based on citizens’ misperceptions, lack of information, or exaggerated fears of project impacts. Common areas of misinformation about new projects include consistency with zoning and general plan criteria; impact on property values, views, traffic, types of residents or commercial tenants; and changes in community character. The developer can minimize opposition spawned from a lack of information by providing clear, credible data about the project. Aside from misinformation, however, Matt Kiefer notes a substantial change in the etiquette of land use debates, over the past 20 years: “Opponents who are impacted by projects used to feel a need to hang their hat on an external, objective concern. Traffic maybe, or environmental concerns. Social mores have changed, in that it is now seen as acceptable to oppose a project based merely on the personal impact of the proposal.”³⁴ An assumption that ownership connoted rights to determine use is no longer a given, and developers that do not understand this end up in litigation.

Developers and planners must address a variety of different constituencies: local residents, including dis-advantaged populations; local merchants; preservation and arts groups; city officials; and public agency officials. Successful developers learn how to operate within their local, inevitably heterogeneous, communities.

According to Daniel Rose, community groups can, at their best, provide perspective and insight; at their worst, they can fall prey to a NIMBY mentality. “Residents often oppose the construction of a fire station in their neighborhood because they object to the accompanying noise. But the necessary services of an urban system must be located somewhere. Someone will have to work or live near a fire station or a garbage disposal site.”³⁵

Gerald Hines emphasizes the role that community acceptance plays in marketability. “We look at each city as a different culture, and if we don’t know the culture, we’re going to have an unsuccessful project. Conferring with community boards and neighborhood associations has become a part of a project’s market analysis and its later acceptance by the market.”³⁶

Because the civic contribution of a development project is not always apparent, developers can benefit from regular civic involvement, such as serving on boards and working with nonprofits and schools. The presumption by opinion leaders of good civic intentions can be a great asset to developers who will, at some point, find themselves asking for the community’s trust. Community leaders should remember that most of their goals for community improvements will be attained only with the participation of developers. The delicate balance between the interests of communities and of developers must be maintained if communities are to grow sensibly and sustainably.

Advice from Industry Leaders

This section presents the wisdom of seven of ULI’s leading figures: Jim Chaffin, Bob Engstrom, Mike Fascitelli, Gerald Hines, Jeremy Newsum, Ron Terwilliger, and Lynn Thurber.^a They reflect on what they have learned from the Great Recession of 2007–2009 and on major trends affecting the real estate industry over the next ten years. They offer advice to both beginning and more experienced developers.

LESSONS FROM THE GREAT RECESSION

Ron Terwilliger observes, “Each cycle is different. You won’t see it coming and you won’t know the depth or duration. You must operate your business with that knowledge. It will affect your ability to access capital and it will affect demand. I learned this time that … while you seem to have alignment with [your investor partners] on the up-cycle, you may not on the down-cycle. I closed on some land with financial partners alongside us. They just walked away from their investment. Land values fell by half or even more severely. I learned from a merchant builder’s standpoint, you should not acquire land with debt. If you can’t buy it with equity, you should wait to buy until you are ready to build on it.”

Lynn Thurber learned to exercise more caution. “The notion that ‘all ships rise with a rising tide’ is no longer true. During the expansion, there was such a flood of capital on both the debt and equity side that secondary locations and asset quality were not differentiated amongst risk takers and in pricing. Today, both debt and equity investors are far more selective.” This observation implies that regeneration of areas will take longer to implement. “Capital will first go to the best locations and best properties and properties that have the best renovation potential. It will be much harder for properties on the fringe.”

Gerald Hines points out that real estate values can go down by as much as half. “Your liquidity needs to be more in bonds and less in stocks and [you need to] have other forms of liquidity. You don’t want both real estate and your other assets to drop at the same speed and magnitude.” He observes, “If the building is slightly off-location, it will have a much bigger drop in value than one with a better location. Risk in marginal buildings is very, very high. They will be rented during a shortage but not in a down market because there are too many other better buildings.”

Jeremy Newsum says that sticking to the principles is more important than chasing the crowd. “The things that went wrong were utterly predictable. Timing is harder to predict, but that is no excuse.” Jim Chaffin observes, “Most of what we know about our business has more to do with humility than intelligence, but we reserve the right to get smarter as we go along.”

TAKING ADVANTAGE OF MAJOR TRENDS

Being prepared for the inevitable down-cycle is critical for building a long-term business. To take advantage of the next up-cycle, one must understand the implications of major trends in demographics, technology, sustainability, urban growth, finance, and globalization.

CHANGING EXPECTATIONS. Lynn Thurber states, “Demographics will impact geography and preferences in ways people my age can’t figure out. In difficult economic times, people must be more flexible about where they will live and how they will work. This will impact where real estate markets recover first.”

Jim Chaffin distinguishes between demographics, which has to do with income, age, and geography, and psycho-metrics, which has to do with psychological changes that affect the market. For second-home communities, he sees a trend back toward smaller homes with less conspicuous consumption. People want smaller homes near their grandchildren. They also want a sense of belonging. College towns, for example, will be more and more popular because they offer stimulation and opportunities to be connected to a community.

RETURN TO THE CITY. City living is more attractive today than previously for baby boomers who no longer want a big house in the suburbs or a long commute. Ron Terwilliger says, “Both younger and older people will look for places where there is more entertainment close to their homes.” Bob Engstrom says that smaller homes and smaller lots will be more in demand—1,200-square-foot (111 m²) foundations with room for expansion. The ambiance of mixed use in a walkable neighborhood appeals to both younger and older people. However, Lynn Thurber predicts that today’s younger generation that grew up in the suburbs will return to the suburbs to raise their children because they will want them to have a similar experience. Ron Terwilliger believes that the return to the city will take place primarily in inner-ring suburbs. “There will be more suburban cores redeveloped to provide a walkable environment for shopping, restaurants, and entertainment. An increasing segment of the population will look for a more holistic environment where they have more walking and commuting options.”

GREEN DEVELOPMENT. Gerald Hines observes that green building has always been a keystone of his company. “It made sense because you could operate for less.”

“Green buildings are no longer considered a fad,” says Lynn Thurber. “They are a very important part of our future. Those technologies are improving rapidly and are a part of all decision-making processes for investing and developing…. Companies on top of knowledge of what’s available and the cost-benefit tradeoff, and companies that are able to collect the data will be more competitive.”

Mike Fascitelli points out that many tenants and governments are forcing landlords to be state of the art as well as forcing improvements in older buildings. Jim Chaffin emphasizes the relationship between sustainability and building a community: “Sustainability gives people a sense of being responsible. People yearn for not just a big home in an exclusive project but being part of a community. Whatever you can do to weave social and environmental responsibility into a community, it gives people more reason to be there.”

FINANCING. Ron Terwilliger advises young developers to align themselves with deep pockets. “Get an investor who can ride through the cycles with you. Avoid too much debt. In the latest cycle, Trammel Crow Residential did not borrow more than 75 percent of cost, which helped it survive the down-cycle.” Trammel Crow decided to give as much of the ownership away as it had to in order to raise 25 percent equity for each project. Raising equity is always the hardest part for beginning developers. “If you build credibility, you will find the right financial partner—a wealthy family or a successful real estate player who is retired but wants to keep a hand in.” Terwilliger adds that “a reasonable deal is whatever the investor is comfortable to begin with. A lot of young people forget if they are being paid a salary and have no money to put at risk, they can’t expect an investor to give them a whole lot of upside. They should have some upside—around 20 percent. Over time, demonstrate you are capable, leave money in the business, and become an equal partner down the road.”

Lynn Thurber predicts that both debt and equity capital will be difficult over the next few years. “Understanding what those sources are expecting from their partners through which they invest will be very important. Because there was so much capital available the last few years, people did not feel they needed to be good partners with their debt source and equity source. They were confident they could get the capital somewhere. Owner/developers will not be in the driver’s seat over the next few years. Younger developers who commit to being good partners with their sources will do better than those who do not put time and effort into their capital sources.”

Jeremy Newsum advises, “One should never guarantee any loan that he or she can’t meet. It is better to share the equity than try to get all the upside and make foolhardy commitments.” He asserts that financiers are being put in the backseat. “They’re not in position to drive the market any more. True real estate professionals are coming back to the fore. Others are leaving [the field] because return expectations have dropped to something more reasonable. Fundamental gearing levels are falling.”

Mike Fascitelli emphasizes the trend toward lower leverage. He says, “Investors want the stability of cash flow and inflation protection.” He quotes Harvard Business School’s Bill Fruhan’s mantra: “DROOC!—Don’t Run Out of Cash.” He says that developers’ balance sheets may not matter during boom times, but today they matter a lot.

STRATEGY AND BUILDING ORGANIZATIONS

Throughout his career, Gerald Hines’s strategy has been to have the best building in the market with the best tenants. This clear strategic goal has defined his company’s image and brought it many tenants and building opportunities. Hines says, “Strive for an outstanding reputation through the quality of what you build and how you deal with people, and leave a good trail behind.” For building an organization, he says, “Get outstanding people. Give them participation in the success. They also have to have something to lose. They need to have something left in the bank in case they make a bad mistake. We give more equity away to our employees than most developers.”

Jim Chaffin observes that one should build his or her organization according to one’s strengths and weaknesses. “If you come out of accounting or the finance side, you must have someone strong on the marketing side. If you come from planning, design, construction, or development, you must have a strong CFO and a strong marketing/salesperson. Later on, add an operations guy.” There are four key areas: marketing and sales, accounting and finance, planning and design, and construction and operations. A firm should reach a certain size before bringing planning and design in house because they are easily contracted.

Lynn Thurber says the most important things for building an organization are cultural, with integrity and transparency at the top. “If you are honest about what you are committing to and follow through on your promises and willingly share accurate information about what is happening with your employees, service providers, and financial partners, that is hugely important. Those who have failed have not done this.” Also important is to “avoid doing things outside of your core competency. When you go outside of it, you are much more likely to run into significant difficulties. You should add on adjacent to your core competency. Move gradually but recognize you are taking on great risk and run the risk of damaging your organization.”

Ron Terwilliger observes that Charles Fraser, one of the 20th century’s most innovative developers, “was a visionary and a dreamer who was way ahead of his time in terms of environmental sensitivity. Charles was able to attract a number of very capable young people. He was charismatic, but did not have any risk management sensitivity. Trammell Crow was a visionary and optimist and very charismatic, but also very generous. He pioneered the partner concept. He always wanted his partners to make a lot of money and do very well. A rising tide raised all boats. His spirit of partnership and generosity are two things I will always remember him for.”

ADVICE TO BEGINNING DEVELOPERS

The seven ULI leaders offer the following advice to beginning developers:

LYNN THURBER:

• Do what you love. You really must enjoy it. It is long hours and tough slogging.

• Hire great people on your team. Trying to save money by hiring people with less experience or talent, or worrying that your hires may outshine you, is only setting yourself up for a struggle.

BOB ENGSTROM:

• “Smaller homes” and “infill” are buzz words today. Beginning developers should avoid attached products if they can help it. Even a 12-unit townhouse project, if it does not sell, can be overwhelming. But with single-family detached homes, there is usually a way to salvage it.

• Once the current overhang of inventory is eaten up, there will be opportunities. Keep things on a manageable scale. Recognize that you will have to give personal guarantees—experienced developers may be able to avoid these. Stick to your local market where you have the advantage of understanding the nuances of the market.

GERALD HINES:

• You have to find a specialty where you have some expertise above someone else. There are also opportunities in bigger firms like Hines but you have a lot of people in front of you.

• If the banks loosen up, there will be opportunity for smaller developers—taking over small properties that need love and attention that are not interesting to bigger players.

• There’s a lot to learn in finance, construction, how to lead an architect—you can’t turn them loose. You need to work for someone else for a long while to learn the business.

• How much equity and personal liability can you handle? Banks will be very restrictive as to who gets loans and how much equity is required. Go build some houses. You learn a lot from this.

• Learn what tenants want and how leases are done and deals are made. Learn about mechanical and other engineering aspects and finance; don’t get caught short with major holes in your education. Leasing and marketing are good ways to get into the business; also, working for a general contractor. A combination of both is even better.

JIM CHAFFIN:

• Complexity and large scale are not the place to go right now. You can get started on distressed and infill properties. Then you can expand into the best products in existing areas. Don’t pioneer.

• You can buy a 10- or 15-acre [4–6 ha] parcel in an existing resort that is coming back and do a terrific 75- to 125-unit project. There is a huge market out there, but you must be smart about where you do it, how you do it, and how you finance it.

JEREMY NEWSUM:

• Tying yourself to occupiers is the best way to achieve early success. Try to understand what occupiers want. When the market went bust, we had an empty building. We were able to relet it quickly because we listened carefully to understand how the occupation of buildings was changing—how companies needed flexible design and layout, what services they wanted, and how workers would use the building.

MIKE FASCITELLI:

• Be very focused on value added. Capitalize yourself for uncertainty. Don’t take short-term financing; use less leverage.

• When things are down, that may be the best time to get in. You want to be on the early end of the cycle. Don’t think that the current situation will last forever. When the turning point occurs, you want to be there already.

RON TERWILLIGER:

• Be a local sharpshooter who focuses on market niches. Good beginning projects are either rehabs or something the big guys can’t afford to pursue. The country is growing, but changing. You need to get out in front of where change is and find your niche.

• Pick the product type you want to work in and the geographic area you want to work in. Try to get with a company in that location. Build credibility and experience. The more relevant your experience, the more likely you are to attract a financial backer.

^aInterviews conducted by Richard Peiser in July and August 2010: Jim Chaffin, chair, Chaffin/Light Associates, Okatie, South Carolina; Robert Engstrom, president, Robert Engstrom Companies, Minneapolis, Minnesota; Mike Fascitelli, president, Vornado Realty Trust, New York City; Gerald D. Hines, founder and chair, the Hines real estate organization, Houston, Texas; Jeremy Newsum, executive trustee, the Grosvenor Estates, London; Ron Terwilliger, chairman emeritus, Trammell Crow Residential, and chair, Enterprise Community Partners, Atlanta, Georgia, and New York City; and Lynn Thurber, chair, LaSalle Investment Management, Chicago, Illinois.

PERSONAL INTEGRITY

A developer’s reputation is the foundation of long-term success, and for the inexperienced developer, a trustworthy character can be counted among a short list of assets. The development community is a very small world. Even in the largest cities, news travels quickly and reputations precede every player. Players who lie, cheat, or break the law find that reputable businesspeople will have nothing to do with them.

Dan Kassell advises that young developers consciously take charge of their reputation building: “When we started out, we had a rule: if you tell the planner you’re going to fax it today, fax it today. That the fax is a minor permit change that won’t be reviewed for four weeks is immaterial. To the recipient of that fax, we are people who do what we say we’re going to do.”³⁷ Many developers will run into cash flow difficulties at some point and will consequently have to renegotiate a loan or the terms of a deal. At such times, a record of honesty and transparency can make all the difference. No one likes bad news, but investors, lenders, and partners invariably like surprises even less. Projects rarely go bad overnight. When partners and lenders are kept informed of the problems, they are more understanding and more willing to try to work things out.

Conclusion

Our understanding of how to shape development to create better cities and neighborhoods is far from complete, but we are making progress. Among the greatest problems facing planners and public policy makers are how and where to invest scarce public funds so that the investment will do the most to enhance areas that are improving or to halt the fall of areas that are declining. Too often, massive public and private expenditures are made to rejuvenate one section of town, only to pull businesses and homebuyers away from another. Similarly, land use, building, and engineering regulations are too often imposed with thought only of curbing the excesses of bad actors, and with insufficient understanding of unintended consequences.

Our recent performance in developing cities has been mediocre; our cities fall short of their potential. Spaces are often poorly planned; boring, repetitive designs are deployed where they are easy to accomplish, rather than where they are appropriate. Once-beautiful neighborhoods are not maintained; the fabric of much of our urban infrastructure is in an appalling state of disrepair. Developing new greenfield sites is easier and cheaper than maintaining or redeveloping older areas.

No one individual or group is to blame for this situation, but all can help remedy it. The development community must exercise stronger leadership, not only in constructing and renovating American cities but also in correcting the harmful aspects of the present development system. By looking after the interests of the community at large, developers serve their own interests.

Development offers one of the most tangible legacies that one can achieve. However, the most successful developers leave behind more than great buildings. Gerald Hines says he is most proud of the people who have worked with him—the team and the longevity of people in his firm, the built environment they have created, their success in a competitive environment where other developers have had to meet higher standards, and the high quality that resulted in the cities where they have built.³⁸

In Jersey City, New Jersey, Hudson Greene combines rental and owner residential units in two towers overlooking New York Harbor and Manhattan’s skyline.

ULI Past President Robert Nahas summarized the attraction of development: “The great developers whom I’ve been privileged to know never worked for money per se…. I think these developers want to leave a footprint in the sand. It’s their particular kind of immortality.”³⁹ All developments must pass the test of serving current market needs or they will fail. But most developments also have a future clientele. Although individual homes and buildings may be replaced, the basic fabric of the community that developers create—street layout, parks, urban design elements—will last for hundreds of years. Indeed, one of development’s greatest rewards—and the source of its greatest responsibilities—is its effect on future generations.

1. Interview with Don Killoren, principal, Celebration Associates, LLC, Hot Springs, Virginia, 2010.

2. Interview with Kenneth Leventhal, founder of the Kenneth Leventhal accounting firm, now E&Y Kenneth Leventhal, 1998.

3. Interview with Bowen “Buzz” McCoy, former director, Morgan Stanley Real Estate, Los Angeles, California, 2010.

4. Interview with Stewart Fahmy, president of Calandev, LLC, San Jose, California, 2010.

6. Interview with John Knott, president, Noisette Company, LLC, Charleston, South Carolina, 2009.

7. Interview with Gerald D. Hines, founder and chair, the Hines real estate organization, Houston, Texas, conducted by Richard Peiser, August 2010.

8. Jonathan D. Miller, Emerging Trends in Real Estate 2010 (Washington, D.C.: ULI–the Urban Land Institute and PricewaterhouseCoopers, LLP, 2009), p. 3.

9. Interview with Robert Larson, chair, Lazard Frères Real Estate, New York, New York, July 2001.

10. Harvey S. Moskowitz and Carl G. Lindbloom, The Latest Illustrated Book of Development Definitions (New Brunswick, N.J.: Center for Urban Policy Research, 2003).

11. Alvin L. Arnold, The Arnold Encyclopedia of Real Estate, 2nd ed. (New York: Wiley, 1993).

12. See Rita Fitzgerald and Richard Peiser, “Development (Dis) Agreements at Colorado Place,” Urban Land, July 1988, pp. 2–5; and Douglas R. Porter and Lindell L. Marsh, Development Agreements: Practice, Policy, and Prospects (Washington, D.C.: ULI–the Urban Land Institute, 1989).

13. Interview with Matthew Kiefer, partner, Goulston & Storrs, Boston, Massachusetts, 2010.

14. See www.cdi.gsd.harvard.edu, the website for the Harvard Design School’s Center for Design Informatics.

15. Elizabeth Hayes, “Radical Changes as Worlds of Tech, Real Estate Merge,” Los Angeles Business Journal, January 24, 2000, p. 36.

17. Interview with Chad Rowe, director of sales, Bundoran Farm, Charlottesville, Virginia, 2010.

18. Interview with Zvi Barzilay, president and chief operating officer, Toll Brothers, Inc., Horsham, Pennsylvania, 2010.

19. Alan Berube, “The State of Metropolitan America: Suburbs and the 2010 Census,” presentation to the Suburbs and the 2010 Census: National Conference, Arlington, Va., July 14, 2011.

20. Interview with Elizabeth Plater-Zyberk, founding principal, Duany Plater-Zyberk & Company, Miami, Florida, 2010.

21. William H. Frey, “Metro Magnets for Minorities and Whites: Melting Pots, the New Sunbelt, and the Heartland,” PSC Research Report no. 02-496, Population Studies Center, University of Michigan, Ann Arbor, February 2002; and William H. Frey and Ross C. DeVol, “America’s Demography in the New Century,” Policy Brief no. 9, Milken Institute, Santa Monica, Calif., March 8, 2000.

22. Interview with Joel Kotkin, author of The Next Hundred Million: America in 2050 (New York: Penguin Press, 2010).

23. “Residential Construction Trends in America’s Metropolitan Regions,” U.S. Environmental Protection Agency, Development, Community, and Environment Division, Washington, D.C., January 2010.

24. Compiled from www.nmhc.org, website of the National Multi-Housing Council, 2010.

26. Interview with David Goldberg, communications director, Smart Growth America, Washington, D.C., 2010.

27. Peter Rummell, “Preserving a Sense of Place,” Urban Land, April 2000, p. 18.

28. Thomas L. Lee, “Place Making in Suburbia,” Urban Land, October 2000, pp. 72–79.

30. Interview with Judi Schweitzer, president, Schweitzer & Associates, Inc., Lake Forest, California, 2009.

31. Interview with Steve Kellenberg, principal, AECOM (formerly EDAW), Irvine, California, 2010.

32. David Schrank et al., The Urban Mobility Report (College Station: Texas Transportation Institute, 2007), Congestion Summary Tables.

33. Andrès Duany, Elizabeth Plater-Zyberk, and Jeff Speck, Suburban Nation: The Rise of Sprawl and the Decline of the American Dream (New York: North Point Press, 2001), p.100.

35. Daniel Rose, chair of Design and Politics conference, New York, April 1988, quoted in Maria Brisbane, “Developing in a Politicized Environment,” Urban Land, July 1988, pp. 6–8.

36. Gerald Hines, founder and chair, the Hines real estate organization, Houston, Texas, quoted in “Developing in a Politicized Environment,” Urban Land, July 1988, pp. 6-8.

37. Interview with Dan Kassell, president, Granite Homes, Irvine, California, 2002.

39. Robert Nahas, former general partner, Rafanelli and Nahas, Orinda, California, quoted in Ed Micken, “Future Talk: The Next Fifty Years,” Urban Land, December 1986, p. 16.