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Real Estate Development Matrix
 1138745049,  9781138745049

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‘The new text Real Estate Development Matrix is the first truly significant advancement on the groundwork laid by James Graaskamp many years ago. Dan Kohlhepp has taken his own years of actual development experience combined with the perspectives gained teaching this material to students and professionals that range from the University of San Diego to Johns Hopkins University, CCIM and NAIOP members and integrated it all into a systematic method of development decision making. Not only are the fundamental areas covered as in the Graaskamp model, but, here we have the players involved, the requirements of achieving more sustainable and responsible development, and the time sequence of development action items. Here, one can study development from the perspective of what the participants in the process actually do, what information they need and when they need to make decisions from idea conception through property value harvesting. Covering this subject matter for all property types and markets, is not an easy task and many developers have told academics you can’t teach this stuff, but Dan Kohlhepp, who uniquely combines his experience in both the academic and private sector worlds, has provided a new comprehensive model that sets a new standard. Great cases are provided, making the concepts within the matrix tangible for the advanced student of real estate. Suitable for advanced students, capstone courses and professionals alike, I give the Real Estate Development Matrix my strongest possible endorsement.’ – Norm Miller, PhD, Ernest Hahn Chair and Professor of Real Estate Finance, University of San Diego ‘The matrix covers the entire development process and breaks it down into the key stages that require critical tasks to be completed successfully to mitigate the development risk. The book blends years of development experience with the academic background of the authors. This is critical for a real estate development text because missing any of the key steps can jeopardize the success of the entire development project. It takes someone who has learned through years of development experience to know what the sources of risk are as you navigate the development matix.’ – Jeffrey D. Fisher, Ph.D., President, Homer Hoyt Institute, Professor Emeritus, Indiana University ‘The Real Estate Development Matrix masterfully blends the complex topics and concepts of the real estate development process into a navigable road map for any real estate professional. Daniel and Kimberly have creatively used real world “case studies” to reaffirm concepts, provoke critical thinking and illustrate discussed topics in a way that brings clarity of the real estate development process to all readers. This book is a must read for the aspiring real estate professional, a seasoned developer and any of the multidisciplinary professionals that plays a critical role in the real estate development process.’ – Bobby Zeiller, Managing Director-Development, Silverstone Healthcare Company ‘Real Estate Development is usually taught as the cap-stone/final class in most real estate programs. Development brings together all the aspects of real estate including: market feasibility studies, market strategy, environmental studies, transportation/accessibility, legal issues, acquisition, financing, approvals and permits, construction of physical improvements, leasing, operations, sales and finally disposition. As a professor teaching real estate development over the past 30+ years, the complex development process is challenging for students

to grasp and master. Finding good textbooks that cover areas that a professor deems most important in their course can be challenging. Real Estate Development Matrix takes a unique “modular” approach to the process, putting each step into a compartment that can be understood and accomplished independently. This allows each of the individual contributors to the development process to be able to understand their role in the process and the value that it creates. A developer is like an orchestra leader who knows what the music should sound like and must lead each instrumentalist to function in a harmonious fashion to produce a good result. Just as an orchestra leader may not be able to play every instrument, a developer does not have to be able to produce alone each task of the land planners, architects, engineers, bankers, contractors, sub-contractors, lawyers, brokers and users they lead; who all have special expertise. The developer must be able visualize and communicate the end goal to all players and then oversee and coordinate all those players to achieve the final result. The book breaks the development process into seven stages: land banking, land packaging, land development, building development, building operation, building renovation and property redevelopment. It then uses the eight tasks needed in each stage: acquisition, financing, market studies and market strategy, environmental studies, approvals and permits, physical improvements, transportation/accessibility, and sales/disposition. Therefore, each player can see their own task and how it fits into the big picture, and the developer can more easily manage the entire project and coordinate the tasks. Each topic is handled in an industry standard fashion that is already being used by the NAIOP (commercial developers) and CCIM (commercial brokers) organizations in their professional courses, providing good consistency, terminology and approach. The Kohlhepps have been developers, operators, and instructors – thus the applied nature of their approach. I recommend that anyone teaching real estate and/or development courses consider this book, as all or parts of it may be useful in many different courses.’ – Glenn R. Mueller, PhD, Professor – University of Denver, FL Burns School of Real Estate & Construction Management, Real Estate Investment Strategist – Black Creek Group, Denver, CO ‘Forever academics have attempted to describe and explain property development in the context of specific property types. Dr. Kohlhepp breaks this paradigm rut by focusing on the 7 different stages of property development and the 8 specific tasks associated with each stage. The brilliance of this framework is that it transcends any property-type specifics and squarely outlines the whole of property development, regardless of property type. Dr. Kohlhepp artfully explains property development as a series of complex and interrelated activities, and demonstrates how the Development Matrix can help bring order to the thought process. The Matrix encourages the reader to think logically and systematically, but not linearly about property development.’ – Jeff Engelstad, Ph.D., FRICS, CCIM, Professor, Burns School of Real Estate & Construction Management, University of Denver ‘The Real Estate Development Matrix is simple, clear, and insightful. The authors breakdown a confusing process into seven understandable stages. This readable and non-technical book is a must read for every participant in real estate development. The companion website nicely compliments the text with in-depth discussions and analysis. The real-world examples clearly demonstrate the authors’ points. Having worked with the senior author for over 30 years, I have participated in most of the projects discussed in

the text. They were always learning experiences and illustrate the stages and tasks in the Matrix. I particularly enjoyed the discussion of “project feasibility” and the Three Commandments of real estate development.’ – Art Fields, Retired President and CEO of Crescent Resources, LLC ‘I have had the pleasure of working alongside Dan Kohlhepp in the presentation of his Development Matrix throughout various US markets. This material has been well received, as it outlines a very logical series of development stages, each containing well defined tasks. The total matrix clears what is typically the ‘fog’ of the development process, and no matter what level of development one is involved in, they can clearly see both their entry into the process, as well as various exits. I highly recommend Dr. Kohlhepp’s material no matter the level of experience, or in what sort of development one is involved.’ – Mark Van Ark, CCIM, SIOR, Sr. Instructor – CCIM Institute, Director – KW Commercial, Denver/Boulder, CO ‘This is the book that real estate/urban development educators in professional organizations and academic institutions have needed for a long time . . . Real Estate Development Matrix shows that one does not have to be a master developer taking a project from start (undeveloped land) to finish (operating building) to be successful. One can be successful by mastering some tasks at some stage of the overall process. . . . real estate developers will empathize with the presentation and discussion of the real world experiences encountered; task experts in a part of the development process – lawyers, bankers, urban planners – will better understand what the developer needs from them; and students new to development will have an overview of what they can expect in their future careers. It is an essential book for anyone dealing with the built environment.’ – Michael A. Anikeeff, PhD, Professor (retired), Johns Hopkins University, Carey Business School, Edward St. John Real Estate Program

Real Estate Development Matrix

This book presents a new way of thinking about, teaching, learning, and practicing real estate development. Real Estate Development Matrix describes the process in a two-dimensional model and presents seven Development Stages which form the horizontal axis, and eight sets of Development Tasks which form the vertical axis to define a 56-cell matrix. In each cell, money is spent and risks are taken to achieve certain tasks and thereby create (or destroy) value. This holistic process considers the entire life cycle of real estate from its “green field” inception to its “brown field” state. The book is written by a real estate developer and academic, and the presented material is conceptual, practical, and non-technical. Jargon has been minimized as much as possible as the authors introduce an entirely new model for real estate development that is both academically authoritative and developed in practice. It is aimed at a general professional audience participating in the development process, but equally the book is ideal for use as a textbook in undergraduate and graduate courses in real estate development, and an excellent supplemental text for business courses discussing real estate finance and investment. It may also be used as a textbook for professional courses, workshops, or seminars in real estate development. The book is supported by an interactive website at http://realestatedevelopmentmatrix.com/ Daniel B. Kohlhepp is the president of Granite Road LLC. He is a former senior lecturer and academic program director of the Master of Science in Real Estate and Infrastructure Program at the Johns Hopkins Carey Business School. He began his career in real estate as a college professor at the University of Oklahoma and Penn State University and then spent 30 years as a real estate investor and developer before returning to academia. In 2007 the Homer Hoyt Institute recognized Kohlhepp as a Hoyt Fellow, and in 2012, he was elected to the board of directors of the Homer Hoyt Institute. He is an equity principal of the Real Estate Counselors Group of America, and he is also a member of the Appraisal institute and currently serves on the editorial board of the Journal of Sustainable Real Estate. Kohlhepp holds a PhD in Real Estate and Urban Planning Analysis from The Ohio State University, and an MBA and BS degree from The Pennsylvania State University. Kimberly J. Kohlhepp, MSREI, LEED AP BD+C is currently the Associate Director of Development for Kimco Realty’s Mid-Atlantic Region in Baltimore, MD. Before joining Kimco, she was a principal at Nestwood, LLC, a consulting firm focused on producing financial proformas, market research, and educational courses for real estate development teams and organizations. Kimberly has also worked with Brookfield Office Properties and Federal Realty Investment Trust in both property management and asset management roles. Kimberly holds a Master of Science in Real Estate and Infrastructure from Johns Hopkins University and a Bachelor of Arts in Anthropology from Ohio University.

Real Estate Development Matrix

Daniel B. Kohlhepp Kimberly J. Kohlhepp

First published 2018 by Routledge 2 Park Square, Milton Park, Abingdon, Oxon OX14 4RN and by Routledge 711 Third Avenue, New York, NY 10017 Routledge is an imprint of the Taylor & Francis Group, an informa business © 2018 Daniel B. Kohlhepp and Kimberly J. Kohlhepp The right of Daniel B. Kohlhepp and Kimberly J. Kohlhepp to be identified as authors of this work has been asserted by them in accordance with sections 77 and 78 of the Copyright, Designs and Patents Act 1988. All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. Trademark notice: Product or corporate names may be trademarks or registered trademarks, and are used only for identification and explanation without intent to infringe. British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging-in-Publication Data Names: Kohlhepp, Daniel B., author. | Kohlhepp, Kimberly J., author. Title: Real estate development matrix : a handbook / Daniel B. Kohlhepp, Kimberly J. Kohlhepp. Description: New York : Routledge, 2018. | Includes bibliographical references and index. Identifiers: LCCN 2017031435| ISBN 9781138745049 (hardback : alk. paper) | ISBN 9781315180779 (ebook) Subjects: LCSH: Real estate development. Classification: LCC HD1390 .K64 2018 | DDC 333.73/15—dc23 LC record available at https://lccn.loc.gov/2017031435 ISBN: 978-1-138-74504-9 (hbk) ISBN: 978-1-315-18077-9 (ebk) Typeset in Times New Roman by Keystroke, Neville Lodge, Tettenhall, Wolverhampton Visit the companion website: http://realestatedevelopmentmatrix.com/

Contents

Prefacexi About the authors xv Acknowledgements xvii Table of exhibitsxxi PART I

1

  1 Introduction

3

  2 Real estate development defined

8

  3 The Real Estate Development Matrix

12

  4 The third dimension

17

PART II

21

  5 Introduction to the Stages of real estate development

23

  6 Land Banking

30

  7 Land Packaging

47

  8 Land Development

76

  9 Building Development

103

10 Building Operations

127

11 Building Renovation

147

12 Property Redevelopment

167

PART III

189

13 Real Estate Development Tasks: an overview

191

14 I. Acquisition Tasks 

195

x  Contents

15 II. Financing Tasks

212

16 III. Market Analysis and Marketing Strategies Tasks

228

17 IV. Environmental Issues

244

18 V. Approvals and Permits Tasks

255

19 VI. Physical Improvements Tasks

269

20 VII. Transportation and Accessibility Tasks

281

21 VIII. Sales and Disposition Tasks

294

22 Summary Afterword

311 313

Index

315

Preface

Purpose The purpose of this book is to define the Real Estate Development Process in terms of a twodimensional model called the Real Estate Development Matrix. The Real Estate Development Process has been discussed and debated for many decades, centuries perhaps. While everyone thinks they know what it is, nobody seems to agree. This is particularly troublesome if one is trying to obtain community support for a proposed project, to raise funds from prospective investors, or to teach real estate development to students with multidisciplinary backgrounds. This Real Estate Development Process has been poorly defined and, consequently, the perceived risks in development can appear overwhelming or be easily ignored. The book aims to define the Real Estate Development Process with a consistent terminology that can be used to clarify participants’ roles and expectations, as well as to specify and describe the societal costs and benefits of real estate development. The risks involved in real estate development are described as the failure to successfully complete specific tasks in the process.

Overview The book describes real estate development very broadly and includes any and all efforts to add economic value to a parcel of real estate. This holistic process considers the entire life cycle of real estate, from its “green field” state to its “brown field” state. This process may take decades or centuries, and the process is repeated over and over again. The book’s general theme is that, at every Stage of the Real Estate Development Process, economic value is added by successfully completing certain Tasks that require special skills. Failure to accomplish those Tasks would result in a loss of economic value. These failures are the risks that real estate developers incur in the process.

Target audience This book is written by real estate developers, and it is aimed at a professional audience of those participating in the development process. This group includes development team members from multiple disciplines and professional backgrounds, as well as civic leaders and public officials who guide the future of their communities. The book is also aimed at students studying real estate development in professional seminars and workshops, and in undergraduate and graduate classrooms. Real estate development is a multidisciplinary process that is formally taught in business, architectural, engineering, and political policy schools. This book is appropriate reading for undergraduate, graduate, and professional students interested in the Real Estate Development Process. The book’s material is conceptual,

xii  Preface practical, and non-technical. Jargon has been minimized as much as possible. A companion website, http://realestatedevelopmentmatrix.com/, contains technical discussions and explains special skills that are used in real estate development.

Authors’ perspectives The co-authors bring very different generational perspectives to the Real Estate Development Matrix. Dan and Kimberly view the Stages and Tasks of development through their different lenses of history, culture, experiences, and political movements. Dan tries to explain the real estate development process that he has experienced over the last 40 years, while Kimberly tries to understand the real estate development process that she has experienced over the last eight years, and that shapes her future expectations. This work is based on James Graaskamp’s “Land Investment Seminar” that he presented in 1973 at The Ohio State University where Dan was a graduate student at that time. Graaskamp described the first four stages of the Real Estate Development Process in the context of residential land development. Graaskamp spoke to Dan’s heart. Dan added the last three Stages to the Process and expanded the context of the Process to other real estate property types. Any misapplication of Graaskamp’s work or intentions is solely Dan’s responsibility. Kimberly has been responsible for keeping the case studies and examples focused and relevant to the issues and concepts being discussed. She has protected the readers from Dan’s tendency to get lost in the details by saying, “Good story; bad example!” Both authors have had multiple roles and responsibilities in numerous projects in various stages of real estate development. Companion website: http://realestatedevelopmentmatrix.com The companion website is more detailed and more expansive than the book. The case studies and examples that are presented in the book are linked to additional information on the website. Each reference to a case study or example is indicated by the notation @REDM. This notation is accompanied with an endnote that provides a URL address for the material. There is also a tab on the website, Book URLs, that provides a list of the URL addresses referred to in each chapter, and in the order of their appearance in the book. There is also a tab on the website, Examples, that lists the URL address for each case study and example by Stage and Task. The website material can be accessed using a filtering process that specifies Stage, Task, and Title. The companion website has another tab, Special Skills, that lists various technical skills that are presented on the website. The Special Skills involve value measurement methodologies, as well as decision-making techniques required to successfully complete the Real Estate Development Process.

NAIOP and CCIM Institute This book reflects a series of online courses that were written by the authors for two major professional organizations: NAIOP: A Commercial Real Estate Development Organization, and the CCIM Institute. The NAIOP courses were introductory in nature and used case studies while the CCIM courses were more detailed and focused on technical examples. These different approaches are reflected in the organization of the book. Part I uses graphic illustrations to explain the Real Estate Development Process and the Real Estate Development Matrix. Part II describes the seven Stages in the Real Estate Development Process using case

Preface  xiii studies, and Part III focuses on the eight sets of Development Tasks using specific examples to better illustrate each Task. The material presented in this book has been presented to professional students in online courses, as well as to students in live, in-person workshops. The students’ input has significantly improved the presentation of this material and helped to clarify many of the ambiguities in the Real Estate Development Process. There is a website tab, FAQs, that answers many of the questions raised by these professional students.

How to use this book Readers looking for non-technical information can use the book in print or eBook form. However, readers looking for more detailed discussions, case studies, or examples are encouraged to explore the links on the companion website. For more detailed information, the print version of the book should be read in conjunction with the website, so the readers have ready access to the Book URLs tab, which will provide the links to the case studies and examples right at their fingertips. Instructors using this book in a classroom setting are encouraged to use the case studies and examples as topics for discussion. Since all of this material is from real-life deals, projects, and developments, the relevant discussion questions could be, “What were the developers trying to accomplish?”; “Did they do the analysis correctly?”; “How could this development task or problem be better addressed?” Curious readers could easily determine how the deal, development, or problem actually turned out!

Takeaways Hopefully, readers will take away some of the following ideas about the Real Estate Development Process: • •

• • •



Real estate development is a multidisciplinary endeavor. Because there are so many different talents, specialties, and skills, no single profession owns this process. Real estate development is intrinsically simple, but incredibly complex. The interaction of public entities and private enterprises, the art and science of building construction, and the competition between tenants and landlords in the real estate marketplace make the Real Estate Development Process infinitely complicated. Real estate development is intellectually stimulating and incredibly interesting. The dynamic, poorly specified, and uncertain constraints present a complexity that can’t be solved, but rather must be embraced. Real estate development is a local activity, except when it is not. The globalization of economic markets and the propensity for federal land use regulations force real estate developers to have a much broader worldview. Real estate development is a public process where the public good and the private interests are evaluated in terms of our society’s values, visions, and fears. Real estate belongs clearly to both the public and private sectors, so its development needs to be debated and discussed in a very open and transparent manner. Finally, real estate development is very humbling because of the long-term consequences of all decisions and actions. Real estate development determines land use patterns, fiscal requirements, and social interactions for several generations. It takes a cautious and respectful voice to predict the future in this complicated process.

xiv   Preface The Real Estate Development Matrix is a foundation for understanding the Real Estate Development Process. This discussion should be expanded: to be more global and less U.S.-centric, to embrace sustainability as more than an environmental Task, to explain and demonstrate more technical tools for analysis, and to discuss the effects that the electronic communication revolution has had on our built-environment. The companion website will be used as a platform to encourage these discussions. Daniel B. Kohlhepp Kimberly K. Kohlhepp

About the authors

Daniel B. Kohlhepp, PhD, MAI Daniel B. Kohlhepp is a senior lecturer at the Johns Hopkins Carey Business School and president of Granite Road LLC, a real estate development company. He began his career in real estate as a college professor at the University of Oklahoma and Penn State University, and he then spent 30 years as a real estate investor and developer before returning to academia eight years ago after he retired from Crescent Resources LLC, as the president of its Commercial Division. At the Johns Hopkins Carey Business School, Dr. Kohlhepp has served as the academic program director of the Master of Science in Real Estate and Infrastructure Program and has been responsible for the real estate development, investment, and financial modeling courses. He has just completed two online courses in real estate development for the NAIOP and eight online courses for the CCIM Institute. At Crescent Resources, Dr. Kohlhepp was responsible for 18 major commercial developments in seven states that included mixed-use, office, warehouse/distribution, and retail projects, as well as 28 master-planned community developments in Florida and southern Georgia. After teaching at the University of Oklahoma and The Pennsylvania State University, Dr. Kohlhepp left academia in 1979 to become a developer in Oklahoma City. In 1984, he moved to Washington, DC, to enter the real estate investment advisory business, and in 1991, he sold his company to Baltimore-based USF&G Corporation. His company was responsible for all development and investment activities for a $1.5 billion real estate portfolio. In 1992, Dr. Kohlhepp started Kohlhepp Realty Advisors, which specialized in real estate portfolio valuation and management for institutional and governmental regulatory clients. In 2001, he joined Crescent Resources to develop Potomac Yard, a 300-acre, mixed-use, urban in-fill project in Northern Virginia. During the development of Potomac Yard, Dr. Kohlhepp and his team were awarded the Northern Virginia NAIOP Best Transaction of the Year (2001), Trenchless Technology’s Project of the Year (2003), Arlington Chamber of Commerce Chairman’s Award (2003), Washington Business Journal’s Best GSA Lease Award (2004), and the Arlington Chamber of Commerce ABBIES “Green” Award (2005). In 2007, One and Two Potomac Yard, a 654,000 square-foot, twin-tower, office project within Potomac Yard, was awarded the “Best Commercial Project” and the “Best Building High-rise” by the Virginia Sustainable Building Network and the Northern Virginia NAIOP, respectively. In 2007 the Homer Hoyt Institute recognized Dr. Kohlhepp as a Hoyt Fellow, and in 2012 he was elected to the board of directors of the Homer Hoyt Institute. He is a principal of the

xvi   About the authors Real Estate Counselors Group of America, and he is also a member of the Appraisal Institute and currently serves on the editorial board of the Journal of Sustainable Real Estate. In 2017, The American Real Estate Society recognized Dr. Kohlhepp with the Practitioner Scholar Award as a real estate practitioner who has significantly contributed to the body of real estate knowledge and who is highly regarded by academic scholars and whose work has been adopted and used by practitioners. Dr. Kohlhepp earned his PhD at The Ohio State University and his BA and MBA at The Pennsylvania State University.

Kimberly Kohlhepp, MSREI, LEED AP BD+C Kimberly Kohlhepp is the Associate Director of Development for Kimco Realty’s MidAtlantic Region. Kimco Realty is one of North America’s largest publicly traded owners and operators of open air shopping centers, traded on the NYSE as KIM. She has also worked on Kimco’s Asset Management & Acquisitions and Dispositions Team in Baltimore, MD. Before joining Kimco, Ms. Kohlhepp was principal at Nestwood LLC, a consulting firm focused on producing financial proformas, market research, and development courses for real estate development teams and organizations. Ms. Kohlhepp has also worked with Brookfield Properties and Federal Realty Investment Trust in both property management and asset management roles. Ms. Kohlhepp is an accredited professional member of the United States Green Building Council and earned LEED AP BD+C in 2014. Ms. Kohlhepp holds a Master of Science in Real Estate and Infrastructure from the Johns Hopkins University and a Bachelor of Arts in Anthropology from Ohio University.

Acknowledgements

The authors would like to recognize and thank numerous persons who helped make this book possible.

Historical While this concept of the Real Estate Development Process was initially formulated by University of Wisconsin Professor James Graaskamp in a land development seminar in 1973, his ideas were expanded to include the concept of value creation by Professor Ronald L. Racster at The Ohio State University. Their legacy is the foundation of this work.

Professional Two professional developers had significant effects on the author, Dan: Art Fields and Bobby Zeiller. For 40 years, Arthur W. Fields has successfully demonstrated a disciplined and dogmatic approach to real estate development by determining where and when property value increases in the process. Throughout his professional career, he has participated in all Stages of the Real Estate Development Process and his accomplishments are historic. Art and Dan did their first deal together over 30 years ago in Nashville and have done dozens of developments together since. Robert H. “Bobby” Zeiller was Dan’s right-hand man in numerous mixed-use developments. Accomplished in engineering and construction management, Bobby became an expert in political and community affairs. His deft hand in the Land Packaging Stage made him incredibly effective in obtaining permits and approvals for Land Developers. Art, Bobby, and Dan have debated market trends, strategies, tactics, and general world events ad nauseum. However, they always agreed on the importance of determining how and when economic value is created in the Real Estate Development Process. Art and Bobby were models of responsible real estate developers. They demonstrated not only what needed to be done, but also how it should be done.

Academic Professor Michael Anikeeff (Johns Hopkins University) was an early supporter of the Real Estate Development Matrix, and he has been extremely supportive and encouraging during this writing effort. Professors Jeff Fisher and Norm Miller (Indiana University and the University of San Diego respectively) have been helpful and gentle as they encouraged us to push this book

xviii   Acknowledgements forward. Jeff first encouraged the website development, and Norm insisted that green building and sustainable development are essential parts of the development process. Professors Wayne Archer and Josh Harris (University of Florida and the University of Central Florida respectively) were instrumental in extolling the benefits of writing this book.

NAIOP and the CCIM Institute As the Educational Director of NAIOP, James Tolliver made this book a reality. Jim convinced the authors to write two online courses, Essentials of the Development Process and Advanced Development Practices, and then set up goals, dates, and financial incentives to ensure their completion. When Jim retired, Barb David Parnarouskis became the Director of Education, and she helped the authors complete the courses and arranged for the authors to personally teach the online courses as well. Walt Clements, the Executive Director of the CCIM Institute, wanted to create a Development Track in the CCIM designation program and asked the authors to work with his team, headed by Andrea Change, to create a series of online courses focused on the Development Tasks, as well as two live workshops that focused on the Stages in the Real Estate Development Process. While the courses were built around the Real Estate Development Matrix, the inspiration of the courses came from Jeff Engelsted, PhD, CCIM, and Mark VanArk, CCIM. Jeff and Mark helped construct the courses and taught them as well. This involvement with NAIOP and the CCIM Institutes helped the authors fine tune the Real Estate Development Matrix and sharpen the case studies and examples. The authors are convinced that online courses are the future of professional education, especially if done in conjunction with live workshops.

Routledge As the authors were completing the NAIOP and CCIM courses, Ed Needle, Editor of Construction and Real Estate for Routledge Publishing, engaged the authors in a discussion about writing this book. While the authors had focused on a narrow professional audience, Ed contended that a textbook should be aimed at a broader audience to include undergraduate and graduate students, as well as real estate professionals in all areas of development. Ed was persuasive. Ed guided the authors through the Routledge review process and established milestones for the completion of the text and its eventual publication. Catherine Holdsworth, Assistant Editor at Routledge, has also been very helpful in preparing the manuscript for publication. Ed and Catherine have been invaluable resources.

The writing team Thirty years ago, Jayne M. Magee, PhD, wrote her dissertation on the writing process in a business setting. Her research concluded that writing was a social activity, especially when done in a business setting. After a career as a Professor of English at Lakeland Community College, retired Professor Magee joined the authors in their effort to produce the book. Jayne has held us to a high editorial standard as she has reviewed numerous drafts of each chapter. Miller Hopkins, MSREI, has worked with the authors as a student intern as well as an administrative research assistant. Fortunately, Miller has continued to work with the authors even after she began her career in real estate development. Miller’s understanding of the

Acknowledgements  xix intricacies of Word and her graphic skills on PowerPoint have enabled the Real Estate Development Matrix to become a quality publishable electronic product. The authors have struggled with the development of an interactive website to present the Real Estate Development Matrix both simply and completely. Thus, when Shane and Lauren Burroughs joined the writing team as website consultants, the development of a simple and complete companion website became a reality. They have continued to refine and expand the website as the authors better understood what they wanted to convey to the users. Also, Shane and Lauren have striven to make the website user-friendly and easily accessible to non-technical readers. When presented with a technological challenge, the authors thought, “Better call Shane.” They will continue to work with the authors to expand the depth and breadth of the Real Estate Development Matrix. Finally, both Dan and Kimberly owe a great deal of gratitude to an unofficial member of the writing team, Donna Sell Kohlhepp, PhD, the wife and mother of the authors respectively. For years Donna has hosted and endured numerous dinners where the authors exhaustively discussed the Real Estate Development Matrix. Donna’s tolerance and culinary skills made these dinners productive and enjoyable. To her credit, she never took sides in the arguments, but her comments and questions sharpened and clarified our issues. Dr. Kohlhepp has also joined the authors on countless site visits.

Our students Special thanks are extended to the undergraduate and graduate students at Johns Hopkins University, the University of San Diego, and the University of Central Florida, who have worked through early drafts of this book in their courses. Also, the professional students in the NAIOP and CCIM courses must be recognized and thanked for their comments and insights on the material presented in this book.

Final thoughts Over the years, our colleagues have shared insights, comments, and criticisms that the authors have readily accepted and incorporated into the real estate development story. The voices of these larger-than-life characters are always in our minds. We owe them a debt of gratitude and heartfelt appreciation.

Table of exhibits

3.1 3.2 3.3 3.4 4.1 4.2 5.1 5.2 5.3 5.4 5.5 6.1 6.2 6.3 6.4 6.5 6.6 6.7 6.8 6.9 6.10 6.11 6.12 6.13 7.1 7.2 7.3 7.4 7.5 7.6 7.7 7.8 7.9 7.10 7.11 7.12

Real Estate Development Matrix Stages of development Developers work down the Matrix Professionals work across the Matrix Third dimension: product type Real Estate Development Cube Real Estate Development Matrix Schematic diagram Box diagram Venn diagram Circle diagram Real Estate Development Matrix Land Banking Schematic diagram Land Banking Box diagram Land Banking Venn diagram Land Banking Circle diagram The Land Banking equation Historic outbuildings Aerial photo: Metro area Aerial photo: Crown Farm site Aerial photo: Armed Forces Retirement Home AFRH sources of annual income Vanderbilt aerial photograph Kiwanis Trail area photo Real Estate Development Matrix Land Packaging Schematic diagram Land Packaging Box diagram Land Packaging Venn diagram Land Packaging Circle diagram Land Packaging equation Crown Farm site photo Revised master plan AFRH vicinity map AFRH site photo AFRH original master plan Final master plan

12 13 15 15 17 18 23 26 27 27 28 30 31 32 33 33 34 40 40 41 42 43 44 45 47 48 49 49 50 50 59 61 63 64 65 67

xxii  Table of exhibits 7.13 7.14 7.15 7.16 7.17 7.18 7.19 8.1 8.2 8.3 8.4 8.5 8.6 8.7 8.8 8.9 8.10 8.11 8.12 8.13 8.14 8.15 8.16 8.17 8.18 8.19 8.20 8.21 9.1 9.2 9.3 9.4 9.5 9.6 9.7 9.8 9.9 9.10 9.11 9.12 9.13 9.14 9.15 9.16 9.17 9.18 9.19

Potomac Yard conceptual master plan Summary of the master plan of the Alexandria portion of Potomac Yard Alexandria land bays Challenging issues in Alexandria Summary of the Arlington master plan for Potomac Yard Arlington land bays in Potomac Yard North Tract portion of Potomac Yard Real Estate Development Matrix Land Development Schematic diagram Land Development Box diagram Land Development Venn diagram Land Development Circle diagram Land Development equation Crown Farm aerial photo Revised overall master plan Phase I of revised master plan Major infrastructure improvements Overall road system Phase I road construction Potomac Yard conceptual master plan Trunk sewer shaft preparation Trunk sewer shaft installation Trunk sewer construction Alexandria land sales Mass Grading in Arlington Arlington infrastructure challenges Perched water problems in Arlington Land bay sales in Arlington Potomac Yard Real Estate Development Matrix Building Development Schematic diagram Building Development Box diagram Building Development Venn diagram Building Development Circle diagram Building Development Equation Crown Farm Land Banking Stage Crown Farm revised conceptual master plan Crown Farm Phase I infrastructure Crown Farm Phase I building development Rendering of the approved Town Center Plaza Actual Town Center Plaza Completed streetscape of Downtown Crown Approved design of One and Two Potomac Yard Photo montage of One and Two Potomac Yard on Land Bay A Top view construction crane swings Side view of the construction crane placement Site plan Rendering of International Plaza and the parking garage

69 69 70 71 71 72 73 76 77 78 78 79 80 88 88 89 90 91 92 93 94 94 95 96 97 98 99 100 103 104 105 105 106 107 115 115 116 116 117 117 118 119 121 121 122 123 124

Table of exhibits  xxiii 10.1 10.2 10.3 10.4 10.5 10.6 10.7 10.8 10.9 10.10 10.11 10.12 11.1 11.2 11.3 11.4 11.5 11.6 11.7 11.8 11.9 11.10 11.11 11.12 11.13 11.14 11.15 11.16 11.17 11.18 12.1 12.2 12.3 12.4 12.5 12.6 12.7 12.8 12.9 12.10 12.11 12.12 12.13 12.14 12.15 13.1 14.1 14.2

Real Estate Development Matrix Building Operations Schematic diagram Building Operations Box diagram Building Operations Venn diagram Building Operations Circle diagram Building Operations equation Potomac Yard master plan One and Two Potomac Yard Investment Grade Value Index vs One and Two Potomac Yard 1400 K Street 650 Massachusetts Avenue Renderings of 650 Massachusetts Avenue Real Estate Development Matrix Building Renovation Schematic diagram Building Renovation Box diagram Building Renovation Venn diagram Building Renovation Circle diagram Building Renovation equation Tysons Corner regional map Tysons Corner Center in 1969 Tysons Corner Center in 1987 Preliminary land plan for renovation (1987) Tysons Corner Center new wing in 2005 Tysons Corner Center interior renovations in 2005 Tysons Corner Center future phased development Interior boutique shops Interior boutique shops New front entrance Original 2001 M Street Renovated 2001 M Street Real Estate Development Matrix Property Redevelopment Schematic diagram Property Redevelopment Box diagram Property Redevelopment Venn diagram Property Redevelopment Circle diagram Property Redevelopment equation Historic St. Elizabeth’s Hospital Redbrick LMD’s Phase I Concept Plan (2.5 million GSF) Edmonton regional map Aerial photo of the ECCA Winning master plan proposal Potomac Yard circa 1980 Decommissioned Arlington North Tract Decommissioned Arlington South Tract with flood control bridges Decommissioned Alexandria Tract Real Estate Development Matrix Real Estate Development Matrix Greensboro Grove massing study

127 128 129 130 131 131 139 140 141 142 144 144 147 148 149 149 150 151 158 158 159 160 161 161 162 163 163 164 164 165 167 168 169 170 171 172 178 180 181 182 183 184 185 186 186 191 195 199

xxiv   Table of exhibits 14.3 14.4 14.5 14.6 14.7 15.1 15.2 15.3 15.4 15.5 16.1 16.2 16.3 16.4 16.5 16.6 16.7 16.8 16.9 16.10 17.1 17.2 17.3 18.1 18.2 18.3 19.1 19.2 19.3 20.1 21.1

One and Two Potomac Yard Back of the Envelope feasibility International Plaza IV Back of the Envelope feasibility Phipps Back of the Envelope feasibility Phipps tower site plan, entrance, and tower renderings Feasibility schematic Real Estate Development Matrix Typical cashflow patterns in real estate development Belgate Land Development Belgate preliminary projections Construction loan vs. permanent loan Real Estate Development Matrix Arlington residential land bays NGA site plan Mueller’s Market Cycle Forecast Existing market cycle conditions Future market analysis, industrial Start big and work into smaller submarkets Estimating market absorption and rental rates Market forecast Competitive property analysis Real Estate Development Matrix Triple bottom line Environmental site assessments Real Estate Development Matrix Simple township subdivision process Complex county subdivision process Real Estate Development Matrix Traditional Design-Bid-Build model Design-Build model Real Estate Development Matrix Real Estate Development Matrix

200 202 203 204 210 212 214 215 216 219 228 231 233 234 235 236 237 238 238 239 244 245 246 255 262 263 269 275 276 281 294

Part I

1 Introduction

The purpose of this book is to examine the Real Estate Development Matrix. @REDM1 The Real Estate Development Matrix combines the seven Stages of the Real Estate Development Process with the eight Tasks that must be completed during each Stage. This 56-cell Matrix captures the real estate development activities in a comprehensive and holistic manner. This broad view of the Real Estate Development Process considers the entire lifespan of a property: 1 2 3 4 5 6 7

Land Banking Stage. Land Packaging Stage. Land Development Stage. Building Development Stage. Building Operations Stage. Building Renovation Stage. Property Redevelopment Stage.

This process may take several decades to complete, and then the cycle starts again as property in the Redevelopment Stage goes back to the Land Packaging Stage and the process begins anew. The development Tasks are also considered in a very broad sense as they are grouped into eight categories: I. II III IV V VI VII VIII

Acquisition. Financing. Market Analysis and Marketing Strategies. Environmental Issues. Approvals and Permits. Physical Improvements. Transportation and Accessibility. Sales and Disposition.

Part I provides the context for the Real Estate Development Matrix while Part II and Part III discuss the Stages and Tasks of development, respectively. Each chapter in Part II will discuss the essential elements of each Stage in terms of how economic value is created in that Stage, and then review the following aspects: • •

key players; critical Tasks;

4   Part I • •

controllable costs; major risks.

In Part III, each chapter discusses a set of real estate development Tasks and explains how those Tasks are accomplished during the various Stages of development. The aim of this book is to present the readers with a conceptual framework in which to discuss, question, and analyze the Real Estate Development Process in the context of their own skills and experiences. The discussion is non-technical and almost free of jargon. THE REAL ESTATE DEVELOPMENT MATRIX COMPANION WEBSITE @REDM 2 This textbook is supported by a website that is based on the Real Estate Development Matrix. The website has an interactive Matrix that allows the user to move from one cell to another to better understand the interactions between the Stages of development and the development Tasks. The website also has an archive of numerous case studies and examples of the topics discussed in this book. The website notation of @REDM indicates that more information is available in the website. There will also be a URL in the endnotes for each website notation. The website has a tab labelled Textbook URLs that lists the URL addresses by chapter in the order that they appear in the text. Finally, these case studies and examples can also be accessed under the Examples Tab by designating the Stage, Task, and Title filters. The website also has a Special Skills tab where numerous analytical skills are presented, discussed, and demonstrated. Readers are encouraged to use the website to supplement the material as they read this book.

Unique characteristics of real estate and real estate markets Real estate has several unique characteristics which affect its physical development, as well as the economic markets in which it is traded.3 Fixed in space The physical immobility of real estate has many consequences for its development. Real estate as a physical asset and tangible asset is readily observable, so the general public recognizes its existence. Therefore, it is easily taxed and regulated. Also, because of its physical immobility, it affects and is affected by its neighbors and adjacent land uses.4 The fixed physical mobility of real estate tends to make its market local in nature; that is, real estate values are determined more by local economic conditions than by regional or national conditions. Complex ownership Ownership of the tangible real estate is defined as a “bundle of rights,” which are intangible rights or assets. Real estate ownership is defined as real property and inherent in this definition are personal property rights that can be owned by private individuals, public corporations, or governmental jurisdictions. These rights are limited by public land use controls, as well as private land use restrictions. Consequently, the market place for these rights is very technical and characterized by high transaction costs.

Introduction   5 Large capital investment Real estate can be defined as a financial asset in terms of debt capital, equity capital, or a combination of both. The large amount of capital to develop or to buy real estate usually requires both debt and equity. Consequently, ability to buy real estate depends on access to both the equity and debt markets. Long economic lives Most permanently constructed real estate projects have expected economic lives of 20 to 30 years, and physical lives of 40 to 50 years. The consequence of this durable asset is that the real estate property will experience several business cycles as well as multiple users and multiple investors. Real estate obsolesces, both economic and physical, result from the properties’ long economic lives in the context of changing construction and operational technologies, as well as the users’ changing tastes and preferences. Lengthy and complex production functions As we will discuss in the following chapters, it takes a long time, numerous players, multiple skills, and lots of capital to change real estate from cornfields to a shopping mall. Consequently, the supply of real estate cannot respond quickly to changes in demand. If demand falls, the supply of real estate stays fairly stable in the short run, so the property will experience higher vacancy rates and a loss of value. On the other hand, if there is an increase in the demand for real estate, developers will take several years to respond to, and increase, the supply and the demand may decline while the real estate is being produced. In the long run, real estate markets can respond to changing market conditions, but in the short run they are fairly unresponsive. This market feature tends to cause real estate to be over-supplied at times or owners to charge monopolistic rents at other times.

General themes Throughout this book, several themes continuously emerge although they may not be addressed directly in the material. Developers create value by accomplishing Tasks in the various Stages of the Real Estate Development Process. The creation of economic value is the heart of the process. As we work through each Stage, the most important takeaway will be the answer to the question, “How is value created during this step?” This question will be answered in each Stage overview. Successfully creating value means that the finished product has more economic value than the sum of the costs incurred to create it. The challenge is not to create value equal to the costs, but rather to create value that exceeds the costs. This increase in marginal value is what the Real Estate Development Process is all about. Sustainable development and green building technologies Sustainability and green building technologies are no longer a choice, but they are now the market standard in real estate development. These are not articles of faith, but rather they provide us with the language that we use to discuss and convey the impact of the development process. In today’s world, no one brags about developing a new “brown” building.

6   Part I Globalization Globalization is also part of our professional world (financing, materials, trade agreements, communications, and technology). While real estate development is considered a “localized” phenomenon, we are working in a global environment that affects all aspects of development. National and world events impact lenders, investors, materials, and occupants; therefore, it is important to keep a global perspective when reviewing all possible opportunities or solutions to each challenge. Entrepreneurship A continued theme in real estate development throughout the ages is entrepreneurship; it is in the developer’s DNA. Adam Smith, the father of economics, defined the factors of production as land, labor, and capital. Therefore, entrepreneurs are the people who combine these factors of production, so the value of the product is worth more than the total cost of production. This is what real estate developers do. Each real estate development is an entrepreneurial endeavor that involves risk taking with the expected commensurate rewards. It is not uncommon for a successful real estate development company to spawn several new real estate development companies as successful employees aspire to become players and run their own businesses.

The three commandments of real estate development There are three commandments for real estate developers; to break these commandments is a mortal sin and perhaps economically fatal. Know thy markets Keeping a keen eye on real estate trends, both locally and globally, is essential for making better assumptions about future returns. The more information that developers have about current markets, even beyond the real estate sector, the better they can predict and satisfy future demands and anticipate future competition. Developers must understand their local product market in terms of rental rates, occupancy rates, absorption rates, and submarket interactions. This market information must include details of related transactions, as well as the status of future planned developments. Know thy costs Developers must know historic costs, current costs, and future costs. In real estate development, everything that can go wrong, will go wrong, and that can get expensive very quickly. Developers cannot control the market, but they can control their costs. Having a solid cost estimating and recording process and keeping realistic, up-to-date budgets are critical to mitigating cost over-runs and unforeseen contingencies. Since the final product will be sold in a future, unknown market, developers cannot control the sale price or demand. Therefore, developers must control their project costs, whenever possible. Developers must know their local product market in terms of land, building, financing, and operating costs.

Introduction  7 Know thy self Brutal self-honesty is critical to survive the Real Estate Development Process. Self-delusion is unacceptable. Developers must know their strengths, weaknesses, biases, special skills, and resources. Before embarking on a project, they must ask themselves, “Can I do this? Do I have the resources or knowledge to solve this problem? Do I know whom to ask if I encounter a challenge that I cannot handle personally?” To quote William Shakespeare, “This above all, to thine own self be true; it must follow as the night the day, and then thou can be false to no man” (Hamlet, Act I, Scene 3: 78–82). Above all, remember that arrogance kills! Over reaching or inflating their abilities will be the developers’ downfall. Developers must be gentle with themselves, but they must know their limits. Sometimes the best deals are the ones they didn’t take. On that same note, developers must always have a viable exit strategy and be cognizant of deteriorating project conditions before it’s too late.

Notes 1 http://realestatedevelopmentmatrix.com 2 http://realestatedevelopmentmatrix.com 3 For a good discussion of the nature of real estate and real estate markets see David C. Ling and Wayne R. Archer’s book, Real Estate Principles: A Value Approach, 4th Edition, McGraw-Hill Irwin, Chapters 1 and 2. 4 In economic terms, this is referred to as an externality which is characterized by “spill-over” effects when an unrelated third-party is affected by the actions of others. These external effects can be positive or negative.

2 Real estate development defined

The analysis of the Real Estate Development Process begins with a working definition of real estate development. In chapter 1, real estate was defined as an immobile and physically tangible product. Real estate was also defined as having intangible ownership rights to the tangible product that could be either real or personal property. Finally, it was defined as a financial asset that could be either debt or equity, or a combination of both. Clearly, real estate can be defined in many different ways. Development is also defined in many ways as the act or process of developing, where the active verb “to develop” can be defined as: • • • •

To cause to grow or get larger To expand as in a business To bring into being as an idea To unfold gradually as a bud.1

Ironically, all of these definitions can be applied to real estate since the development of real estate involves all of them. Of course, there is great debate over the “true” or best definition of real estate development among educators, professionals, and government agencies. In this book, real estate development is generally defined as the process of adding economic value to the real estate enterprise through various stages of development. JAMES A. GRAASKAMP James Graaskamp can provide a more comprehensive and nuanced discussion of the question, “What is real estate development?” Graaskamp was a professor of real estate at the University of Wisconsin–Madison from 1964 until his death in 1988. In 1988, he was named a trustee of the Urban Land Institute (ULI) and was profiled in the 2004 ULI book, Leadership Legacies. Of the ten people profiled, Graaskamp was the sole academic. He was often accused by the academic community of being too practical and by the professional community of being too theoretical. He was an iconoclastic thinker who crossed academic boundaries and coined new terms and concepts. His early work provides the framework of the Real Estate Development Process.2 The following quotes are taken from Graaskamps’s monograph, Fundamentals of Real Estate Development, published by Urban Land Institute.3 The first real estate development occurred when:

Real estate development defined   9 “Someone rolled a rock to the entrance of a cave and created an enclosed space for his family, a warmer, more defensible shelter distinct from the surroundings.” Graaskamp would say that this is the classic example of real estate development where a man-made artifact interacts with a natural resource, thereby creating a product that improves the human condition. He continued: The real estate development process involves three major groups—a consumer group, a production group, and a public infrastructure group . . . Each group benefits from cooperation and a full understanding of the values, short- and long-term objectives, and major limitations controlling the other two groups . . . Unlike many mass-production industries, each real estate project is unique and the new development process is so much a creature of the political process that society has a new opportunity with each major project to negotiate, debate, and reconsider the basic issues of an enterprise economy, i.e. who pays, who benefits, who risks, and who has standing to participate in the decision process . . . Thus, the development process remains a high silhouette topic for an articulate and politically sophisticated society. Graaskamp’s comments and insight help real estate developers appreciate the role they play in society and lift our pragmatic thinking to a higher conceptual level. Graaskamp further explained: The creation and management of space-time units is termed real estate development. Real estate developments range from a simple cave to the complex technology of the Park Avenue skyscraper. Like a manufactured product, a real estate project is part of a larger physical system programmed to achieve long-term objectives, but each real estate project is also a small business enterprise of its own. Thus, the development process is a continuum of construction technology, financing, marketing skills, administrative controls, and rehabilitation required to operate the real estate enterprise over many years. The Real Estate Development Process is a challenging manufacturing process because its subsystems are so complex and because it is the instrument of change which affects all of a community and a society—not only for today—but also for future generations.

Real estate developers defined Real estate developers can be defined in many ways, from different perspectives. Here are three points of view. As entrepreneurs Economists may define real estate developers as entrepreneurs because real estate developers combine land, labor, and capital hoping to make a profit by creating a finished product whose value is greater than the costs of the component inputs. Real estate developers take the risks of the business enterprise with expectations of achieving an economic return that adequately rewards this risk-taking behavior.

10   Part I As prominent citizens Successful real estate developers sometimes are considered prominent citizens as they are building cities or enhancing communities’ built-environments. Real estate developers also are active in community charities, events, and programs. As disappointments However, many citizens have unrealistic expectations that developers should continue to own their projects for their entire economic lives and are disappointed when that doesn’t happen. Often, citizens are disillusioned and complain that developers just “flip” their projects and abandon the community after the projects are built.

Real estate developer activities Another way to understand the Real Estate Development Process is to define what real estate developers do. Here are several activities that are performed by all successful real estate developers. Obtain public approvals and permits Developers must obtain the required governmental approvals and permits, as well as meet the restrictions and limitations which are the prerequisite conditions for these approvals and permits. Predict the future Developers attempt to create future economic value by predicting or forecasting future market conditions, future governmental regulations, and future investment environments. Form multiple teams Developers must form teams that combine multiple professional disciplines: architects, engineers, contractors, building suppliers, and municipal inspectors all view the Real Estate Development Process differently. In addition, lawyers, accountants, lenders, and marketing experts have incredibly different expectations of the development process. Define roles Developers must define the roles, objectives, and compensation schemes for each professional on the team. These team members must be managed, so the finished development has a value greater than the costs it takes to create.

Developers’ self-descriptions Clay Emery Clay Emery is an active octogenarian real estate developer who started his career with James Rouse in the Columbia, Maryland, new town project in the 1960s. He then formed his

Real estate development defined   11 own company, which has built over one million square feet of offices and warehouses in the Mid-Atlantic Region. Addressing a graduate real estate class in 2011 at Johns Hopkins University, Emery explained the Real Estate Development Process as follows: The real estate development process is really a very simple business. You find the opportunity, evaluate the risks and returns, and then arrange the financing. At that point he straightened his six foot seven frame and, looking upward, shaking his head, he continued, “Real estate development is a very simple business,” then looking down, he continued, “but a very difficult one!” R.W. “Wes” Finley Wes Finley was one of the most successful real estate developers in Oklahoma in the 1970s and 1980s. He built the first regional mall in Oklahoma and assembled the largest real estate transaction in the history of Oklahoma—at that time. He literally worked out his deal on the back of used envelopes that he carried in his vest pocket. Addressing a graduate real estate class at the University of Oklahoma in 1975, Wes explained what it takes to be a real estate developer: It takes three things to be a real estate developer. First, you’ve got to be dumb. If you think too much about a deal or a project, you’ll just drive yourself crazy. Secondly, you have to be able to swallow dry. When that banker looks at you across the desk and says, “Do you want the loan or not?” your mouth and throat get real dry, so you have to swallow hard, look him in the eye, and say, “Yes sir, I’ll take it.” Finally, and this is really important, you need plenty of sour mash whiskey!

Summary In this chapter, several definitions of real estate development have been proffered and discussed. Clearly there is not a single or simple definition. For the purposes of this book, the Real Estate Development Process will be defined as the process of adding value to the real estate property by achieving certain tasks that require special skills and additional capital. Persons who form and lead these teams will be called real estate developers.

Notes 1 Webster’s New Universal Unabridged Dictionary, New York: Barnes & Noble Books, 1996, p. 543. 2 James A. Graaskamp Collection of Teaching Materials. V. Industry Seminars and Speeches Sponsored by Other Universities. 10. “Land Investment Seminar,” sponsored by R.E. Educational Services, Inc., Columbus, OH, December 1, 1973 at the Christopher Inn. 3 Graaskamp, James A. Fundamentals of Real Estate Development. Washington, DC: ULI–The Urban Land Institute, 1981.

3 The Real Estate Development Matrix

CREATING THE REAL ESTATE DEVELOPMENT MATRIX The Real Estate Development Matrix is created by combining the seven Stages of the Real Estate Development Process across the horizontal axis with the eight Task categories of development on the vertical axis, thus creating the 56-cell matrix that is shown above as the Real Estate Development Matrix (Exhibit 3.1), which lays out a comprehensive workspace for the real estate development activities. Exhibit 3.2 illustrates how the Real Estate Development Matrix can be identified using Arabic Numbers for the development Stages and Roman numerals for the development Tasks as identifiers. For example, Cell I.1. would be the Acquisition Tasks in the Land Banking Stage. Cell III.4. would be the Marketing Tasks in the Building Development Stage, and so on.

Overview of the seven Stages of real estate development James Graaskamp originally identified the first four stages of real estate development, but the development process was expanded by three more stages to include the operation, renovation, and redevelopment of properties in the Real Estate Development Process. These

Exhibit 3.1 The Real Estate Development Matrix.

Real Estate Development Matrix   13

Exhibit 3.2 Stages of development: Stages across; Tasks down.

stages will be discussed at length in Part II of this book, but for this introduction, the seven Stages in the Real Estate Development Process can be summarized as follows: 1 2 3 4 5 6 7

Land Banking – Acquiring unimproved land. Land Packaging – Obtaining zoning, approvals, and permits for possible development. Land Development – Constructing “horizontal” infrastructure and public area improvements. Building Development – Constructing buildings (making “vertical” improvements). Building Operations – Operating a completed building, managing revenues, and expenses. Building Renovation – Making improvements on an existing building; use remains the same. Property Redevelopment –Acquiring and holding improved properties that need new land uses.

In each Stage of development moving forward, the following conditions generally occur: • • • • •

risk and uncertainty diminish; additional capital is required (bad news); additional capital has a lower cost (good news); value is created by producing a new product; value is created by incurring additional risks and increasing capital exposure.

In each Stage, developers must answer these questions: • • •

Can we do what’s got to be done? Do we have the get up and go, to get up and do what’s got to be done? Do we have the skills, resources, time, team, and support? Do we know our markets, our costs, and ourselves? Can we handle the risk of failure? Can we recover if we’re wrong, or are we out of business?

14   Part I •

Can we create real value? At the end of each Stage, will the value created be greater than the costs incurred to create the value?

Overview of the eight development Task categories The various Tasks in each Stage of the Real Estate Development Process are divided into eight groups that require special skills to accomplish them. The development Task groups will be discussed in great detail in Part III of this book. Briefly, here are the major questions that must be addressed for each Task: I Acquisition: Should the project be acquired, and if so, how? II Financing: Who should finance the project, and how can it be done? III Market Analysis and Marketing Strategies: What are the expected market conditions, and how can the market opportunities be captured? IV Environmental Issues: What are the environmental concerns, and how should they be addressed? V Approvals and Permits: What approvals and permits are needed, and how should they be obtained? VI Physical Improvements: What are the required physical improvements, and how and when should they be designed, engineered, constructed, and operated? VII Transportation and Accessibility: What are the transportation and accessibility issues both within and outside of the site, and how should they be addressed? VIII Sales and Disposition: How should the value created in this Stage of development be captured, sold, or rolled forward?

Task/Stage cells in the Development Matrix Not all Task/Stage cells have the same importance, but all of the cells must be addressed in one way or the other. Ignoring or overlooking cells can lead to mistakes, errors, and ultimately an unsuccessful real estate development project. It is important to note that in each cell three things happen: 1 2 3

Expenditures are made. Risks are taken. Value is created or destroyed.

Developer behavior in the Development Matrix Developers create value in each Stage of development by completing the Tasks for that Stage. Each Stage requires different skills to complete the Tasks, and no one person can do everything. Hence, different development teams are formed for each Stage of development. The developers work down the columns of the Matrix. They can’t or shouldn’t go to the next Stage of development until all the development Tasks of the current stage are completed. Each Stage begins with the Acquisition Tasks, and ends with the Disposition Tasks (see Exhibit 3.3). In between, Tasks are done in various orders, usually simultaneously, as the Tasks are all related to each other. For example, developers can’t get a building permit until the Environmental Tasks have been done and the plans and specifications have been completed. Real estate development is a great example of multi-tasking.

Real Estate Development Matrix   15

Exhibit 3.3 Developers work down the Matrix.

The completion of the Disposition Tasks may lead developers to the decision not to sell and instead continue on to the next Stage of development. Through the Disposition Tasks, developers become well aware of the value that they have created, as well as the Tasks that are required for the next Stage of development. Even if developers decide to continue to the next Stage of development and put the created economic value at risk, they must assemble a new team of professionals to accomplish the Tasks for the next Stage and hopefully create additional value. Sometimes this works; sometimes it doesn’t.

Professionals and service providers in the Development Matrix Many times, real estate service providers and professionals ask, “Where do we belong in the Real Estate Development Matrix?” The answer is simple: everywhere! Professionals generally specialize in one Task category and work across the various Stages of the Development Process (see Exhibit 3.4). However, it should be noted that different types of professionals are used in the various Stages of development. For example, the best land broker used in the Land Banking Stage would not be used in the Building Development Stage, where the best leasing agents and building brokers would be used by the developer. Also, the building contractor in the

Exhibit 3.4 Professionals work across the Matrix.

16   Part I Building Development Stage would probably not have the necessary skills for the construction required in the Building Renovation Stage.

The Development Matrix as a model The Real Estate Development Matrix is a descriptive, predictive, and normative model which attempts to describe the complex, multidisciplinary nature of the Real Estate Development Process. The Development Matrix lays out what happens and who does it. Along those lines, the Development Matrix predicts what happens when in the development process, and finally the Development Matrix indicates what should happen, who should do it, and when it should be done. Thus, the development model is descriptive, predictive, and normative.

Summary In this chapter, the Real Estate Development Matrix is a 56-cell, Stage/Task matrix, which describes the entire Real Estate Development Process in seven Stages, from the Land Banking Stage to the Redevelopment Stage. In each Stage, there are eight categories of Tasks that need to be addressed. The main thesis of this interdisciplinary model is that there are discrete Stages in the Real Estate Development Process where value is created. To create value in each Stage, real estate developers must complete different Tasks using specialized skills. The aim of this book and the Real Estate Development Matrix website is to provide complementary tools and the knowledge to navigate the Real Estate Development Process.

4 The third dimension

THE THIRD DIMENSION: PRODUCT TYPES In the previous chapter, the Real Estate Development Matrix was presented in a twodimensional space; seven Stages of development and eight groups of development Tasks. This 56-cell matrix may seem complicated enough, but there is another dimension—a third dimension—that is critically important. This third dimension is the type of real estate product that is being developed, as illustrated in Exhibit 4.1. Product types can be described very broadly, such as multi-family developments or office developments, or they can be defined more granularly as student housing or senior housing. The Real Estate Development Matrix emphasized that no single developer can do all of the Stages of development, nor achieve all of the required Tasks. Along the same lines, no single developer can be an expert in all types of real estate products. Each product type requires special construction, marketing strategies, and political knowledge and skills. Paraphrasing former U.S. Secretary of Defense Donald Rumsfeld, “we know what we know, we know what we don’t know, and we don’t know what we don’t know.”1 When real

Exhibit 4.1 Third dimension: product type.

18   Part I

Exhibit 4.2 Real Estate Development Cube.

estate developers attempt to be experts in two different product types, they quickly learn what they don’t know. The third dimension can be visualized as a cube (see Exhibit 4.2) in which the Stages, Tasks, and product types are all related. This Real Estate Development Cube should contain all of the real estate development opportunities. William Brueggeman and Jeffrey Fisher had the following list of product types:2 Single-family residential • • •

detached; cluster developments; zero lot line developments.

Multi-family residential • • •

high rise; low rise; garden apartments.

Office • • • • • •

major or multi-tenant—central business district; single or multi-tenant—suburban; single tenant—build to suit; office/showroom; medical office; other specialized office uses.

Retail • •

regional shopping centers/malls; neighborhood centers;

The third dimension   19 • • •

strip mall centers; specialty centers; discount centers.

Industrial/warehouse • • • • • •

heavy industrial warehouse; light industrial warehouse; office/warehouse; distribution warehouse; research and development; flex space.

Hotel/motel • • • • • •

business/convention; full service; tourist/resort; limited service; extended stay; all suites.

Recreational • • •

country clubs; marinas/resorts; sports complexes.

Institutional • • • •

hospitals/convalescence homes; university buildings; government buildings; other.

Mixed use •

Some combination of the above.

Product type examples on the website @REDM3 The product type examples presented on the companion website under the Third Dimension tab are categorized broadly as offices, retail centers, warehouses, apartments, residential, and hotels. As the real estate development sector continues to expand and evolve, product types are constantly shifting in the real estate marketplace. Readers who have additional product type examples are asked to send these examples to the authors (through the Contact Information link on the website), who will add them to the list.

20   Part I

Part I: summary Chapter 1 began with a description of general themes and the unique economic characteristics of real estate and was followed by a declaration of the three commandments of real estate development. In Chapter 2, the definition of real estate development was discussed through the words of the legendary James Graaskamp, who laid out the foundation of this book. The real estate developer was defined from several points of view, and the major activities of real estate developers were described. Chapter 3 described the Real Estate Development Matrix in terms of the seven Stages of development and the eight development Task groups, which will be the thrust of this book. This chapter explained that product type was a third dimension that could be added to the Real Estate Development Matrix, so that a Real Estate Development Cube could be defined. Readers are directed to the companion website4 to find product type examples for every Stage and Task group on the Matrix. The eight chapters in Part II will discuss in depth each Stage of the Real Estate Development Process, and the nine chapters in Part III will discuss the development Tasks that are required in each Stage of development.

Notes 1 Defense.gov News Transcript: DoD News Briefing – Secretary Rumsfeld and Gen. Myers, United States Department of Defense. Reports that say that something hasn’t happened are always interesting to me, because as we know, there are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns – the ones we don’t know we don’t know. And if one looks throughout the history of our country and other free countries, it is those in the latter category that tend to be the difficult ones. 2 William Brueggeman and Jeffrey Fisher, Real Estate Finance and Investments, 14th Edition, McGraw-Hill, p. 255. This list was abbreviated in their 15th Edition on p. 257. 3 http://realestatedevelopmentmatrix.com/pages/third-dimension.html 4 http://realestatedevelopmentmatrix.com/

Part II

5 Introduction to the Stages of real estate development

Part II—Chapters 5 through 13—reviews the Real Estate Development Process as the horizontal axis of the Real Estate Development Matrix that is shown in Exhibit 5.1. This chapter describes the seven Stages of the Real Estate Development Process from several perspectives. Detailed explanations of the seven Stages of development are presented in the following chapters: Chapter 6: Land Banking Chapter 7: Land Packaging Chapter 8: Land Development Chapter 9: Building Development Chapter 10: Building Operations Chapter 11: Building Renovations Chapter 12: Property Redevelopment

Exhibit 5.1 Real Estate Development Matrix.

24   Part II THE REAL ESTATE DEVELOPMENT PROCESS William Shakespeare described the world as a Stage and life with seven acts: All the world’s a Stage, And all the men and women merely players; They have their exits and their entrances, And one man in his time plays many parts, His acts being seven ages.1 Similarly, this text presents the real estate development world in seven Stages where, “all the men and women are merely players,” and where no one person, man or woman, can play all of the roles in all of the Stages. Without additional strained literary metaphors, Part II of this textbook gives an overview of each Stage of the Real Estate Development Process using diagrams, and then the Stage is described in terms of its key players, critical Tasks, controllable costs, and major risks. In this chapter, the Real Estate Development Process is described holistically from the time a property is a “green field” (Land Banking) through the various Stages until it becomes a “brown field” and is ready to be redeveloped. The Process is described verbally and then with a schematic diagram, a box diagram, a Venn diagram, and a circle diagram. While each description is of the same process, each of these Exhibits may provide the reader with a slightly different perspective or nuance.

Verbal descriptions The seven Stages of the Real Estate Development Process are listed and defined as follows: 1. Land Banking Stage Land Bankers acquire or hold undeveloped or “raw” land that becomes increasingly attractive for future development because of general and broad market trends. 2. Land Packaging Stage Land Packagers buy either the raw land from the passive Land Bankers, or the deteriorated property from Property Redevelopers and then improve the value of the property through conceptual land planning, zoning changes, financing schemes, or other “paper enhancements” like title insurance, accurate surveys, or environmental studies. 3. Land Development Stage Land developers buy the land with the paper enhancements from the land packager and then construct the horizontal improvements like roads, utilities, and sanitary sewer systems, so finished building sites can be sold to building developers. 4. Building Development Stage Building developers buy the finished pad from the land developer and then produce the vertical development by constructing the buildings.

Real Estate Development Matrix: Stages   25 5. Building Operations Stage Building operators lease the property, manage the property, and develop a building operating history, so it can either be sold to other building operators during its economic life, or to a building renovator at the end of its economic life. 6. Building Renovation Stage Building renovators buy the property with substantial economic and/or physical depreciation and create value by curing these deficiencies and then remarketing and operating the building until the property is ready for redevelopment. 7. Property Redevelopment Stage Property Redevelopers buy the property with such serious, incurable physical or functional deficiencies that the improvements must be torn down and/or redeveloped for another use.

Schematic diagram description The schematic diagram in Exhibit 5.2 illustrates that each Stage in the Real Estate Development Process is separate and distinct in the creation of value. Developers should make a deliberate decision whether or not to sell to a third-party or to continue to the next Stage of development. In effect, the developers decide whether to cash in their chips and leave the table, or let their money ride and move on to the next Stage of development. Exhibit 5.2 shows the order of the Stages of development over the life of the real estate project as it moves from “green fields” in the Land Banking Stage, to the “brown fields” in the Project Redevelopment Stage. Both of these Stages move to the Land Packaging Stage, where the project is redefined in terms of public approvals, market studies, and physical characteristics. Usually developers are good at one Stage of development, but keep reaching back (up) or forward (down) in the process until their inadequacies catch up with them. The critical thing to note is that in each Stage, certain Tasks have to be completed to create value, and the accomplishment of these Tasks requires special skills and talents. No one is good at everything, no matter what their mother told them growing up.

Box diagram description The box diagram in Exhibit 5.3 illustrates the seven-Stage model and emphasizes that in each Stage, the developers “buy one thing and sell another.” The colloquial expression of “flipping real estate” suggests that developers just buy and sell the same property without “adding value” by completing Tasks. Rather the “flippers” just cash in and out of market anomalies. In this diagram, developers buy an “opportunity” and capture that opportunity by successfully accomplishing the requisite Tasks in that Stage. In doing so, developers create an “opportunity” for other developers in the next Stage of development. If developers are unsuccessful in creating value by accomplishing the required Tasks, then the development stops until it can be restarted by another developer with the necessary vision, skills, and capital.

26   Part II

Exhibit 5.2 Schematic diagram.

Venn diagram description The Venn diagram in Exhibit 5.4 presents the seven-Stage Real Estate Development Process and illustrates that the Stages in the Real Estate Development Process are not as neatly separated as shown in the Development Matrix, the schematic diagram, or the box diagram. Rather, they overlap to some extent in the overall development process. Effectively, developers may capture some of the value in the next Stage of development by incurring some costs and risks associated with each Stage. In doing so, developers reduce the risks in the next Stage and hopefully enhance the value of the project for the next Stage developer. For example, a building developer may pre-lease part of a building during construction and

Real Estate Development Matrix: Stages   27

Exhibit 5.3 Box diagram.

Exhibit 5.4 Venn diagram.

is then able to sell the pre-leased building at a premium to a building operator because of the reduced leasing risk.

Circle diagram description The circle diagram in Exhibit 5.5 shows the relationship between each Stage of development and demonstrates how the renovated building in the Renovation Stage may recycle back to the Building Operations Stage, rather than just being held, operated, and eventually sold to property redevelopers. This diagram also illustrates how the Redevelopment Stage continues on to the Land Packaging Stage, and the cycle begins all over again. This circle

28   Part II

Exhibit 5.5 Circle diagram.

diagram clearly illustrates the holistic nature of the Real Estate Development Process. The complete circle may take several decades or even longer, depending on the real estate market conditions and the maintenance and repair of the improvements.

Summary This chapter has described the Real Estate Development Process from several different perspectives. Each diagram emphasizes a different aspect of the overall development process; however, the theme remains the same in each diagram. In each Stage of development, economic value is created by accomplishing certain tasks that require special skills and talents. Successful developers match their skills and talents to the Tasks that they can achieve in the Stage of development that they understand.

Real Estate Development Matrix: Stages   29

Note 1 William Shakespeare, As You Like It, Act II Scene 4, Lines 139–166. Below is the full verse with the real estate Stages of development inserted appropriately: All the world’s a Stage, And all the men and women merely players; They have their exits and their entrances, And one man in his time plays many parts, His acts being seven ages. At first, the infant (LAND BANKER), Mewling and puking in the nurse’s arms. Then the whining schoolboy (LAND PACKAGER), with his satchel And shining morning face, creeping like snail Unwillingly to school. And then the lover (LAND DEVELOPER), Sighing like furnace, with a woeful ballad Made to his mistress’ eyebrow. Then a soldier (BUILIDNG DEVELOPER), Full of strange oaths and bearded like the bard, Jealous in honor, sudden and quick in quarrel, Seeking the bubble reputation Even in the cannon’s mouth. And then the justice (BUILDING OPERATOR), In fair round belly with good capon lined, With eyes severe and beard of formal cut, Full of wise saws and modern instances; And so he plays his part. The sixth age (BUILIDNG RENOVATOR) shifts Into the lean and slippered pantaloon, With spectacles on nose and pouch on side; His youthful hose, well saved, a world too wide For his shrunk shank, and his big manly voice, Turning again toward childish treble, pipes And whistles in his sound. Last scene of all (PROPERTY REDEVELOPER), That ends this strange eventful history, Is second childishness and mere oblivion, Sans teeth, sans eyes, sans taste, sans everything.

6 Land Banking

INTRODUCTION Land Banking is the first stage of the seven-stage Real Estate Development Process (Exhibit 6.1). It is often overlooked as a way to create value in the Real Estate Development Process, but it plays an important role in the overall process. The Land Banking Stage occurs when the highest and best use of the site is not the current use. Also, Land Banking may occur when the current use is expected to change in the “investible future.1” In this sense, some farmers are also Land Bankers, and some farmers are just farmers. The Land Bankers acquire and hold undeveloped or raw land that they believe will become attractive for future development because of general and broad market trends. Land Bankers can be active in the pursuit of the acquisition of opportunistic land buys. Although some land owners—such as family estates, government agencies, or public utilities—can inadvertently become Land Bankers. This is a relatively passive investment position. When Land Bankers believe that the market conditions are right, they sell the land to Land Packagers.

Exhibit 6.1 Real Estate Development Matrix.

Land Banking   31

Schematic diagram The schematic diagram in Exhibit 6.2 illustrates the decision process of the Land Banking stage. Land Bankers hold the undeveloped land for an indeterminate amount of time, until they believe that the market conditions are right, and they decide to sell the property to Land Packagers. Alternatively, Land Bankers may decide not to sell and to continue into the Land Packaging stage.

Exhibit 6.2 Land Banking Schematic diagram.

32   Part II

Exhibit 6.3 Land Banking Box diagram.

Box diagram As illustrated in Exhibit 6.3, Land Bankers buy land with some potential and sell land with great potential. For example, Land Bankers may buy land on the edge of the urban area, in anticipation of the extension of the road systems and utilities. In this scenario, the most critical Tasks are correctly predicting the direction and timing of the population growth and the extension of the transportation system and necessary utilities (sewer, water, electric, and gas), and identifying land parcels that will be positively affected by these trends.

Venn diagram Land Bankers are relatively passive participants in the development process as they wait for the predicted positive market trends to occur. However, sometimes Land Bankers may advocate for the inclusion of their land into a regional land use plan or a regional transportation study. Land Bankers may also apply to have their land annexed into an adjacent municipality in order to make it more attractive to Land Packagers. Land Bankers performing some Land Packaging Tasks before selling to a Land Packager is an example of the overlapping nature of the stages, as shown in Exhibit 6.4. Land Bankers may also create opportunities for the Land Packagers by providing financing in the form of purchase money mortgages.

Circle diagram The circle diagram in Exhibit 6.5 illustrates how both the Land Bankers and property redevelopers sell their land to Land Packagers. Land Bankers are often considered the beginning of the Real Estate Development Process, but as the circle diagram shows, Property Redevelopers essentially represent a new beginning for the property’s development.

Exhibit 6.4 Land Banking Venn diagram.

Exhibit 6.5 Land Banking Circle diagram.

34   Part II

Exhibit 6.6 The Land Banking equation.

Land Banking: what happens Once the land increases in value, Land Bankers sell the property to a Land Packager, or they can continue onto the Land Packaging Stage themselves if they have the requisite skills to complete the Land Packaging Tasks. By providing financing or favorable contract terms to Land Packagers, Land Bankers can share in some of the additional value created in the Land Packaging Stage. Land Bankers need patient money, interim land uses, and the ability to assemble additional land parcels to make the eventual development more feasible. The Land Banking Equation (Exhibit 6.6) requires that the eventual sales price is sufficiently greater than the sum of the acquisition price and net holding costs2 to provide Land Bankers with acceptable financial returns. This required “spread,” or minimum profit, may occur quickly or over several years. The expected size of the spread reflects the property’s appreciation during the holding period. For example, Land Bankers may expect the property to double in value in the future, which is often referred to as a “multiple of two or 2X.” This is not a time-adjusted annual return, but rather this is a gross measure of return. If the property doubled in value over ten years, the time-adjusted annual return would be 7.1%. This is also called an internal rate of return. However, if the property doubled in value over five or seven years, the time-weighted returns would be 10.4% or 19.3% respectively. These returns are on the entire real estate asset, rather than just the equity investment. However, developers must focus on the performance of the real estate enterprise, in this case passive land holding, so that the appropriate capital structure can be determined. Financing Land Banking activities with debt can be tricky because of the indeterminate nature of the holding period and the annual net holding costs.

Land Banking: key players Some key players in the Land Banking Stage include the following. Existing land owners who are motivated sellers These are the people or organizations who currently own the land and are motivated (for many different reasons) to sell the land to Land Bankers. For example, these may be farmers

Land Banking   35 who are going out of business, or businesses with surplus land because of changing market conditions or facility relocations. Motivated sellers may also be families with estates who are selling land holdings to make other investments. Real estate brokers Real estate brokers who specialize in agricultural or rural land transactions have important and valuable market information about recent sales, transaction terms, and potential sellers. They know what land is available for sale and how motivated the current land owners are. Surveyors and civil engineers Surveyors need to determine and verify the accuracy of boundary lines, easements, and rights of way. Civil engineers can opine on the suitability of the property’s future development potential. Environmental engineers and professionals Environmental engineers and professionals need to identify the absence or existence of the site’s environmental issues by performing a Phase I Environmental Survey. They can also help identify environmental conditions that may influence future development or raise issues regarding future land uses. Attorneys and title insurance companies Title insurance is imperative in any land acquisition; not just because of the insurance aspect in case of a financial loss, but also because the title insurance companies will identify all of the “exceptions” to the insurance coverage. These exceptions are where the title problems are. Attorneys need to help define and evaluate the title exceptions, as well as understand deed restrictions, easements, and rights of way. Attorneys are also valuable in drafting purchase and sale contracts with the appropriate conditions for a sale. Local and regional public authorities and politicians Undeveloped land is governed by several governmental authorities at the municipal, county, state, and federal levels. It is important for Land Bankers to understand which authorities control the subject land and what their future expectations are for that property. Politicians, elected or appointed, usually have opinions about the future development of their jurisdictions. Land Bankers need to know their opinions and place their bets accordingly. Local and regional economists and market analysts Most areas have both public and private market analysts who predict the future economic development and corresponding populations of an area. Most national real estate service companies with regional offices also provide current and projected statistics of real estate market conditions.

36   Part II Potential Land Packagers Land Bankers’ best friends are the potential Land Packagers who are looking for opportunities to increase a property’s value by obtaining the required public approvals for future land development. Land Packagers may also look for opportunities to fix or correct existing problems on the property such as title issues, survey disputes, or environmental conditions. Land Bankers want to work with Land Packagers so that each side has a winning situation, and so the Land Packagers can acquire the property and get the required public approvals for development.

Land Banking: critical Tasks Predicate accurate forecasts Accurate forecasts of economic trends, market conditions, and public improvement construction are paramount for success. Land Bankers’ predications are critical to determine “when to buy” and “when to sell” a property, as well as to promote the value of the property in the light of future economic events. Identify and control attractive land Land Bankers need to be visionaries who evaluate land in terms of its value; both today and in the future. They must identify characteristics of attractive land holdings and figure out ways to control that land during the holding period. There are many ways to control land without purchasing the land outright. The use of purchase options, installment sales, and land leases need to be considered as ways to “control” the attractive land. Negotiate land acquisition Land Bankers need to negotiate the acquisition of the land by meeting the seller’s investment expectations, while still providing the Land Bankers with a low enough price to hold and carry the land until it has appreciated and the market conditions are right for a sale. Arrange financing of acquisition and carrying costs Land Bankers must pay the carrying cost of the land while they are waiting for the market conditions to improve and increase the value of the property. The taxes, insurance, and maintenance expenses must be paid, as well as the financing costs if the property is acquired with a mortgage loan. It is usually very difficult to finance raw land acquisition through normal lending sources, so Land Bankers must be imaginative in arranging financing from the seller (a purchase money mortgage) or through private investors. This is why Land Bankers must consider interim land uses to help defray the carrying costs. Control legal and consulting expenses Land Bankers must be careful not to over-commit to legal studies, market studies, or land use studies—even though it is tempting to commission these studies to help the Land Packagers conceptualize the potential of the property. Land Bankers need the discipline of good accounting, budgets, and periodic reports to ensure that the costs remain under control.

Land Banking   37 Limit maximum losses Land Bankers must be careful to limit their financial and legal liabilities. Non-recourse loans are imperative, as well as limiting any responsibility for existing environmental conditions. Pre-arranged default provisions with the lenders, as well as indemnifications from former land owners are essential. All developers need a “back door” out of the process if everything goes wrong (Murphy’s Law). Acquire adjacent land parcels (assemblage3) Land Bankers may be able to substantially increase the value of their land by acquiring adjacent land parcels that enhance the value of the entire land holding. The acquired land may provide improved access, visibility, or development potential.

Land Banking: controllable costs Controllable costs are costs or expenses that Land Bankers can and must control or limit to the best of their abilities. These costs must be identified and quantified prior to acquisition, and then carefully monitored and managed during the holding period. Interest on borrowed capital Because of the potentially long-term nature of the Land Banking Stage, interest on borrowed capital should be at a fixed rate, rather than a variable one. Some loans may have “pay and accrue provisions” that allow the borrowers to pay interest at a rate below the “contract rate” and accrue the difference between the “pay rate” and the “contract rate,” but adding it to the outstanding loan balance. This may be appropriate if there are unexpected changes in market conditions or expenses, but it is a risky practice to engage in long term. Cumulative preferred returns on equity capital Cumulative4 preferred returns give some equity owners a priority for capital distributions based on a predetermined rate. These provisions should be avoided by developers if possible. However, if they are used, they should be capped at some level and calculated annually, so developers know where they stand relative to capital distributions when the property is sold. Option payments If there are option payments related to the purchase contract, the timing and amount of the option payments should be clearly defined. There should be provisions to extend the option agreement if necessary. Liability insurance Liability insurance is a must for land ownership, and the policy provisions, limits, and premium should be arranged prior to acquiring the property. If necessary, there should be a cash reserve to make these payments.

38   Part II Real estate taxes Real estate taxes, sometimes called property taxes or ad valorem taxes, must be paid to municipal authorities, school districts, and other special taxation districts. These taxes need to be promptly paid and closely monitored. Whenever possible, the discounts for early payments should be taken. Often, taxing authorities attempt to increase tax revenues by aggressively increasing the property’s assessed value. These re-assessments should be challenged and appealed. However, Land Bankers may view the increased assessments as verification of the increasing market value of the property, and use the new, higher assessment to market the property. Road and drainage channel maintenance While roads and drainage channels need to be maintained at some level, a strict budget must be enforced. However, failure to maintain drainage systems may inadvertently create wetlands and cause another set of development restrictions. Adjacent land acquisitions Bigger is not necessarily better. Additional land purchases should be critically evaluated; not only in terms of overall value creation (plottage value5), but also in terms of additional financing and carrying costs. This is both a critical Task and a controllable cost. Improvements for interim land uses Gates, fences, outbuildings, and security systems that are required for interim land uses need to be budgeted for and carefully matched to the rental income associated with their leases. The costs should be anticipated and included in the leases of the interim land users.

Land Banking: major risks External factors that don’t materialize Expected public improvements are not approved or funded as anticipated: interstate highway by-passes are cancelled; transit-way construction is indefinitely delayed; or public sewer lines extensions are not approved. Also, the new employer may not move to the area, or the expansion of the existing manufacturing plant is cancelled. Pre-purchase market analysis was inaccurate The expected population growth and household formation may not occur because of slow or negative job growth. The economic base of the area may have eroded because of changes in the broader national and international market conditions. Site conditions and characteristics never become valuable The general public may have perceived the steep slopes that provide beautiful views as too dangerous upon which to build. Also, the general public may not have appreciated the solitude of the remote area, and preferred to be in more accessible neighborhoods. Finally, the

Land Banking   39 adjacent land users may not be perceived as attractive neighbors. For example, an exclusive hunting club may be considered “killing fields,” rather than a rich rural tradition. Financing costs and other holding costs become overwhelming Variable interest rate loans may increase financing costs, or loan extension fees are too high. Also, insurance premiums or property taxes may increase above budget levels. Finally, the income expected from interim land uses may not materialize. Force majeure Terrorist attacks, wind, fire, rain, earthquakes, and other acts of God, diminish the attractiveness of the property. If it’s not one thing, it’s another! Even if insurance proceeds and government loans are available, the delayed recovery may never increase land values as expected. No “backdoor” to get out of the deal Every real estate development should have a back door, so the developer can get out of the deal. However, life happens and personal guarantees or indemnifications force Land Bankers to continue to hold the property and incur ruinous financial losses. Partnership issues emerge Because of the indeterminate nature of the Land Banking Stage, some partners may want to sell the property, while other partners want to continue to hold onto it. Partnership conflict resolution provisions, like buy-sell arrangements, could force a potential sale of the property. Another partnership issue that may emerge could be that financial partners suffer economic losses, and they can no longer meet promised capital contributions. Because inherited land holdings involve so many relatives, so many generations, and so many economic agendas, the partnership issues can be very personal and non-economic.

Land Banking: case studies Following are some Land Banking case study scenarios of a family farm, a government facility, regulation change, an institutional merger, and a corporate acquisition—all of which illustrate many of the discussion points in this chapter. Crown Farm: a family farm scenario @REDM6 The Crown Farm is a good example of how farmers can become Land Bankers when agricultural is no longer the highest earning and best use of the property. The 182-acre agricultural land area had been owned and operated the Crown Family for over 100 years.7 An historic house and a few outbuildings built in the 1880s remained on the property (Exhibit 6.7). In the early 2000s, the Crown family decided that farming was no longer the highest earning and best use of the land and it would best suit the family to sell the property. Crown Farm is located to the northwest of Washington, DC (as outlined in white in Exhibit 6.8) and just outside of Interstate 495 (outlined in black) which serves as the beltway connecting the DC, Maryland, Virginia metropolitan area. The site now sits at the intersection

Exhibit 6.7 Historic outbuildings.

Exhibit 6.8 Aerial photo: Metro area.

Land Banking   41

Exhibit 6.9 Aerial photo: Crown Farm site.

of two interstate highways—I-270 and I-370—and is in the health and science corridor along I-270 in Montgomery County. As you can see in Exhibit 6.9, urban development is trending outward and upward and Crown Farm is among that wave of urban sprawl. The fields in the middle of Exhibit 6.9 are the Crown Farm site and, as you can see, the farm is now surrounded on all sides by dense residential developments and research parks. Strong demographics and the demand for density made Crown Farm the hole in the donut for development opportunity. The Land Bankers (the Crown family) decided to capitalize on the market shift and began to market the site for sale to a Land Packager. Consequently, the property was marketed and the Crown family negotiated a purchase and sale agreement with a partnership composed of two major home builders: KB Homes and Centex (the Partnership), for over $180 million. However, the closing was contingent upon the Crown Farm site being annexed into the City of Gaithersburg. In other words, the Partnership would not have full control of the property until the annexation was approved. The Partnership began entitling the property for redevelopment and pursued the annexation. The Partnership was successful in their efforts and the annexation and closing occurred in 2006. By delaying closing until several entitlement hurdles were met, this is an example of how the Land Banker can facilitate a sale to a Land Packager by sharing part of the entitlement risk. To put this in terms of the Development Matrix, the Land Banker (the Crown family) sold their family farm to a Land Packager (the Partnership) by sharing entitlement risk. The Land Banker would not receive the proceeds from the sale until the Land Packager could meet certain approvals, thereby mitigating the Land Packager’s risk by not paying the total cost of the land unless their development plans were approved.

42   Part II Armed Forces Retirement Home: a government facility scenario @REDM8 The Armed Forces Retirement Home (AFRH) is an example of a federal government sponsored facility with excess land available for redevelopment, and the opportunity to collect additional revenue from that sale. This example is one account of the decision-making process for a Land Banker to move the property from the Land Banking stage into the Land Packaging Stage. The Armed Forces retirement home is a federal government sponsored senior housing facility for 1,100 service veterans, which sits on 272 acres in Washington, DC. In Exhibit 6.10, the white border shows the total site of the 272-acre campus and the shaded area shows the excess land that is proposed for development by the private sector. A brief history In 1851, General Winfield Scott received a bounty from Mexico City during the MexicanAmerican War. Returning to Washington with the bounty, Scott worked with US Representative Jefferson Davis to convince Congress to use the bounty to purchase the Riggs family farm as a retirement home for old soldiers. The site has served as the Presidential retreat of Chester Arthur, Rutherford B. Hayes, James Buchanan, and most prominently Abraham Lincoln. “Anderson Cottage” was built by the U.S. Army and was nominally leased to the President of the United States to use as a summer retreat. The cottage was recently (2000) restored as a national monument and renamed the “Lincoln Cottage.”

Exhibit 6.10 Aerial photo: Armed Forces Retirement Home.

Land Banking   43 The golf course to the west of the proposed development area continues to be a retreat for members of the U.S. Congress, as well as the Presidents of the United States. It is unique for two reasons: 1) it has no sand traps, and 2) it has Level V Security. Understanding the decision to develop The AFRH currently serves as a senior housing facility for 1,100 service veterans. In 1991, an independent agency of the Executive Branch and trust fund were created to operate and finance the retirement community for non-commissioned veterans from all service branches (Army, Navy, Air Force, Marines). AFRH is funded entirely from the Armed Forces Retirement Home Trust Fund and receives no annual appropriations from Congress. The Trust Fund is financed with a 50 cent payroll deduction from active duty military and by fines and forfeitures from military disciplinary actions (see Exhibit 6.11). AFRH is restricted by law to investments in low-yield Treasury bonds. Federal law prohibits AFRH from soliciting contributions, applying for grants, or running capital fundraising campaigns. The AFRH is set up to be funded from those designated funds, which are now dwindling as the all-volunteer (not-drafted) Army, Navy, Air Force, and Marines are better behaved with lower funds available from disciplinary fines. Also, restrictions imposed by Congress to protect the AFRH’s capital endowment are now limiting the income available from the endowment. In addition to the limitations of funding sources discussed above, there has been an increased demand of funding due to increased operational costs. As time goes on, there are simply more service veterans and longer-living service veterans, which creates a larger population that requires greater services throughout their extended lifespans. To maintain and improve services for senior housing, operational costs for the facilities and grounds continue to rise. Funding sources and uses were two major reasons for the federal government to make the decision to move forward with the development process for this parcel of the excess land. The Trust decided to issue a Request for Proposals to investigate development options for the Armed Forces Retirement Home. In 2007, the AFRH selected Crescent Resources

Exhibit 6.11 AFRH sources of annual income.

44   Part II Ltd as the “designated developer” (Land Packager) to obtain the necessary approvals to develop the excess land. Duke Energy: a regulation change scenario @REDM9 This case study illustrates how a key player, government authorities, can create Land Banking opportunities. The state utility commission changed the regulation that eliminated the value of the property by disqualifying it from the “rate making base.” This forced the Land Banker to move property through the development process, to Land Packaging. Duke Energy’s historic development of hydro-electric dams throughout North and South Carolina caused this regulated utility company to acquire large amounts of land in the process of the development and construction of these infrastructure projects. To purchase the land, Duke Energy had to buy the mountain land, along with the bottom land for the dam construction. However, in 1980, changing state utility regulations limited the ability of the company to include the “excess mountain land” in the “rate making base”10 for determining utility rates. In the mid-1980s, Duke Energy formed Crescent Resources LLC to develop the timber land by selling it for commercially developable land in metropolitan areas using 1031 TaxDeferred Exchanges. Crescent Resources developed the commercial land into warehouse/ industrial parks, office parks, master planned communities, and apartments. Vanderbilt University and Peabody College: An organizational merger scenario @REDM11 The merger of Vanderbilt University and Peabody College is a good example of excess land becoming available because of organizational mergers. Founded in 1785, Peabody College’s 50-acre campus was adjacent to Vanderbilt University and contained 15 acres of athletic fields across from the historic retail area, Hillsborough Village. See Exhibit 6.12.

Exhibit 6.12 Vanderbilt aerial photograph.

Land Banking   45 When Peabody College merged with Vanderbilt University in 1979, Peabody’s athletic fields were no longer necessary for student recreational activities. Thus, Vanderbilt became a Land Banker with 15 acres of excess land. Vanderbilt partnered with the Mathews Company to develop the excess land in 1988. This land eventually was developed into a mixed-use development, The Village at Vanderbilt. Kiwanis Trail: a corporate acquisition scenario @REDM12 The Kiwanis Trail case study is a good example of how a Land Banker purchased the property based on its current land use—timber—and was able to hold it as the timber continued to mature, and the land increased in value because of nearby economic development and municipal infrastructure improvements. See Exhibit 6.13. In Exhibit 6.13, the white oval is a rough estimate of the Kiwanis Trail property border. The new developments of the Catholic school and medical center have reached the edge of the Kiwanis Trail property, creating a development opportunity for the adjacent land. In 1995, K-corp bought Clearco Corporation, whose sole asset was 400 acres of timberland called Kiwanis Trail. The sellers were motivated to sell the stock of Clearco, rather than the asset to avoid double taxation by the federal government. The stockholders of Clearco provided the buyer, K-corp, with a 90-day loan to acquire the stock. During the 90-day loan period, K-corp harvested the timber, set up operating reserves, and paid off the acquisition loan. This enabled K-corp to be a Land Banker and to hold the

Exhibit 6.13 Kiwanis Trail area photo.

46   Part II property as it increased in value. Over the last 20 years, the following events increased the property’s value: • • • • •

township extended domestic water lines to property line; township extended sanitary sewer lines to one-half mile from property line; regional Medical Center expanded to one mile from site; Catholic school system built new campus half a mile from site; township received grant to undertake a land use and infrastructure master plan.

The Land Banker, K-Corp, is now looking for a Land Packager and has contacted local public officials about including this land in the comprehensive land use study that will include the four other municipalities.

Summary While there are numerous ways to become a Land Banker, they are relatively passive as they wait for general market conditions to improve, or for certain public infrastructures to be completed; both of which will increase the value of the property. Land Bankers need a keen understanding of the positive effects on their property of future market forces, and their biggest risk is paying the holding costs during the indeterminate waiting period, especially when the market forces are delayed. Land Bankers often facilitate the sale of their property to Land Packagers by providing financing or by agreeing to favorable terms of sale.

Notes   1 The term “investible future” is determined by the investment horizon of the Land Banker. This term may be simply a period of time, say ten years, or an indefinite time period like the “next generation.”   2 Net Holding Costs refer to the annual out-of-pocket costs incurred that are not offset by the income from interim land uses such as hunting leases, parking income, or agricultural income.   3 Assemblage is “The combining of two or more parcels, usually but not necessarily contiguous, into one ownership or use; the process that creates plottage value.” The Appraisal of Real Estate. Chicago, IL:Appraisal Institute, 2008, p. 213.   4 Cumulative returns increase at a specified compound rate each year if they are not paid currently. This cumulative return rate is similar to compound interest on accruing loans.   5 Plottage value is “The increment of value created when two or more sites are combined to produce greater utility.” The Appraisal of Real Estate. Chicago, IL: Appraisal Institute, 2008, p. 213.   6 http://realestatedevelopmentmatrix.com/textbook/res/task1/stage1/Crown+Farm.pdf  7 www.gaithersburghistory.com/crown-farm.html   8 http://realestatedevelopmentmatrix.com/textbook/res/task1/stage1/Armed+Forces+Retirement+ Home.pdf   9 http://realestatedevelopmentmatrix.com/textbook/res/task1/stage1/Duke+Energy.pdf 10 Electric utility companies are regulated by state commissions, who set the rates that utilities can charge to customers by determining a rate that provides the utility with a minimum return on the assets that it uses to generate the electricity, “the rate making base.” When the “mountain land” was eliminated from the rate making base, Duke Energy could no longer earn a return on this land. Thus, Duke decided to dispose of this excess land by trading it for more commercially developable land. 11 http://realestatedevelopmentmatrix.com/textbook/res/task1/stage1/Vanderbilt+University+and+Pe abody+College.pdf 12 http://realestatedevelopmentmatrix.com/textbook/res/task1/stage1/Kiwanis+Trail.pdf

7 Land Packaging

INTRODUCTION Land Packaging is the second stage of the seven-Stage Real Estate Development Process (see Exhibit 7.1). Land Packaging involves obtaining the major public approvals like zoning, master plans, and environmental impact studies, along with market studies, engineering analyses, financial proposals, surveys and title insurance that make the property a compelling opportunity for Land Developers. While these paper enhancements are routinely done by developers, they are often not considered a separate Stage of development. However, this Stage has unique Tasks that require specialized skills that are very different from the skillsets associated with Land Bankers, Property Redevelopers, and Land Developers.

Schematic diagram Land Packagers can acquire sites from Land Bankers, as well as from Property Redevelopers. Land Packaging is the process of taking an acquired property or parcels from Land Bankers or Property Redevelopers and proceeding through the necessary planning and approval processes to create an opportunity for land development. This often includes municipal

Exhibit 7.1 Real Estate Development Matrix.

48   Part II

Exhibit 7.2 Land Packaging Schematic diagram.

annexation, zoning changes or modifications, and the creation of a conceptual master plan. Land Packagers acquire the attractive “green fields” from Land Banker or “brown fields” from Property Redevelopers and then obtain the appropriate “paper enhancements” (like title insurance, accurate surveys, or environmental studies) or paper infrastructure. Land Packagers then sell the enhanced property to the Land Developer as illustrated in Exhibit 7.2. Of course, Land Packagers can continue on and assume the role of Land Developer, but they must realize that the skills of successful Land Packagers are very different from the requisite skills of successful Land Developers. Examples of Land Packagers are land planning firms, politically skilled lawyers, and governmental agencies who attempt to obtain government approvals for land they own. This packaged land or “land with a plan,” is then sold to Land Developers.

Box diagram The box diagram in Exhibit 7.3 demonstrates the adage that at every stage of development, “the developer acquires one thing, adds value, and sells another.” In this case, Land Packagers

Land Packaging   49

Exhibit 7.3 Land Packaging Box diagram.

acquire land with great potential from the Land Bankers or Property Redevelopers, and sell “land with an approved plan” to Land Developers.

Venn diagram The Venn diagram in Exhibit 7.4 demonstrates that the stages of the Real Estate Development Process are not as neatly separated as the schematic diagram and the box diagram suggest. Land Packaging may overlap with Land Banking or Property Redevelopment as Land Packagers attempt to encourage a municipal annexation, modified zoning provisions, or a new master plan, even though the Land Packager has not taken title to the property.

Exhibit 7.4 Land Packaging Venn diagram.

50   Part II

Exhibit 7.5 Land Packaging Circle diagram.

When adverse environmental conditions are discovered or exposed during the packaging process, Land Packagers may need to remediate the environmental problems before Land Developers take over the development process. Since environmental remediation is not a neatly defined process, Land Developers usually avoid these situations.

Circle diagram The circle diagram in Exhibit 7.5 demonstrates how the development process moves from Land Banking to Land Packaging, as well as from Property Redevelopment to Land

Exhibit 7.6 Land Packaging equation.

Land Packaging   51 Packaging, as the circle of development continues on. Of course, the Land Packaging Stage moves to the Land Development Stage if and when the Land Packager is successful.

Land Packaging: what happens The diagram in Exhibit 7.6 shows an illustration of the Land Packaging equation. The purchase price and holding costs, cost of approvals, design costs, and consulting costs must be less than the sales price to Land Developer. The difference between those two values is known as the “spread.” The spread is the value difference that is created in this Stage of development. Economists call this the “profit” earned in this stage while accountants may call this net income, or capital gain. Nevertheless, this spread may occur quickly over several months or over many years. Land Packaging is sometimes viewed as the riskiest Stage of the development process since so many public authorities and approvals are involved and the holding period is very indeterminate. In some cases, an Act of Congress may be necessary for the Land Packaging Stage to be complete. Land Packagers are well connected with local governmental authorities and have extensive contacts and experience with land use regulations. It is important for Land Packagers to correctly assess the political hurdles, environment obstacles, and title and survey issues. Land Packagers can have a multitude of backgrounds; they are often retired politicians or civic leaders, real estate attorneys, real estate brokers, environmental and engineering firms, land planning or architectural firms, or market research firms. The Land Packagers know that it is more important to control attractive land parcels, rather than to own them outright. Therefore, Land Packagers are familiar with land contracts, installment sales, purchase money mortgages, and option agreements. Sometimes Land Packagers acquire control of the land using a lease with purchase options or a sales contract with multiple extensions. The cost of holding the land throughout the packaging process is very dependent upon the terms and conditions under which the property was acquired— especially since the timing of the approval processes are so uncertain.

Land Packaging: key players There are numerous key players in the Land Packaging Stage because of the very public nature of the Real Estate Development Process. Land Packagers need to present their vision for the property to a public audience—both private citizens and government officials—and ask for their support for the land use approvals that are necessary. Land Packagers attend meetings, make presentations, and educate stakeholders. Because numerous authorities have overlapping responsibilities, this process can seem circular, but Land Packagers must persevere. The goal of Land Packagers is to prepare the property for land development, to be “shovel ready” in the government vernacular. Federal authorities Federal agencies have an incredible amount of control over local land uses. Probably the most notorious are the U.S. Environmental Protection Agency and the Army Corps of Engineers. The Clean Water Act gave them control over “the waters of the United States,” and the definition of this term has caused numerous lawsuits and court rulings. The U.S. Department of Transportation must approve any land development that impacts the Interstate Highway System of Federal Highways. Also, the U.S. Department of Interior, through the

52   Part II National Parks Service, must approve any land use that impacts federal parks, monuments, trails, or wildlife sanctuaries. The Department of Interior, through the Bureau of Indian Affairs, controls development on and around the tribal lands of Native Americans. The National Environmental Policy Act also requires an Environment Impact Study for land development projects that use federal funds, and the Davis Bacon Act requires the payment of “prevailing wages” (union wages) on any project that uses federal funds. The National Historic Preservation Act also gives the Federal Government control of historic sites and buildings through the National Register of Historic Places and the Section 106 review process. The U.S. Department of Defense and the Department of Homeland Security may control local land uses, as well as the other federal departments and agencies. Of course, the Internal Revenue Service controls how the proposed improvements will be treated for federal income tax purposes. Land Packagers must identify these regulations or restrictions and determine whether only notification is required, or if actual approvals or permits are needed. The notification and approval processes are technical and time consuming. State authorities States usually have agencies that support the federal agencies, and these agencies enforce federal regulations and restrictions, as well as state regulations and restrictions of land use. For example, the State Department of Environmental Protection will enforce federal regulations, as well as state regulations; the State Historic Preservation Office will also enforce both the federal and state regulations; the State Department of Highways will focus on state highways and transportation systems; and the state Department of Natural Resources will also have authority if land uses impact state parks or recreation areas. Similarly, the state’s Fish and Game Commission has authority if the local wildlife is affected. Again, Land Packagers must determine which agencies and authorities need to approve the proposed land use changes. Regional economic and development authorities Regional authorities or commissions are very important overlays on local land uses. Below is a sample of some of these regional authorities: • • • • • •

Regional water authorities can determine how drinking water is distributed and used over several municipalities. Regional sanitation sewer authorities can determine the availability and costs of sanitation sewer services over several municipalities. Regional transit authorities determine how the commuter trains and buses are operated, and how the transit systems are maintained and expanded over several states and municipalities. Regional airport authorities also regulate and maintain airports that impact land uses in several municipalities and states. Regional master plans are designed and enforced by a regional planning commission or a regional council of governments. County governments also may restrict and regulate land use in their unincorporated areas, as well as townships, boroughs, and cities within the county.

Land Packagers must understand the role and functions of these regional authorities in order to determine the appropriate strategies they can use to gain their support for the proposed land uses.

Land Packaging   53 Local authorities Local municipalities control land use through their planning commissions and zoning boards, which usually have well-defined procedures for applying for changes to the existing land use regulations. These procedures often include a review of the proposed changes by various municipal departments, such as public works, fire and police, parks and recreation, and transportation, as well as established neighborhood associations. Land Packagers must understand that while, “You can’t fight City Hall; City Hall won’t fight neighborhood associations.” Annexations to increase the size of a municipality are initiated by the municipality, are governed by state laws, and are subject to state approvals. Adjacent land owners Adjacent land owners are vital key players, and their support is critical to obtaining the various approvals and permits—especially at the municipal level. Adjacent land owners may be private individuals, multinational corporations, or government organizations. Each one needs to be approached and informed of the proposed changes, and convinced that these are beneficial and will not negatively affect them. Neighborhood activists Neighborhood activists often operate outside the defined regulatory land use approval process, but their support is critical for land use changes. Activists usually have a special issue that they are advocating, such as affordable housing, sustainable development, or improved recreational opportunities. Therefore, proposed land uses need to be respectfully discussed with them even though their issue may be, “no growth, no change,” or Not On Planet Earth (NOPE). Former politicians Former or retired politicians may be especially helpful in lobbying for government approvals or providing insight into the local planning process. They know how the system works and who works it. Land owners/sellers The entity or person selling the land must be motivated to sell at an attractive price and with terms that are agreeable to the Land Packager. The sellers may agree to make the sale’s closing contingent upon receiving certain approvals, or they may be willing to provide some sort of seller financing. Their support may also be invaluable in obtaining approvals. Property Redevelopers are often government agencies who are willing to help in the approval processes. The agencies may also have access to grants or low-interest loans that the Land Packager can access. Title attorney and title insurers Title attorneys and title insurance companies help the Land Packagers identify problems or clouds on the title. Sometimes these problems can be fixed by the seller prior to closing, but

54   Part II sometimes the resolution of these problems is an important way for Land Packagers to create value. In either case, knowledge is power, and Land Packagers must determine what risks or problems to accept and which ones to avoid. Surveyors and engineers Surveyors are key players who determine where the physical boundaries, easements, and rights-of-way of the property are and what kinds of boundary issues must be addressed. Again, Land Packagers must determine which issues to accept and solve after closing and which issues to avoid by making the seller solve them before closing. Engineers, especially geotechnical engineers, are key players who determine the geological conditions that must be addressed in the new land plan. They can the conduct necessary testing and report on the geotechnical conditions that impact the physical feasibility of various land uses. Land planners Land planners create and design a conceptual master plan that shows proposed land uses. This plan must represent the Land Packagers’ vision for the property and be flexible, too. Land planners must prepare maps, pictures, and layouts that help the Land Packagers tell the story of the proposed land use changes. Traffic consultants and engineers Traffic consultants and engineers are able to show the future effects of the proposed land uses on the existing and proposed transportation systems. Identifying the potential traffic requirements or restraints of the new concept master plan is critical for its acceptance. Traffic consultants and engineers can make the traffic systems come to life using animated videos to describe the effect of traffic controls or highway improvement on the local neighborhoods. Environmental and sustainability experts Environmental experts conduct necessary surveys and testing to estimate the existence (and extent) of environmental issues on the property. They may also determine if remediation is required and propose procedures to deal with these conditions. Public concern for “sustainable development” manifests itself at all levels of government. Sustainability experts help Land Packagers explain and articulate the sustainable nature of the proposed land uses and determine what sustainable practices will be employed in the development. These are sometimes vague and broad discussions, but Land Packagers must address sustainability issues.

Land Packaging: critical Tasks Land Packagers must develop the “paper infrastructure” for the newly proposed land uses. Consequently, Land Packagers must produce understandable reports and proposals to share with all of the stakeholders who will decide or influence the decisions for the required approvals and permits. Land Packagers must carry out “conceptual selling” to skeptical audiences.

Land Packaging   55 Conduct feasibility studies Land Packagers must evaluate the current (and predict the future) physical, political, and market conditions that will affect the future use of the site and the proposed land uses. Land Packagers may commission third-party reports or they may do it themselves. In any event, these reports must be understandable and readily communicated to the various stakeholders in the process. These reports include the following: • • • •

existing physical conditions: surface, underground, and atmospheric conditions; required regulatory or political approval or permits; current and existing market conditions; historic or cultural consideration for the development of the site.

Commission conceptual land plan Land planners must be reputable and experienced, and prepare a conceptual master plan for the site. The conceptual plan should be flexible and correspond to the various feasibility studies that have been undertaken, as well as the major concerns of the stakeholders. Initially, this plan is for “comment and discussion,” but eventually it may become part of the “Entitlement Documents Package.” Urban Design Guidelines, prepared by the land planners, are often included as part of the master plan authorization legislation. Cure title and survey problems Land Packagers can create tremendous value by curing title or survey problems that have prohibited or limited the development of the site property. A clear title and accurate survey are requisite conditions for a sale to Land Developers. Obtain basic public approvals Each local municipality has its own vocabulary for the approval process. The Land Packager must have a keen understanding of the municipality’s land use approval policy, as well as the correct terms and vocabulary for each approval. The timing of the approval process is very important. Government boards or commissions can casually delay or postpone review of approvals without recognizing the deleterious effect of these delays on the Land Packager. The trick is to work the system effectively without alienating the public-sector people. At the end of the day, the basic public approvals must be obtained with reasonable and doable conditions attached to them. Obtain required private sector approvals, permits, and agreements Often, obtaining the approval and permission from adjacent land owners is very difficult and contentious. Land Packagers may temporarily need access agreements like easements or rights-of way during the property’s construction period. In urban areas, staging areas for construction are usually on private property. Some easements and rights-of-way may need to be permanent for the successful operation of the building and facilities. Sometimes property trades, such as neighbors’ abandonment of an unused right-of-way or outright purchases are necessary. Public utility companies like electric, gas, or water also require permits that may be difficult to obtain.

56   Part II Arrange financing Because of the uncertain nature of the timing of the approval process, the Land Packagers need to control the property for an indeterminate time, so the payment of regular debt payments is problematic. Consequently, Land Packagers should finance the required expenditures with equity, or perhaps partnership loans from the equity partners; of course, this is where seller financing can be so important. Also, option agreements or sales contracts are ways to control the property without putting too much cash into the property. Extension provisions in these agreements are essential. Determine marketing strategies and costs Land Packagers must promote the conceptual land plan to the general public, concerned stakeholders, and government officials. However, it is also important to market the project to potential and specific Land Developers. A marketing strategy should include general and specific materials that can be presented in person or online, both publicly and privately. Controlling these costs is paramount. Staging major on-site events is tempting, but not advised because of Murphy’s Law1 and the possibility of actually increasing public anxiety. Create opportunities for Land Developers The opportunity for Land Developers is to acquire land with an approved land plan that includes the necessary permits, so that it can be immediately improved with utilities, roads, and other infrastructure. The Land Developers’ opportunities also include improving market conditions and favorable financing alternatives.

Land Packaging: controllable costs Controllable costs are those costs and expenses that Land Packagers can and must control, or limit to the best of their abilities. Because so many parts of Land Packagers’ environments are beyond their control, these controllable costs must be identified and quantified prior to acquisition and then carefully monitored and managed during the packaging process. Acquisition price and financing expenses Land Packagers must determine what the investment value of the unimproved and unpermitted property is, and how it can be acquired and financed. The purchase agreement should specifically and accurately define the Land Packager’s financial obligations, when they occur, and how they can be extended if necessary. Permit and approval fees While it is difficult to estimate these fees since local authorities can change them, Land Packagers must make a best guess about what permits and fees are required and how much they will cost—directly and indirectly. Understanding the historic costs of the required approvals and permits is important because government agencies seem prone to uniform fee structures.

Land Packaging   57 Land planner and engineering fees The land planner and engineering fees can increase quickly if these consultants are not used efficiently and closely monitored. Fee schedules and the scope of work should be determined prior to their engagement and invoiced monthly. It is important for the public officials to recognize that these professionals are expensive and thus cannot be used arbitrarily. Surveying and title expenses The surveying and title expenses should be considered in conjunction with the land purchase agreement. Specifically, the cost of the survey and title expenses could be paid by the seller or by the buyer, or shared in some equitable manner. These fees can easily get out of control unless they are closely monitored on a monthly basis. ALTA Surveys2 may not be needed for the acquisition of the property, but they are probably required for the sale of the property to Land Developers. Marketing costs and advertising expenses The budget for marketing and advertising expenses must be established upfront and closely monitored. Land Packagers may be tempted to promote and advertise their vision, but the cash costs or expenditures can easily mount up. This is especially true when developing videos/virtual tours of the proposed development. This technology is amazing, but expensive.

Land Packaging: major risks The major risk in the Land Packaging Stage is that Land Developers are not able to successfully complete the critical Tasks described above in a timely manner. Below is a brief discussion of these major risks. Feasibility studies are unfavorable The costs of undertaking feasibility analysis are great, and the outcomes and conclusions may be unfavorable. Various feasibility studies were undertaken with the hope of increasing the property’s value by proving the viability of the future value and changing its current use. Sometimes the feasibility studies confirm the Land Packager’s worst fears: • • •

the site is physically unsuitable for development; the regulatory environment will not even consider the changes; the market for the proposed use does not exist.

Land Packagers need to be realistic and begin their exit strategy. Expected development costs increase While there are a myriad of “development costs” (both hard and soft), usually the direct construction costs of the proposed land development improvements, or the direct cost of the proposed building development improvements, are the most important. These cost increases usually occur because of material shortages in the world-wide commodity market, such as

58   Part II oil, cement, or steel. It is not uncommon for Land Packagers to engage in value engineering at this preliminary design effort if there are major changes in development costs. Expected market conditions deteriorate Unfavorable changes may occur in market conditions. The unfavorable market changes can be due to national or international conditions—such as a major banking collapse, or from a dramatic change in the local and regional markets like a major employer leaving town or shutting down. Regulatory standards change While legislative bodies pass laws, every government agency can pass regulations which have the same effect as laws. Regulations can stop activities like a building moratorium or redefine the conditions for use changes, such as major infrastructure improvements or contributions to various governmental programs. Land Packagers must have a keen sense of the regulatory environments and what new regulations are likely to occur in the future. Sometimes the good intentions of the regulators are met with strong negative consequences for developers, and the regulators rescind or modify the regulations. Storm water management regulations have changed dramatically over the last 15 years as technologies have changed, and the public perception of water management ponds have changed as well. Sometimes, public notions of sustainable development change, which can then result in regulatory changes. Capital markets deteriorate Interest rates may increase, and the availability of capital may decrease. Land Packagers must look forward to the financial markets that directly affect Land Developers, the Building Developers, and Building Operators. If Building Operators cannot access the funds to purchase the finished building, then Building Developers cannot borrow the funds to construct the building, and then Land Developers cannot obtain the financing to construct the horizontal infrastructure. As a result, the Land Packagers’ plans are put on hold. Control of the land is lost Land Packagers can lose control of the land in many ways. They may default on the purchase agreement or the mortgage loan agreement, or fail to pay an option fee when it is due. If the Land Packaging process is going well, this is very unfortunate. However, if the Land Packaging process is going poorly, this may be a way for Land Packagers to get out of their deal. In any event, pre-arranged agreements should articulate how Land Packagers get out of the deal without lingering liability exposures. Obtaining public approvals is denied or delayed Of course, this is the most devastating end to the Land Packaging process. There are many reasons for the denial or delay of approvals, so Land Packagers must decide whether to hold on or get out. Also, the approval may be granted, but with adverse restrictions or onerous conditions.

Land Packaging   59 Land Packaging is a very long process, during which the market will continue to cycle, resulting in higher (or lower) development costs. The longer the Land Packaging Stage takes, the greater the risk of shifts in the market, regulations, and financing options (favorable or unfavorable).

Case studies of the Land Packaging Stage of development Several case studies of the Land Packaging Stage of development are presented here to demonstrate and illustrate many of the discussion points in this chapter. Below are Land Packaging examples of the Crown Farm in Montgomery County, MD; the Armed Forces Retirement Home in Northwest Washington, DC.; and Potomac Yard in Northern Virginia. Crown Farm @REDM3 Crown Farm is a 182-acre site located in the I-270 Health Sciences Corridor, ten miles northwest of Washington, DC.4 After owning and operating the land for over 100 years, the Crown family (Land Banker) decided to sell the property to a partnership of two national homeowners, KB Homes and Centex (the Partnership) (Land Packager). Exhibit 7.7 shows the condition of the property when the Crown family and KB/Centex signed the purchase and sale agreement in 2004. The purchase and sales agreement provided that the closing was contingent upon the City of Gaithersburg approving the annexation of the property, as well as approving the master plan of development, known as the “sketch plan.” The annexation and the sketch plan were approved by the Gaithersburg City Council in 2006. At that time, closing occurred and the Partnership financed the acquisition with a loan from Bank of America.

Exhibit 7.7 Crown Farm site photo.

60   Part II Unfortunately, the economic downturn in 2008, also known as the Great Recession, delayed the development of the site, and the Partnership declared bankruptcy and lost the property to a lender consortium led by Bank of America. More unfortunately, the changing economic conditions and inherent design flaws made the approved annexation agreement, sketch plan, and schematic development plan unworkable in the new market environment. Sunbrook Partners (Land Packager 2, or Repackager) acquired the property through bankruptcy for $77 million in December 2009. On May 5, 2010, Sunbrook obtained all of the final approvals for the original master plan, and on May 6, 2005, Sunbrook began the Land Packaging process all over again. Sunbrook obtained the final approvals for the original master plan in case the Repackaging effort was unsuccessful. There were five major problems that had to be addressed in the Repackaging process: 1 2

3

4

5

Changing market conditions and mixed-use complications: The original plan specified vertically mixed uses whereas multiple-use plans were more efficient and more acceptable to end users in the market. Multi-builder program and product segmentation: The original plan anticipated KB Homes and Centex building everything. No outside building developers were considered, so only KB Homes and Centex products were considered. Utilizing other builders and products could provide greater specialized expertise and increased variety of marketable products to adjust to changing market trends. County right-of-way taking: During the KB/Centex ownership and bankruptcy proceedings, Montgomery County re-routed a major highway which would cause a substantial reduction in the size of the main entrance to Crown Farm. Consequently, the entrance would need to be re-designed and re-engineered. Design inefficiencies of infrastructure and usable density: The original infrastructure design used more private and public roads than were necessary to access the building pads, which unnecessarily increased the cost. Also, the original residential density was concentrated in one 20-storey tower, which reduced the variety of possible residential offerings. Preservation of storm water approvals: During the original approval process, the State of Maryland revised its storm water regulations. Compliance with these new regulations would ruin the anticipated land plan revision, so Sunbrook vested the approvals under the previous requirements.

The Repackaging process for Sunbrook was the same as the original approval process, so Sunbrook faced a very daunting challenge. Briefly, the following steps and approvals were required before Land Development could begin: • • • • • • • •

amend annexation agreement; revise sketch plan; develop schematic development plan; develop infrastructure and final site plans; develop final engineering plans; finalize development agreements; post surety (performance) and financial (payment) bonds; construction permits (shovel-ready).

Land Packaging   61 The revised master plan shown in Exhibit 7.8 had the following features that responded to the new market conditions, as well as the needs of the Land Developers and the eventual Building Developers: • • • • • • • •

Wider range of uses which expanded the types of residential units permitted. Consolidation of the neighborhood amenities that allowed for the creation of a community indoor/outdoor recreational center. Relocation of major open spaces to create a town square for better place making. Broader range of heights that allowed for buildings of varied heights and lower skyline. Commercial core and transit-oriented development that improved infrastructure efficiencies and accommodated a dedicated transit way. Redesigned infrastructure plan that reduced the number of streets and created alleyways. Increase in usable density but overall density remained the same by eliminating a 20-storey multi-family tower, thereby allowing four, five-storey buildings. Flexibility to reallocate density that allowed for better responsiveness to market conditions (e.g. two-over-two townhouses, rather than traditional townhouse units).

Repackaging must address the municipality’s pre-conceived idea of what the eventual development will be. Crown Farm demonstrates the complexities of Land Packaging that are caused by changing market conditions and inefficient and over-specified master plans. Land Packaging can be a very long process covering multiple real estate cycles. The Land Packager must be able to remain flexible in the plan and adjust to the ever-changing market conditions. This is one example where multiple Land Packagers were required to successfully entitle the property to move into the Land Development stage. The Crown Farm case is not unique; master plans are often re-packaged to correct initial design issues or to meet new demands of the Land and Building Developers and Building Operators.

Exhibit 7.8 Revised master plan.

62   Part II Armed Forces Retirement Home: multiple jurisdictions and historic restrictions @REDM5 The Armed Forces Retirement Home (AFRH) case study demonstrates the potentially exhaustive list of key players and authorities that may regulate a property for development. It is critical that the Land Packager understands the roles of each, their regulatory authority, and decipher the powers of control. While some may not have distinct legal authority, they may have powerful influence, so it is important to invite all potential stakeholders into the conversation, while balancing the objectives of the Land Packager and development plan. The Armed Forces Retirement Home is located on 272 acres in northwest Washington DC, just two miles north of the U.S. Capitol Building, as shown in Exhibits 7.9 and 7.10. AFRH’s plan was to find a qualified developer to act as the “master developer” for Zones 3 and 4. AFRH expected the master developer to carry the project through the Land Packaging Stage, Land Development Stage, Building Development Stage, Building Operations Stage, and Renovation Stage for 60 years, which was the expected term of the land lease given to the developer. These AFRH assumptions were convenient but wholly unrealistic. In 2005, the AFRH published a Request for Qualifications (RFQ)6 for interested developers. In 2006, the AFRH chose three developers to respond to its Request for Proposals (RFP).7 The deadline for submission was June 6, 2006. The RFP required potential developers to prepare a more detailed development plan that included the framework infrastructure, a sustainable development that would meet the USGBC LEED-ND Pilot Program, and a financial offer. On May 26, 2007, AFRH chose Crescent Resources LLC to be the “preferred developer.”8 The proposed development plan provided for the following uses on the 77-acre site (see Exhibit 7.11): • • • • • • • •

Residential: 2.9 million ft2 Commercial office space: 1.4 million ft2 Hotel and meeting facility: 126,000 ft2 Future hotel expansion: 150,000 ft2 Neighborhood retail: 214,000 ft2 Future assisted living: 214,000 ft2 Open space: 23.4 acres Flex space: 500,000 ft2

Crescent Resources quickly learned that both the District of Columbia and the United States of America claimed authority over the development of the site. The Federal Government said that it had “total control” of the site’s approval process because it owned the site, which it purchased from the Riggs family over 100 years ago. The District of Columbia claimed that it had “total control” of the site because the proposed development was for use by private citizens and not the U.S. Government. Both the Federal Government and the District of Columbia had very lengthy and complicated approval processes. For example, the Federal Government required input and approvals from the following stakeholders before a building permit could be issued: • •

CFA – Commission of Fine Arts NPS – National Park Service

Exhibit 7.9 AFRH vicinity map.

Exhibit 7.10 AFRH site photo.

Exhibit 7.11  AFRH original master plan.

66   Part II • • • • • • •

ACHP – Advisory Council on Historic Preservation NCPC – National Capital Planning Commission EPA – Environmental Protection Agency DOD – Department of Defense FEMA – Federal Emergency Management Agency US Army Corps of Engineers FHA – Federal Highway Administration

Finally, the United States Congress, the House of Representatives and Senate, would vote on the project. Similarly, the District of Columbia required input and approvals from the following “local stakeholders” before final development approval would be granted: • • • • • • • • • • •

DCOP – District of Columbia Office of Planning SHPO – District of Columbia State Historic Preservation Officer DDOT – District of Columbia Depart of Transportation District of Columbia of Parks and Recreation District of Columbia Council Members District of Columbia Deputy Mayor for Planning/Economic Development District of Columbia Department of Consumer and Regulatory Affairs LSDBE – Local, Small, Disadvantaged Business Enterprises HPRB – District of Columbia Historic Preservation Review Board WMTA – Washington Metro Transportation Authority Community Stakeholders who included the following: ○ ANC – Advisory Neighborhood Commissions ○ AFRH residents ○ Institutional – Washington Hospital Center/Medstar, CNMC, VA Hospital, National Rehabilitation Center ○ Educational – Howard University, Catholic University, Trinity College ○ Surrounding Community Neighbors ○ UNIC – United Neighborhood Coalition ○ NTHP – National Trust for Historic Places.

Clearly, there were a colossal number of stakeholders involved in the packaging process of the Armed Forces Retirement Home. Each stakeholder’s input and satisfaction was critical in order to achieve the necessary approvals. On August 2, 2007, Crescent Resources was able to negotiate a Memorandum of Understanding (MOU) between the District and Federal Government that provided that the two governments and their agencies would cooperate so that the final development plan would be acceptable to the District’s Office of Planning and the Federal Government’s National Capitol Planning Commission.9 As shown in Exhibits 7.11 and 7.12, the original master plan was systematically modified throughout the packaging process to gain the approval of all of the various stakeholders. The uses and density stayed the same, but the roads and lot configurations were modified. The most significant accomplishments for the master plan approval were the following: • • •

National Historic Preservation Act (NHPA) Programmatic Agreement National Environmental Protection Act (NEPA) Record of Decision Stakeholder negotiations involving:

Land Packaging   67 ○ adding Irving Street Retail for the DC Office of Planning (DCOP); ○ committing to a shuttle service for the DC Department of Transportation (DDOT); ○ agreeing to a parking compromise with National Capital Planning Commission (NCPC), the DC Office of Planning (DCOP), and the District Department of Transportation (DDOT).

Exhibit 7.12 Final master plan.

68   Part II The final master plan was approved by the National Capital Planning Commission (NCPC) on July 10, 2008. Because of the Memorandum of Understanding, the DC Office of Planning agreed to approve the NCPC’s plan if all of the local stakeholders’ approvals were obtained. This approval process took the Land Packager three years to accomplish, at a cost of over $3.5 million. The most remarkable part of this packaging process was that just two weeks after the final approval, the Federal Government unilaterally declared an “impasse” without any explanation and stopped all communications with the Land Packager. The moral of the story for Land Packagers is to acquire and maintain clear, legal control over the site before the packaging process begins. Regardless of the creditworthiness of the seller, the Land Packager must mitigate against the major risk of losing control of the land. Potomac Yard: a tale of two municipalities @REDM In 1996, an international investment banking firm, Lazard Freres (now Lazard, Ltd), acquired a portfolio of assets from the railroad company, CSX Corporation. One asset was a 369-acre strip of land in Arlington and Alexandria, Virginia, that was a decommissioned rail yard with a 600,000 ft2 big-box retail center in the middle of it.10 A Lazard subsidiary, Commonwealth Atlantic Properties (CAP) was tasked with the overall objective to rezone and master plan the decommissioned rail yard, so it could be sold to a Land Developer. Unfortunately, Potomac Yard stretched across Arlington County and the City of Alexandria. Each municipality had a distinct self-image and expectations for the future development, which were reflected in unique requirements and challenges. Arlington County envisioned a high-density, mixed-used development (primarily office) on the 48-acre South Tract and a County Park on the 40-acre North Tract. “New urbanism” was the term used to describe this transit-oriented development that would be served by a light rail system. The City of Alexandria envisioned a low-density, mixed-use development (primarily residential) on its 212 acres where “neo–traditional neighborhoods” would be served by a new metro station on the existing heavy rail line. Each municipality expected about five million square feet of new development in its portion of Potomac Yard, so the total 300-acre Potomac Yard Project would represent ten million square feet of new development. Exhibit 7.13 is the overall master plan for the entire Potomac Yard which shows both the Arlington and Alexandria approved master plans. Alexandria Potomac Yard Alexandria City approved the master plan of their portion of Potomac Yard in a Coordinated Development District (CDD) and accompanying Urban Design Guidelines in October 1999. Arlington County approved the master plan of their portion of Potomac Yard in a Phased Development Site Plan (PDSP) and accompanying Urban Design Guidelines in October 2000. Both municipalities had very complicated master plans because some development conditions in the Alexandria CDD were tied to the future development of Arlington, and some development conditions in the Arlington PDSP were tied to the future development in Alexandria. The terms and conditions of the approved Alexandria CDD are summarized in Exhibit 7.14.

Exhibit 7.13 Potomac Yard conceptual master plan.

Exhibit 7.14 Summary of the master plan of the Alexandria portion of Potomac Yard.

70   Part II

Exhibit 7.15 Alexandria land bays.

The Alexandria Potomac Yard was divided into land bays, each with specific land uses and densities, as shown in Exhibit 7.15. Detailed descriptions and specifications for each land bay were in the Urban Design Guidelines that were approved with the zoning ordinance. The Alexandria portion of the Potomac Yard included four challenging areas, that are shown on Exhibit 7.16. First, the Central Operations Facilities and Refueling area was so heavily contaminated with diesel fuel that a major remediation effort was undertaken to remove all of the contaminated soil from the site. Second, the Monroe Avenue bridge, a four-lane, dog-leg structure carrying US Route 1 and crossing over CSX rail tracks and the WMATA metro lines, needed to be repaired and expanded or replaced with a new, straightened bridge. Third, interim uses on this area included a GSA warehouse, a rental car facility, and some temporary soccer fields, which needed to be relocated. Fourth, the biggest hurdle was the construction of a two-mile trunk sewer line from Potomac Yard through Old Town Alexandria to the water treatment plant. This sewer would have a capacity of 12 million gallons per day that would be allocated as follows. • • •

one third of the sewer capacity was for Potomac Yard; one third was for existing sewage users; one third was for future development outside of Potomac Yard.

The final site plan would not be approved until the required trunk sewer line was complete.

Land Packaging   71

Exhibit 7.16 Challenging issues in Alexandria.

Arlington Potomac Yard The Arlington master plan for Potomac Yard is summarized in Exhibit 7.17. Arlington’s zoning strategy was that the existing or “by-right” zoning density in the 40-acre North Tract would be transferred to the 48-acre South Tract when the North Tract ownership was transferred, free and clear of all encumbrances, to Arlington County.

Exhibit 7.17 Summary of the Arlington master plan for Potomac Yard.

72   Part II

Exhibit 7.18 Arlington land bays in Potomac Yard.

Similar to the Alexandria portion, the Arlington portion of Potomac Yard was divided into land bays, each with specific land uses and densities, as shown in Exhibit 7.18. Also, detailed descriptions and specifications for each land bay were in the Urban Design Guidelines that were approved with the zoning ordinance. The North Tract, as shown in Exhibit 7.19, is a 40-acre tract of ground, separated from the South Tract by Crystal City, a ten million square foot office development constructed in the 1970s by the Charles E. Smith Company. The North Tract was part of the early rail yard, but for the last 75 years, it has been used for outside storage and industrial activities, causing a serious land contamination issue. The railroad tracks were removed as part of the decommissioning, but several one-storey industrial buildings were left intact and rented for interim income. This valuable piece of ground was bordered by the Potomac River, the Interstate Highway 395, the Pentagon, and Crystal City. The Washington Monument can be seen in the background. Arlington County planned to convert this area to recreational park area when it obtained the free and clear ownership. Arlington’s precondition for development that the North Tract be transferred to Arlington County free of all encumbrances, included the National Environmental Policy Act (NEPA) litigation that was initiated by the Charles E. Smith Company. This lawsuit was baseless, but it could delay the development of Potomac Yard. Delaying the development of Potomac Yard office projects was critically important to the Charles E. Smith Company, who had just lost three million ft2 of US Government tenants, who had moved their offices to Alexandria

Land Packaging   73

Exhibit 7.19 North Tract portion of Potomac Yard.

and Washington, DC. The vacancy rate at Crystal City was 30%. The Smith Company hoped to delay Potomac Yard so it had more time to re-lease its vacant space before getting new competition. This is a great example of the importance of community stakeholders in the real estate packaging process. By convincing Arlington to include the “free and clear” language, the Smith Company was able to postpone and delay the transfer of North Tract Development Rights to the South Tract and thereby restrict future competition; at least temporarily. This lawsuit was eventually dropped, and Crescent Resources (Land Developer) transferred the North Tract (free and clear) and consequently had the development rights transferred to the South Tract. From Land Packaging to Land Development In late 1999, the Land Packager (CAP) began marketing the Potomac Yard property, along with multiple other assets, to qualified Land Developers that it screened through a series of interviews. CAP solicited bids on the entire portfolio from 28 qualified Land Development teams. After receiving the first round of bids, it was obvious that the valuation of the non-real estate assets was very problematic. CAP then requested a second round of bids for the acquisition of only the real estate assets. Again, after reviewing these bids, CAP felt that

74   Part II the existing retail shopping center and the vacant land outside of Potomac Yard confused the prospective Land Developers. Finally, a third round of bids was solicited for only the vacant land that was part of the Potomac Yard master plan for Arlington and Alexandria. Cabin Mountain Land @REDM11 In this case, the Land Packager has submitted a Letter of Intent to purchase 1,348 acres in Tucker County, West Virginia, for the potential development of a resort and residential community. The LOI outlines a payment of $50,000 to the seller to allow for a 180-day due diligence period, in which the Land Packager may perform site and market feasibility studies and review any potential title issues. If the Land Packager decides that the development is not feasible during that time they may walk away from the deal without any further financial obligations or losses. However, if the Land Packager then decides to proceed after this option period, they have also included other conditions to close, to mitigate potential risk. One of three conditions to close is the successful rezoning of the property to allow for the desired uses of the Land Packager. If the Land Packager is unable to complete this critical Task, then the condition to close is not met and they will not be obligated to purchase the property; i.e. pay the total purchase price. Finally, the purchase price includes a base purchase price of $20,000 per acre plus an earn out provision of 10% of annual net profit from lot sales. This is an example of a mechanism the Land Packager may use to control the acquisition cost, as well as the Land Banker sharing in some of the entitlement risk for the potential of increased revenues from the sale of the land.

Summary The Land Packaging stage of the Real Estate Development Process interacts directly with three other stages of development—Land Banking, Property Redevelopment, and Land Development—and indirectly and dramatically affects the other three stages of development. Land Packagers should be the visionaries that can see a development plan before it exists. Land Packagers should also be skilled political operatives who understand the approval and permitting process, and they also should be brilliant market forecasters. Often, Land Packaging is overlooked as a separate Stage of development, but it has the greatest chance of creating incredible increases in the financial value of the property. Unfortunately, Land Packaging also has the greatest risk of failure. This is a very challenging Stage of development and requires an experienced, skilled, and multidisciplinary team. The case studies demonstrate some the significant risks of the Land Packaging Stage. Crown Farm shows how the Land Packager can lose the property when the market dramatically changes, while the Armed Forces Retirement Home shows how various levels of governments can claim control over the property. It also shows how the Land Packager can lose control of the property by not having secure contractual agreements. Potomac Yard illustrates the Land Packaging challenges that occur when the property lies in two separate political jurisdictions. Finally, the Cabin Mountain Land case demonstrates a Land Packager’s attempt to control a property throughout the permitting and approval process through a series of closings.

Land Packaging   75

Notes   1 Murphy’s Law is an old adage that is usually stated, “Anything that can go wrong, will go wrong.”   2 ALTA Surveys are the Cadillac of boundary surveys. They are more accurate, more detailed, and extensive than ordinary boundary surveys. A more complete discussion of Alta Surveys can be found at: http://info.courthousedirect.com/blog/bid/323492/what-s-the-difference-between-analta-acsm-land-title-survey-and-a-boundary-survey   3 http://realestatedevelopmentmatrix.com/textbook/res/South+Tryon+Assemblage+I.pdf   4 http://www.gaithersburghistory.com/crown-farm.html   5 http://realestatedevelopmentmatrix.com/textbook/res/task1/stage2/Armed+Forces+Retirement+ Home.pdf   6 To respond to the RFQ, potential developers had to assemble a team, determine a strategy to “protect, preserve, and enhance” the unique AFRH assets, submit a vision for the site, and explain how the development would generate revenue to assist the AFRH to care for current and future residents.  7 http://realestatedevelopmentmatrix.com/textbook/res/AFRH+press+release+June+14+06.pdf The RFP required potential developers to prepare a more detailed development plan that included the framework infrastructure, a sustainable development that would meet the USGBC LEED-ND Pilot Program, and a financial offer.   8 http://realestatedevelopmentmatrix.com/textbook/res/afrh_press_release_03.26.07.pdf   9 http://realestatedevelopmentmatrix.com/textbook/res/afrh_mou_dc_and_usa.pdf 10 A Brief History of Potomac Yard: 1905: Richmond Fredericksburg and Potomac Railroad (RF&P) opens tracks and station 1906–1980: RF&P Rail switching yard 1975: Four Mile Run Flood Control Channel completed by US Army Corps of Engineers 1987: Site identified as toxic waste site because of diesel fuel contamination in Central Operations area 1989: Rail yard decommissioned by CSX 1995: Redskins Stadium proposal denied, retail shopping center approved in center of site 1996: Big box shopping center constructed 1996: Acquired by Lazard Freres (now Lazard Ltd) 1999: Alexandria Coordinated Development District (CDD) Approved 2000: Completed soil remediation project in Central Operating Area 2000: Arlington Phased Development Site Plan (PDSP) Approved March 22, 2001: Acquired by Crescent Resources, LLC 11 http://realestatedevelopmentmatrix.com/textbook/res/9-4-07Letter_IntentCabin+Mountainclean.pdf

8 Land Development

INTRODUCTION Land Development is the third stage of the seven-Stage Real Estate Development Process (see Exhibit 8.1). The general public considers this Stage of development as “real development” since it requires the construction of the “horizontal infrastructure,” which includes the roads, storm sewers, sanitary sewers, utility lines, and so forth. Land development also includes common area improvements such as water retention ponds, parks, and other recreational areas. These observable activities give the neighbors and community a sense that something is really happening on the property. This can be good or bad, depending on the developer’s relationship with the many stakeholders in the project. The Land Development Stage is unique in the Real Estate Development Process because Land Developers usually sell their finished lots to several Building Developers, rather than a single buyer.

Schematic diagram Land Developers acquire the property from Land Packagers (see Exhibit 8.2), construct the horizontal infrastructure, and then sell the finished lots or building pads to one or more

Exhibit 8.1 Real Estate Development Matrix.

Land Development  77

Exhibit 8.2 Land Development Schematic diagram.

Building Developers. Of course, Land Developers may decide to continue on to the next phase of development and do the “vertical construction” or Building Development. Hopefully, Land Developers know that Building Development requires sets of skills, risks, and Tasks that are very different from Land Development.

Box diagram The box diagram in Exhibit 8.3 graphically illustrates the old adage: “The developer always buys one thing and sells another.” In this case, Land Developers acquire land with proper zoning for the proposed uses, a concept master plan, some necessary approvals, and some feasibility studies already performed. Land Developers then construct the infrastructure improvements to the site to create the economic opportunities for Building Developers.

78   Part II

Exhibit 8.3 Land Development Box diagram.

Land Developers sell building-ready (or shovel-ready) pads, sites, lots, or land bays to one or more Building Developers. What does “building ready” or “shovel ready” mean? These terms usually mean that the building pad or sites have proper zoning, approvals, and construction permits for the proposed building, as well as direct access to basic utilities such as water, sewers, and power; that is, the utility lines are constructed to the edge of the site pad. The building sites also have access to the roads that connect the sites to the major off-site public roads. The exact definition of “building-ready” is flexible and may change depending on the contractual terms and conditions agreed upon by the Land Developers and the Building Developers.

Venn diagram The Venn Diagram (Exhibit 8.4) shows that the Stages of development are not clearly defined, so that the Land Development activities may include Tasks usually undertaken by

Exhibit 8.4 Land Development Venn diagram.

Land Development   79 the Building Developer or those sometimes done by the Land Packager. For example, while Land Developers usually addresses the soil contamination issues, Land Packagers may do the remediation as a way to reduce the Land Developer’s risk and increase the price that Land Developers are willing to pay. Along the same lines, Land Developers may do additional site preparation or foundation excavation for Building Developers, to reduce site issues such as rock formations or difficult soil conditions.

Circle diagram The circle diagram (Exhibit 8.5) shows how Land Developers relate to Land Packagers and Building Developers in the larger circle of the Real Estate Development Process.

Land Development: what happens Land Developers buy the property with the paper enhancements1 (land with a plan) from Land Packagers and then improve the land with the horizontal infrastructure and common area improvements so it can be sold as finished building pads to one or more Building Developers. A good example of a Land Developer is an industrial park developer who

Exhibit 8.5 Land Development Circle diagram.

80   Part II constructs the road, utilities, and storm water management ponds and then sells the building pads to Building Developers who construct warehouses or industrial facilities. Another of example of a Land Developer would be a master-planned community developer who constructs the roads, utilities, and recreational facilities and sells the building lots to home builders. Land development companies may be road building companies, excavation companies, or utility companies. Other land development companies would include home building companies that want to develop their own inventory of lots. The major risks they face are cost over-runs, major construction delays, and changing market conditions. The land development business is a “beat the clock” enterprise. As soon as Land Developers acquire the property, they must start construction and bring the finished lots to market according to their schedules. Not only are Land Developers accruing interest on their construction loans, but they are also taking the risk that the existing market conditions may deteriorate, which would extend the contemplated sell-out period.2 Land Developers typically use equity capital to acquire the land and then use a short-term construction loan with variable and accruing interest to fund the necessary horizontal improvements. A critical provision in the construction mortgage are the provisions that allow Land Developers to remove the “sold lots” as collateral, so they can be conveyed lien-free to the Building Developers; these are commonly referred to as release provisions.3 Exhibit 8.6 shows that the input costs (acquisition costs, net holding costs, land development costs, and marketing expenses) must be less than the sales price to the Building Developers. The difference between the cost and the sales price is known as the “spread.” Economists call this the “profit” earned in this stage. The expected profit needs to be large enough to compensate the Land Developer for taking the risks in this stage of development. If the tract of land to be developed is very large, the developer will need to break down the development into phases so that the market is not over-supplied or saturated with building lots. This would increase the eventual sell-out period and increase the risk to the Land Developer, unless the Land Developer can arrange for the Land Packager to hold the undeveloped land until the market is ready for it. Ironically, the U.S. Internal Revenue Service classifies the profit that Land Developers earn as “ordinary income” rather than “capital gains,” because Land Developers are considered “dealers” for income tax purposes. Land Developers are special people in the eyes of the IRS.

Land Development: key players Land Developers recognize that there are several key players who are instrumental to their success in this phase of the development process. Some of these players are listed as follows:

Exhibit 8.6 Land Development equation.

Land Development   81 The existing land owner The existing land owner may be the Land Banker, or more likely the Land Packager, and must have control of the land and be willing to undergo improvements to it. The existing land owners may be willing to sell the land to the Land Developer on an “as-needed” basis, or by phases with attractive takedown provisions.4 Also, the existing land owner may be willing to finance the land acquisition with a purchase-money mortgage5 that is subordinate to the Land Developer’s construction loan. In this case, release provisions6 would be included in the mortgage agreement, so Land Developers could sell the building lots debt-free (or unencumbered) to Building Developers. The state Department of Transportation, and the municipal department or public works These departments have jurisdiction over the road design requirements and the permits needed to construct the roads according to approved plans. Their cooperation and timeliness is critical for the Land Developer’s success. Many times, there are overlapping jurisdictions so that Land Developers may need to meet the construction specifications of local and state jurisdictions. Local utility companies Local utility companies include electric, gas, and water companies, as well as sanitary water treatment authorities and communication companies. The timely and coordinated construction of these utilities is a key component of land development. Good working relations with these utilities are imperative for successful land development. The U.S. Environmental Protection Agency and the Army Corps of Engineers The U.S. Environmental Protection Agency and its designee the Army Corps of Engineers have jurisdiction over the “Waters of the United States,” which are commonly referred to as wetlands. Successful Land Developers must comply with all of these regulations and obtain the necessary approvals before beginning construction. These regulations are always being modified, usually because of federal court decisions, so compliance may be difficult. Most importantly, Land Developers don’t want to fight with these agencies because of the lengthy delays that are involved. Environmental engineers and experts Environmental engineers and experts are critically important in determining what the environmental consequences of the development are, and how these consequences can be anticipated, monitored, and managed. Environmental plans are formulated prior to any construction and these approved plans must be implemented and documented during construction. Adjacent land owners The adjacent land owners will be the ones most impacted by the noise, dust, and possible water run-off caused by the infrastructure construction activities. Invariably, there will be

82   Part II ingress and egress issues, as well as discussions about the location of all staging activities. The cooperation of adjacent land owners is imperative, so Land Developers should be proactive in gaining their support and cooperation. Neighborhood activists Every time land is developed, neighborhood anxiety increases because of the uncertain long-term effects and consequences of the development. Successful Land Developers manage the community’s expectations, both positive and negative. A neighborhood outreach strategy includes meetings, printed information, websites, and news articles about the land development activities, as well as the eventual use and operation of the property. The Land Development Stage is probably the most publicly controversial part of the Real Estate Development Process because in the eyes of the stakeholders, “Something is really happening!” Civil engineers, surveyors, land planners, and landscape architects These professionals ensure that improvements are built according to the master plan and in the correct location at the correct elevation. Consequently, they are involved throughout the construction period. Inaccurate or sloppy workmanship can be disastrous. Land Developers must bring qualified and experienced professionals to the team so that the public and the future land users can be confident that the land development improvements are built in accordance with the approved plans and specifications. General contractors The general contractor and major subcontractors are needed to build the horizontal infrastructure improvements on time and on budget. The contractor agreement needs to provide for unexpected soil conditions, weather delays, and changes mandated by permitting authorities during construction. An inspection protocol must be established before, during, and after construction. Equity capital partners Land Developers’ equity capital partners typically provide the money to acquire the land and to fund any costs that are not funded by the construction loan. The equity capital partners may also be instrumental in providing financial guarantees and bonds that are required by government authorities and construction lenders. Construction lenders The construction lenders provide funds for certain improvements as they are built and inspected. The construction loan is usually for a short period of time (24 to 48 months) and with a variable interest rate that accrues during the loan period. Land Developers must submit monthly draw requests to the construction lenders that are accurate and well documented. A good working relationship with the construction lender is imperative for success. A critical part of the construction loan agreement is the provision to release the individual building lots as collateral for the mortgage agreement. Thus, the Land Developers can sell the unencumbered lots to Building Developers.

Land Development   83 Building Developers (buyers) The Land Developer’s best friends are the Building Developers who will purchase the finished building lots. Typically, the Land Developers and Building Developers have a history of working together, so the details of the post-closing land developments can be reasonably negotiated. Land Developers are successful when they manage to create profitable opportunities for Building Developers. Because there may be several Building Developers in a land development project, it is critical that Land Developers establish guidelines and agreements that foster cooperation among the Building Developers, rather than cut-throat competition. To avoid ruinous competition, Building Developers who are successful bidders may want the Land Developers to give post-closing guarantees that additional lots sales will be delayed for a period of time until a certain level of leasing has been achieved by the Building Developers. They may also ask for a first right of refusal, or the first right of offer, when additional lots are brought to the market.

Land Development: critical Tasks The critical Tasks in the Land Development Stage are as follows: Obtain specific public approvals and permits The public approvals and permits for the Land Development Stage are probably the most difficult to obtain. Approvals are needed at all levels of government—especially since the U.S. Environmental Protection Agency is claiming sovereignty of virtually “all waters of the United States.” This means that the U.S. Army Corps of Engineers/the state-level Departments of Environmental Protection must approve the land development plans. Also, the overlapping jurisdiction between state-level highway departments and municipal-level public works departments make their joint approvals extremely difficult to obtain. In addition, regional water and sewer authorities, as well as regional transportation and transit authorities, can have multiple agendas that make obtaining permits very challenging. Moreover, construction permits usually require Land Developers to post surety bonds7 and performance bonds.8 Negotiate various contracts within budget Land Developers must arrange construction contracts with a general contractor and subcontractors that are within the development budget. The Land Developer may have several general contractors for the multiple projects that are required, such as storm water management ponds construction, road and bridge construction, public parks and recreation areas, off-site utility construction projects, and traffic control systems. Stage, manage, and control development projects on time and on budget The most important Task for Land Developers is to stage, manage, and control the construction of the multiple projects on schedule and on or under budget. Once construction has begun, it is imperative that all of the necessary materials are on-site when needed, subcontractors are available on schedule, and the required inspections are made in a timely manner. Delays of any kind cost money and are almost impossible to make up later in the process.

84   Part II Obtain and close sales contracts During construction, Land Developers must market to, contract with, and sell to Building Developers so that the finished lots can be sold within the projected sell-out period. Most likely, Land Developers will sell to multiple Building Developers, and each one will have specific timing and accessibility requirements. Without these sales, the Land Developer is out of business. These sales become especially difficult if the potential Building Developers compete with each other or if there are multiple uses in the project, such as residential and commercial projects. Negotiate development agreements with Building Developers Often, Building Developers will want to close the sale and start construction before the land development is complete. Therefore, the sales contracts will specify the following postclosing provisions which are called Development Agreements: • • •

exactly what land development projects will be done after closing; exactly when the projects will be completed after closing; exactly what the penalties and cure provisions are if the Land Developers cannot fulfill their post-closing obligations.

Create opportunities for Building Developers In essence, the Land Developer must create attractive business opportunities for Building Developers. The land development projects must provide an exciting environment for the future building users, so that Building Developers can’t wait to buy the building-ready lots and start the construction of the buildings.

Land Development: controllable costs Controllable costs are costs or expenses that Land Developers can and must control or limit to the best of their abilities. These costs must be identified and quantified prior to land acquisition and then carefully monitored and managed during the Land Development Stage. Acquisition costs Land Developers must determine the maximum price they can pay for the acquisition of the “land with a plan” and negotiate a price and terms within that maximum price objective. Over-paying for land puts Land Developers in a hole that is difficult to dig out of! Large land acquisitions may need cooperation from the seller so that the land can be purchased in stages over time. A successful first phase of land development will increase the value of subsequent phases so that Land Developers are in a position to acquire the more valuable future phases at attractive prices. Construction costs Land Developers need an accurate construction budget and must negotiate contracts with the various contractors/subcontractors within that budget. Because of the uncertainty of the

Land Development   85 actual soil conditions encountered and weather conditions experienced, contingency reserves9 should be established in the budget. The construction costs will determine the amount and timing of the expenditures, as well as the amount of the required construction loan draws and the accrued interest. Permit and approval fees The fees for approvals/permits should be known and included in the land development budget. These fees can change administratively at any point depending on the local authorities. There may also be expenses associated with obtaining those fees and permits, such as design work, printing costs, editorial revisions, and so forth. Land Developers should know the cost of permits and approvals that were granted to other Land Developers. These costs and fees set precedents that government authorities usually respect. Marketing expenses Marketing expenses include the advertising and promotion of the project in order to sell finished lots to Building Developers, as well as to build support for the project within the community. Sales commissions for outside real estate brokers, as well the in-house sales staff must also be included in this budget. Holding costs Holding costs include real estate taxes, insurance premiums, and office overheads. Operating costs and income from interim land uses should also be included in these costs. Construction financing Construction loans usually have variable interest rates with the interest accruing during the loan term. Construction lenders may also charge front-end fees or “points” to Land Developers, which raise the cost of the borrowed capital. Construction loans work on a “draw” system that requires the Land Developers to prove that work is being done according to the plans and specification before the requested funds are disbursed by the lender. Accordingly, Land Developers must provide documented proof of inspections that confirm the correct construction. This is a little tricky if the improvements are underground or beneath road beds. Understanding and complying with the draw system will reduce the time needed to obtain the construction funds.

Land Development: major risks Delays in obtaining permits and approvals The public sector is not as time-conscious as the Land Developer, so the approval and permitting periods may take longer than expected, especially if the developer is not knowledgeable about the process or the proposed project has some exceptional or controversial features. Successful Land Developers know that “time wounds all deals,” so they must press for the timely approvals without alienating or angering the governmental authorities. Diplomacy is critical.

86   Part II Unfortunately, some jurisdictions use the permitting process as an opportunity to renegotiate the terms and conditions for the approvals. Delays in completion of improvements The timely staging of the materials and crews is extremely vital to maintaining the projected schedule. Also, the world-wide commodity markets for oil, cement, and steel can affect the availability of construction materials while local construction activities can affect the availability of workers and equipment. Because of such delays, the work simply does not get done on time, and it is virtually impossible to make up for these delays. Because Land Development is mostly an “outside sport,” adverse weather conditions must be respected and considered in the construction schedule. Cost over-runs The major risk of cost over-runs is that the budgeted funds are not sufficient to cover unforeseen costs due to changes in the price of materials or labor. Higher costs will lead to lower returns. Land Developers would like to put the risk of higher costs on the contractor’s shoulders, but in return the contractors will charge a higher price for taking those risks. For example, if the construction does not begin for 12 months, the price of building materials may change dramatically, which in turn would dramatically affect the agreed upon development budget and contracts. Land Developers and contractors could agree upon a price index to adjust the pricing of the project. Poor quality of improvements Both the poor quality of the material, and the poor quality of the workmanship, can lead to poor quality improvements. From the very beginning of the project, Land Developers must insist that the material and the workmanship meet the highest standards. The major risk is that the low quality is not discovered until the improvements have been constructed or installed. When this happens, the improvements must be dug up, torn down, or removed and replaced. This results in serious delays, as well as cost over-runs. Unsuitable soil conditions are often the culprit for the faulty installation of horizontal improvements, which results in settling problems. Soils must constantly be tested, and if they are not suitable they need to be removed and replaced with appropriate aggregate material. Unexpected soil conditions The most elaborate geotechnical studies rely on a sampling of soil borings; this is an imperfect science at best. The occurrence of unexpected rock formations or the existence of unsuitable soil can affect the feasibility of constructing the land improvements and may require them to be redesigned or re-engineered. In any event, this means delays and additional costs. Deteriorating market conditions These negative market changes could be caused by national or international forces like the collapse of the banking system, or they could be caused by local or regional forces such as

Land Development   87 the loss of a major employer. For Land Developers, these negative events result in longer sell-out periods, may stall work completely, or may require a major shift in the master plan. Downward shifts in the marketplace will cause a reduced demand by the end users of the building, thereby decreasing the attractiveness of the building-ready pads to the Building Developer. Land Developers must have a keen understanding of the market conditions of the end users to be sure that Building Developers are willing to buy the land parcels they are preparing. Lower sales prices or higher cost of sales The deteriorating market conditions will lower the demand for the building lots and the prices that can be charged. Consequently, an abundance of competing land development projects will force the sales prices lower and/or cause Land Developers to increase incentives or inducements for the Building Developers to purchase the land. Lower prices and more generous terms can ruin the profitability of a land development project. However, the slower rate of sales, such as a six-year sell-out rather than a three-year sell-out period, can be equally ruinous even if the target sales prices are achieved. Unexpected environmental conditions Unexpected environmental conditions can occur in the soil or may occur above ground. The discovery of an old and undocumented oil spill or a dump site may create unexpected costs or limit the feasibility of the development plans. Also, the discovery of endangered animals or plant species may force the revision of such plans. Finally, floods or storms may cause unworkable conditions. Land development is an outdoor sport! Previously unknown but newly discovered grave or burial sites are incredibly difficult to deal with. Approvals to remove the graves take extended periods to process and often the approvals are never obtained. These kinds of archeological problems should be addressed during the due diligence period prior to purchasing the site, but sometimes they are overlooked or under appreciated.

Case studies of the Land Development Stage Several case studies of the Land Development Stage of the Real Estate Development Process are presented here to demonstrate and illustrate many of the discussion points in this chapter. The examples below are a continuation of the Crown Farm and the Potomac Yard developments that were discussed in the previous chapters. Crown Farm scenario @REDM10 Crown Farm land development: Phase I This case study focuses on the importance of phasing and how the sale of bays to building developers creates the economic opportunity for the Land Developer. The 182-acre Crown Farm property was purchased by Sunbrook Partners, a Land Development company, out of bankruptcy from a consortium of lenders headed by Bank of America for $77 million in 2010 (see Exhibit 8.7). Unfortunately, the approved master plan

88   Part II

Exhibit 8.7 Crown Farm aerial photo.

was not feasible for several design and market conditions, so Sunbrook had to “re-package” the property by revising both the annexation agreement and the master plan with the City of Gaithersburg. The revised overall master plan is shown below in Exhibit 8.8 and Phase I of the revised master plan with illustrations is shown in Exhibit 8.9.

Exhibit 8.8 Revised overall master plan.

Land Development   89

Exhibit 8.9 Phase I of revised master plan.

As the Land Developer, Sunbrook’s goal was to construct the horizontal improvements, or infrastructure, and then to sell the finished building sites to Building Developers. While the overall infrastructure budget was $90 million, $50 million was allocated to the construction of the Phase I improvements which included: • • • • •

major roads; retaining walls; storm water management ponds; wet utilities (water, storm water, and sanitary sewer lines); dry utilities (gas, electric, telecommunications lines).

The major Phase I infrastructure improvements are shown on Exhibit 8.10. Phasing strategy As you can see in Exhibit 8.11, the developable area was divided into three phases. Each phase would bring additional building sites and uses to the market as the infrastructure was expanded. Proper phasing for any Land Development Stage is critical for market absorption of the finished lots and managing the capital financing needs of the improvements. Exhibit 8.12 shows the major public roadways that the Land Developers constructed to provide initial access to the land bays so that they could be sold to the Building Developers; additional smaller roads were also added. During Phase I construction, Sunbrook was able to sell all of the Phase I building pads to various Building Developers who specialized in each product type. The retail pads (260,000 ft2) were sold to JBGR, a retail Building Developer; the multi-family pads (537 units) were sold to Bozzuto, a large local apartment builder; and the single family residential lots were sold to numerous home builders including Ryland, Pulte, KB Homes, M.I. Homes, and

90   Part II

Exhibit 8.10 Major infrastructure improvements.

Wormald Homes. The purchase and sale agreements for all buyers included an “all-at-once” provision that required the Building Developers to construct all of the vertical improvements immediately, rather than to construct them in multiple phases or at independent times. The purpose of these provisions was to immediately create a sense of place for the new community and establish “Downtown Crown,” which would be the nexus of the mixeduse development and serve as the main amenity and incentive for future home builders on Phases II and III. The sale of the Phase I lots created the market demand for the continuation of Phases II and III and provided the capital for the additional land development in those areas. Sunbrook completed the Phase I infrastructure improvements of the Land Development Stage in 2014, on time and on budget! Phase II and III infrastructure construction began in 2015. In summary, Sunbrook acquired Crown Farm for $77 million. The total expected land sales were $300 million and the expected development costs were $90 million. The potential land sale value demonstrates the potential value created in the Land Development Stage by constructing infrastructure improvements and creating prepared land bays for Building Developers.

Land Development   91

Exhibit 8.11 Overall road system.

Potomac Yard land development: a tale of two municipalities @REDM11 This is a continuation of the Potomac Yard case study that was introduced and discussed in Chapter 7 as an example of the Land Packaging Stage of the Real Estate Development Process. This chapter focuses on Potomac Yard as an example of the Land Development Stage. Crescent Resources, the Land Developer, acquired the 300-acre property on March 22, 2001, from Commonwealth Atlantic Properties, the Land Packager, for $122 million by trading 16 “1031 properties.” As shown in Exhibit 8.13, Potomac Yard is divided by Four Mile Run stream into an 88-acre Arlington County portion to the north, and a 212-acre City of Alexandria portion to

92   Part II

Exhibit 8.12 Phase I road construction.

the south. Consequently, the Land Development Stage is controlled by two master plan ordinances: Arlington’s Phased Development Site Plan (PDSP) and Alexandria’s Coordinate Development District (CDD). Both ordinances had accompanying Urban Design Guidelines, which provided detailed description and specifications of the allowable improvements. Alexandria Potomac Yard land development Alexandria’s CDD provided that a two-mile long trunk sewer line had to constructed and completed before any individual site plan would be approved. Alexandria’s motivation for making the trunk sewer a pre-condition for development approval was caused by the capacity

Land Development   93

Exhibit 8.13 Potomac Yard conceptual master plan.

limitation and condition of the existing sewer system. In order to solve the existing problems, as well as to accommodate the future development of Potomac Yard in Alexandria, the trunk sewer construction became a required first step. Alexandria decided to add another 50% of capacity to the required sewer capacity just to be safe, as well as exploit the opportunity of having a private developer do (and pay for) something the City was unable to do. The CDD conditions also provided for a trenchless installation technology to be used to dig the sewer line, rather than traditional “open cut” construction methods. The trenchless installation technology had never been used in an urban area. The trunk sewer design began June 2001, and in March 2002, permits were issued by the City of Alexandria, Virginia Department of Health, CSX Transportation, WMATA (Metro), and Alexandria Sanitation Authority (ASA) in March 2002. The trunk sewer was completed in June 2003, but the City of Alexandria did not issue a certificate of acceptance until March 2004.12 Crescent began its trunk sewer effort by completing a feasibility study that reviewed factors such as geology, groundwater levels, existing utility interference, topography, community impact, and constructability. It was based on these factors, that the proposed alignment was selected. Because of the geology and high groundwater levels, an earth-pressure balanced technique was chosen. This technique maintains a constant pressure by slurry injection to counteract the earth and water pressures. Coinciding with the feasibility activities, Crescent implemented an aggressive community outreach program, which included informational meetings, mailings, web-based updates, a toll-free hotline to register complaints, and a student mural project. The community outreach efforts included meetings with over 30 impacted neighborhood associations and 11 business/ civic groups. The result of the extensive community outreach efforts was widespread support and acceptance of the project. At the time the Potomac Yard Trunk Sewer Project was constructed, it was the longest micro-tunnel project in an urban setting.

94   Part II

Exhibit 8.14 Trunk sewer shaft preparation.

The first phase of the project included the installation of the vertical shafts, ranging between 30–50 feet deep.13 The six-month shaft installation effort included many bouts with existing unknown utilities, potential archaeological sites, and overhead utility lines. Exhibits 8.14, 8.15 and 8.16 show the installation of the vertical shafts into pre-drilled holes. The larger shafts in Exhibit 8.15 contained the drilling rigs, and the smaller shafts in Exhibit 8.16 received the drilled pipes.14 The second critical phase of construction was the installation of the pipe by micro-tunnel. In order to maintain an aggressive schedule, two—and eventually three—separate tunnel crews were employed at various locations along the alignment. During the entire process, all installations were monitored by surveying crews to ensure that no detrimental settling was experienced. The completion of the trunk sewer project enabled the sale of Land Bays A and C (Potomac Greens and Potomac Plaza) to a local townhouse/apartment development partnership, Eakin Youngentob Associates and Elm Street Development.15

Exhibit 8.15 Trunk sewer shaft installation.

Land Development   95

Exhibit 8.16 Trunk sewer construction.

The remaining parcels of the Alexandria Portion of Potomac Yard were sold without any further on-site infrastructure improvements to a partnership of Pulte Homes and Centex Homes, two national real estate homebuilding companies who had limited experience in urban land development. In summary, the $12 million trunk sewer project enabled Crescent Resources to sell over $133 million of land bays in Alexandria. This is a good example of a private Land Developer constructing a major off-site infrastructure improvement as part of the Land Development Stage and creating valuable building sites. It also demonstrates the public nature of real estate development and the importance of Land Developers working to seek community stakeholder support. Literally hundreds of thousands of citizens were inconvenienced by this project and did not receive any direct benefits. Arlington Potomac Yard land development In 2002, Crescent realized that the residential markets were much stronger than the office markets, so it decided to bring the residential land bays in Arlington to the market. This decision required that the Arlington Infrastructure be constructed as soon as possible. Design work began in January 2002, and building permits and approvals were issued by the City of Alexandria, Arlington County, Virginia Department of Health, and the Virginia Department of Transportation. Construction of the on-site infrastructure commenced in

96   Part II

Exhibit 8.17 Alexandria land sales.

June 2003, with mass grading operations and installation of the deep utilities. It was completed to base pavement on the roads by September 2005. As a former river bed, a flood control project, and railroad switching yard, the geotechnical conditions were most challenging. Tidal flows from the adjacent Four Mile Run stream dictated work times for the installation of storm sewers. Many creative geotechnical solutions were implemented to reinforce road subgrades. The actual construction was monitored and subjected to performance milestones in multiple development and completion agreements. The Arlington infrastructure budget was $20 million for the construction of the following projects: • • •

5,000 linear feet of public roads with associated utilities and traffic signals; 1,500 linear feet of private roads with wet and dry utilities; a sanitary sewer pump station located on Arlington County property with one million gallons per day capacity. (The pump station included 50% excess capacity for use by Arlington County.)

In 2003, Crescent elected to market the various land bays as finished (or to be finished) sites to Building Developers and thus planned to construct the entire infrastructure plan. A contributing factor to this decision was the overall mass earthwork and soil management plan. Ultimate development plans would generate nearly 1.2 million cubic yards of excess dirt from Arlington, but the Alexandria development would need nearly 650,000 cubic yards of import to balance. Also, approximately 40,000 tons of contaminated cinder ballast (discovered on the site after closing) had to be handled as special waste. The Virginia Waste Disposal Regulations made disposal of the material off-site extremely difficult and very costly.

Land Development   97 Crescent’s approach to address these soil issues was twofold: 1

2

Address the soil management issues by creating a Model Soil Management Plan (SMP). The SMP would establish in-situ soil characterization protocols, earth moving procedures, daily screening protocols, confirmatory testing protocols, and airborne particulate monitoring. The SMP was approved by Virginia Department of Environmental Quality in the summer of 2003. The SMP would later become the framework for several development agreements and the off-site disposal of the impacted material. Find possible re-use opportunities for cinder ballast.

Exhibit 8.18 shows the Soil Management Plan in action. The soils are tested and characterized in place before being loaded onto trucks. If they are not contaminated,16 they are hauled to and dumped in Alexandria. If they are contaminated, they are taken to a dump site in Arlington. The photo in Exhibit 8.19 shows the interior road on the right (finished to the base pavement) and the pile of “impacted soil” in the middle. The top of the photo shows the Arlington County Waste Water Treatment Plant and existing office buildings on U.S. Route 1. The required pump station is to be constructed off-site on the Water Treatment Plant property, and all of the Potomac Yard sewer lines must cross under U.S. Route 1, which was also a county road known as the Jefferson Davis Highway. The design and permitting phase posed many challenges, due in part to the fact that the scope of work straddled county/city boundaries, involved state highways and local streets, and crossed a federal flood control project, so multiple jurisdictions claimed review and approval authority.

Exhibit 8.18 Mass Grading in Arlington.

98   Part II

Exhibit 8.19 Arlington infrastructure challenges.

Ultimately, Crescent would obtain approvals from six different agencies: 1 2 3 4 5 6

Arlington County; City of Alexandria; Virginia Department of Transportation (VDOT); Virginia Department of Environmental Quality (VDEQ); Virginia Department of Environment and Health (VDEH); The U.S. Army Corp of Engineers.

The Soil Management Plan required all questionable or impacted soil to be removed and piled up for later removal from the site. Most of this soil was cinder ballast fill (from coalfired steam engines) that was contaminated with arsenic; a popular defoliant during the days of steam engines. This material was eventually delivered to local land fill companies as daily fill and road construction without any “premium” as contaminated soil. When the U.S. Army Corp of Engineers dredged and straightened Four Mile Run (1970s), it dumped the dredged material into an “uncontrolled” fill area. This uncompacted fill caused several problems in the Land Development Stage. For example, the uncompacted clay soil held “perched water,” a seam of water held in the soil. Consequently, when the perched water was excavated, several acres of water would drain immediately into the excavation area. Exhibit 8.20 shows the track hoe sinking up to its roof (note the driver with the white hat on top of the roof) and the rescue bulldozer (note the driver running for safety) being engulfed by soupy clay material as they are swamped, and sink into the muddy excavation. No one was hurt, and the men and machines were all dragged to safety. Work resumed

Land Development   99

Exhibit 8.20 Perched water problems in Arlington.

the next day with new, long-armed track hoes digging from the safe areas away from the “perched water area.” Like the cinder ballast problem, this is a good example of difficult soil conditions caused by previous land users and not by Mother Nature. Land Developers must be keenly aware of the historic uses of the site, along with its natural geological conditions. Geotechnical studies are invaluable to land developers, along with Phase I and Phase II environmental reports. During the construction of the Arlington infrastructure, Crescent was able to sell Land Bays B, C, D, E, and F using development agreements that were post-closing obligations of the Land Developer, in which Crescent agreed to complete certain infrastructure projects and meet various Arlington PDSP requirements and obligations. The land bay sales are shown in Exhibit 8.21. The following Building Developers were involved in these Arlington land bay sales:17 • • •

June 11, 2004: Land Bay D-East was sold to Camden Property Trust, a multi-family developer and REIT, for $16,427,111. October 28, 2004: Land Bays B, C, D-West, and E were sold to Meridian Development, a mixed-use property developer, for $80 million. December 15, 2005: Land Bay F was sold to Comstock Homes, a condominium developer, for $21.15 million.

The Arlington portion of Potomac Yard is a good example of the Land Developer creating value by solving the contaminated soil issues and constructing the Arlington infrastructure.

100   Part II

Exhibit 8.21 Land bay sales in Arlington Potomac Yard.

In summary, over five years, the Land Developer purchased the property for $122 million, constructed the Alexandria trunk sewer for $12 million, constructed the Arlington infrastructure for $20 million, and incurred $3 million of other costs: totalling $157 million of costs. The total revenues from land bay sales were $258 million, so the profit (or spread) was $101 million. This is good example of creating value in the Land Development Stage. Belgate City infrastructure case study @REDM18 Sometimes, Land Development projects may be required by municipalities or are created in partnership with the local municipality. One example of this is the Belgate City Infrastructure project in which the Land Developer (Crescent Resources) participated in a development agreement with the City of Charlotte to construct roadways and water lines that were necessary for Crescent’s development plan and desired by the city. By partnering with the City, the Land Developer was able to benefit from another means of funding (contribution from the City); however, this did not alleviate the process of approvals from the Department of Transportation. Potomac Yard water quality case study @REDM19 One way to mitigate concerns from neighborhood groups is to keep them informed about the ways in which the Land Developer is limiting the environmental impact of the development or, hopefully, the ways in which the development is improving their environment. This case study is a presentation that was made to numerous neighborhood groups and environmental organizations to describe the positive effects of the land development infrastructure improvements on the water quality of the Potomac River. As part of the land development, the Land Developer made repairs and improvements on the Arlington and Alexandria sanitary sewer and waste water systems. Providing presentations to neighborhood groups

Land Development   101 like this one are critical marketing components, since the final visible remnants of most underground improvements are only small manhole covers, which lack the gravitas to demonstrate the great benefit to the surrounding community.

Summary Land Developers acquire “land with a plan” from the Land Packager and sell finished building sites to the Building Developer. In between the land acquisition and the lot sales, Land Developers must construct the required horizontal infrastructure and the common area improvements on time and on budget: it’s a beat the clock game. Land Developers must also sell to multiple Building Developers, who may or may not be competitors. Land Developers must with also deal with multiple phases of development, as well as numerous post-closing conditions. The Crown Farm case study illustrates a multiple-phase land development. The Potomac Yard case study demonstrates the challenges of off-site infrastructure improvements and difficult soil conditions. The Belgate City case study shows how a Land Developer and municipality can work together in a private-public partnership to finance and construct mutually beneficial road improvements. Finally, the Potomac Yard water quality case study shows how a Land Developer can market the project to community stakeholders to increase public support.

Notes   1 Paper enhancements refer to the permits and approvals necessary for the Land Developer, as well as market, environmental, and engineering studies.   2 Sell-out period refers to the length of time it takes for the Land Developer to sell all of the finished building pads or lots.   3 Release provisions in construction loan documents provide that a lot can be released as mortgage collateral if the Land Developers pay more than the pro-rata value of the lot. For example, if a lot represented 10% of the mortgage collateral, it would could be released as mortgage collateral at a 120% release rate if the Land Developer paid off 12% of the loan.   4 Take-down provisions in a land purchase agreement define when and how the land can be purchased during the contract period. Attractive take-down provisions would enable the land developer to purchase only part of the property when it was ready for immediate development. The balance of the property would be purchased at a later date.   5 A purchase-money mortgage is created when the seller provides debt financing to the buyer in the form of a mortgage note.   6 Release provisions in the purchase-money mortgage provide for the Land Developer (borrower) to withdraw parcels of ground from the seller’s mortgage collateral or lien.   7 In general, a surety bond is a promise by a guarantor (usually an insurance company) to pay one party (usually a government agency) a certain amount of money if a second party (usually the real estate developer) fails to meet a contractual obligation.   8 A performance bond is a type of surety bond used in real estate construction and development. Many times a land developer will require its road building contractor to post a “bond” that guarantees an amount of money will be paid by the guarantor to finish the project in the event that the contractor goes bankrupt or otherwise defaults on the agreement and cannot complete the project. Also, a municipality may require a land developer to post a performance bond to guarantee that the approved infrastructure will be completed.   9 Contingency reserves are budget lines that are not for specific costs, but rather are for unexpected items or cost over-runs. 10 http://realestatedevelopmentmatrix.com/textbook/res/task1/stage3/Crown+Farm.pdf 11 http://realestatedevelopmentmatrix.com/textbook/res/task1/stage3/Potomac+Yard.pdf

102   Part II 12 The project was awarded Trenchless Technology’s New Installation of the Year in 2004. 13 The sewer ranges in depth from 22 feet to 42 feet deep below the surface and has approximately 25 feet elevation change between the start and termination point. The system consists of 24 vertical shafts that range in depth from 30–50 feet. 14 The shafts are connected by 8,643 linear feet of 30-inch Vitrified Clay Pipe and 2,500 linear feet of 27-inch PVC (PolyVinylChloride) pipe. 15 Potomac Properties were two excess parcels of ground (not part of the Potomac Yard CDD) that were sold to a local retail developer. 16 Soils were deemed contaminated if they contained mineral constituencies above a certain threshold. 17 The Land Developer did not sell Land Bay A because it had decided to undertake the Building Developer Role after preleasing a substantial amount of office space on Land Bay A. 18 http://realestatedevelopmentmatrix.com/textbook/res/Belgate+City+Infrastructure+Dev+Agr+ 5-21-07.pdf 19 http://realestatedevelopmentmatrix.com/textbook/res/potomac_yard_and_the_water_quality_of_ the_potomac_river.pdf

9 Building Development

INTRODUCTION Building Development is the fourth stage in the Real Estate Development Process, Exhibit 9.1. Land Development is sometimes referred to as “horizontal development,” and Building Development is referred to as “vertical development.” Building Developers who routinely sell their completed buildings are often referred to as “merchant builders.” Home builders are also good examples of Building Developers. The building construction part of the Building Development Stage is probably the most studied and most emphasized part of the Real Estate Development Process in our colleges and universities, as architects and engineers study the most efficient designs and construction techniques for the latest technologies, materials, and sustainable standards. Consequently, today’s building contractors are really good. They are able to estimate costs to the dollar and schedule time to the day. Building contractors often provide estimating and scheduling advice as “pre-construction services” to Building Developers, which is invaluable. This kind of “front-end” analysis helps to keep Building Developers out of “bad projects and losing deals.”

Exhibit 9.1 Real Estate Development Matrix.

104   Part II

Schematic diagram The Building Development Stage is the fourth stage in the overall Real Estate Development Process as shown in the schematic diagram in Exhibit 9.2. In the Building Development Stage, the Building Developers buy a building site from Land Developers, construct a building, and then sell it to Building Operators. Building Developers who continue on to the Building Operations Stage often face problems as the development enterprise must be recapitalized with a long-term mortgage. Building Developers soon realize that the critical Tasks and specialized skills in Building Operations are significantly different than those in Building Development.

Box diagram The box diagram in Exhibit 9.3 emphasizes the development rule: “Buy one thing and sell another.” In this case, the Building Developer buys a building pad (or building-ready site)

Exhibit 9.2 Building Development Schematic diagram.

Building Development   105

Exhibit 9.3 Building Development Box diagram.

from the Land Developer so that all the Building Developer has to do is construct the building(s) and sell the improved property (land and building(s)) to the Building Operator. The Building Operator may be an owner-user who occupies the building as part of its overall business plan, or sometimes the Building Operator may be an investor who leases the property to third-party users. Of course, the family that buys the new house and makes it their home is the ultimate owner-user!

Venn diagram Exhibit 9.4 demonstrates that the Stages of the Real Estate Development Process are not neatly defined and separated, and that they may overlap to some extent. This Venn diagram illustrates how the Land Developer may do some of the site preparation or excavation as a way to entice the Building Developer to purchase the property.

Exhibit 9.4 Building Development Venn diagram.

106   Part II For example, the Land Developer may grade the site to remove any large surface irregularities or other conditions that would make a building foundation difficult, or the Land Developer may actually prepare the site for a parking structure or multi-level parking lot. The Land Developer may also accept responsibility for difficult or contaminated soil conditions, so the Building Developer will not be exposed to these risks. The Building Developer could construct a building for a “build-to-suit” tenant; one who will occupy and lease the entire property. In this case, the Building Developer will capture or recognize all of the increased property value by removing the risks associated with leasing before selling the property to a Building Operator. This is an example of the Building Developer taking on the leasing task before the Building Operator acquires the property. However, the Building Operator usually does not have the entire building pre-leased to a single tenant. More often, the property may be partially pre-leased or not leased at all. Whoever leases the property removes the occupancy risks and captures the resulting profit or increased value. Sometimes Building Operators actually seek out properties that are not leased so that they can capture all of the leasing profit and value increases.

Circle diagram The circle diagram shown in Exhibit 9.5 show how Building Developers relate to Land Developers and Building Operators in the great circle of real estate development.

Exhibit 9.5 Building Development Circle diagram.

Building Development   107

Building Development: what happens Building Developers buy the finished pad from Land Developers and then undertake the vertical development by constructing the building improvements. During construction, Building Developers may also attempt to lease the building, so the finished building can be sold to Building Operators. Building Developers who construct an office building and then sell the finished product—that may or may not be leased—are often called “merchant builders.” Home builders are another good example of Building Developers. Exhibit 9.6 is an illustration of the Building Development Equation. That is to say, the acquisition price, holding costs, hard costs, and soft costs should be less than the sales price to the Building Operator. The difference between those two values is known as the “spread.” The spread is the marginal value that is created in this Stage of development. Economists call this the “profit” earned in this stage. The spread is earned by selling the property at a Market Capitalization Rate1 that is less than the Building Developer’s Return on Total Cost.2 The typical capitalization of the Building Development Stage involves a short-term construction loan and equity capital. The construction loan will not cover all of the development costs so that equity capital is required to pay for the rest of the shortfall.

Building Development: key players Land Developers Land Developers need to offer the finished building site to Building Developers at a price and with terms that are compatible with the Building Developer’s strategy, budget, and capital expectations. The acquisition needs to be timely and fair to the person who controls the land. A difficult problem can be the control of future or subsequent site pad purchases. Building Developers may ask for the first right of refusal, or the right of first offer on future lot sales. Building Developers may also ask for future lot sales to be restricted to noncompetitors or delayed for a specific time or lease-up period. Architects Building Developers must deal with several kinds of architects, such as building architects, interior architects, and landscape architects. Building architects design the size, shape, and exterior covering of the building, while interior architects design the inside spaces of the

Exhibit 9.6 Building Development equation.

108   Part II building such as lobbies, common areas, and tenant finishes. Landscape architects design the outside areas of the building lot including the roof-top gardens. All of these architects are important to Building Developers, and very large architectural firms will have all three. More commonly, the architects will have alliances with other architects with whom they have worked in the past. Sometimes, a nationally recognized building design architect will provide conceptual drawings, and the hard work of creating working drawings and specifications is turned over to the “architect of record,” which is usually a local firm that is knowledgeable about the local building codes and permitting requirements. All of these architects should have a keen understanding of green building designs and certification requirements. Engineers Like architects, several kinds of engineers are important to Building Developers. The two broad engineering categories are structural and mechanical. However, within these categories, there are several specialties that are used depending on the building design and location. Some engineers specialize in mechanical, electrical, and plumbing systems; and others, such as acoustical engineers, focus on particular building issues. Environmental engineers are hard to categorize, but they are important, too. However, all engineers should be familiar with the latest green building practices and requirements to achieve a green certification. General contractor and major subcontractors When Building Developers choose a general contractor, they are also choosing, directly or indirectly, the major subcontractors who will do the majority of the work. Both the general and major subcontractors need to be experienced and available, and offer competitive pricing. Tenants The tenants, or the end users of the building, are extremely important to Building Developers as they want to lease the property and consequently receive the maximum value for the completed property with tenants in place. Even if the building is completely vacant and unleased, the constructed building must be attractive and serviceable to future tenants and end users for a successful project. Leasing and sales agents Building Developers have two marketing problems: first, to lease the building under construction; and second, to sell the building at the end of the construction period. Leasing agents who specialize in the appropriate product type (office, retail, industrial, etc.) are critically important, whether they have leasing agreements with the developer (owner’s agents) or with the tenants (tenant’s representative). Sales agents are also critically important if the developer wants to sell the improved property. Again, the sales agents can have agency agreements with either the owners or the buyers. Building Developers should engage both leasing and sales agents as soon as they acquire the building pad.

Building Development   109 Building inspectors Building inspectors work directly for the local municipalities, either as employees or independent contractors. They perform quality assurance inspections for certifications and municipal permits. Contractors and Building Developers must work closely with these inspectors to stay on schedule. Environmental professionals Environmental professionals may be architects, engineers, or other professionals who provide a wide range of services, but in the Building Development Stage they facilitate achieving green building certificates (LEED or Energy Star). They are also critical in the “commissioning3” of the building. Building commissioning is required for LEED Certifications as well as for many government occupied buildings. Additionally, environmental professionals can guide and perform environmental remediation efforts, if needed. Construction lenders The construction lender is a banking specialist who provides the interim construction loan to fund certain specified improvements. Building Developers must submit a draw request for funds to the lender that describes the constructed improvements and provides verification that they have been correctly installed. A knowledgeable and responsive construction lender is critical for the scheduling and timing of the building construction. Since these draw requests are usually monthly, a good working relationship with the construction lender is imperative. Building operators Building Developers must maintain good relations with numerous Building Operators so that a sale of the property can be arranged. Building Developers must understand the strategies, preferences, and capital capacities of these Building Operators. Ideally, the Building Operators would be involved throughout the construction period so that the finished building and its systems are familiar and operating correctly.

Building Development: critical Tasks Obtain construction permits and approvals Building Developers seem to complain about this Task the most. Most local governments have “expediters” or “facilitators” who are invaluable in getting the permits and approval applications in a timely fashion. Also, the building contractors usually have an excellent working knowledge of the permitting process and know what is required and who can approve it. Many times, the municipalities have a series of building permits such as: • • • • •

excavation, sheeting and shoring; foundation to grade; building shell; partial occupancy; building occupancy.

110   Part II Negotiate contracts within budget Building Developers must arrange pricing and contracts with the general contractor that are within the construction budget. In addition, Building Developers must negotiate contracts or agreements with all of the other vendors and professionals who are part of the larger development budget. Stage, manage, and control construction projects Building Developers, in conjunction with their project managers, must stage, manage, and control the construction projects, so they are completed on time and on budget. The myriad of issues and conflicts that occur every day must be resolved quickly, fairly, and efficiently. Essentially, the contractors establish their maximum profit when they agree to the price for the project. Thus, they must work as quickly and efficiently as possible to capture as much of the profit as they can. This motivation is in contrast to leasing and sales agents, who do not have profit potential until a prospective buyer or tenant is presented. Stage, manage, and control the marketing efforts of the leasing and sales agents The marketing of the building(s) for lease and/or sale occurs during the construction period, and often conflicts arise between the marketing and the construction teams. Marketing and construction are equally important, so Building Developers must balance the needs, demands, and time constraints of both activities. At the beginning of the Building Development Stage, the construction is more important, and toward the end of the Building Development Stage, the marketing of the project is more important. These are good problems to have, and a successful Building Developer will stage, manage, and control both the construction activities and the marketing activities. Arrange interim and long-term financing Sufficient capital—both debt and equity—must be arranged to cover the hard costs, soft costs, and site acquisition costs. A construction loan is usually obtained from a commercial bank for the majority of the hard or direct construction costs. Often, the construction loan will cover some of the soft costs and land costs, but not all of them. While the building construction period is known, the lease-up period and eventual sale of the property is uncertain. Consequently, the construction loan should have pre-arranged extension periods. Sometimes a long-term loan is arranged to pay off (or take out) the short-term loans if the Building Developer’s ownership continues for longer than the specified construction and lease-up periods. Other times a mini-perm loan4 can be arranged for the Building Developer to extend the lease-up and sales period. Arrange necessary equity capital Building Development costs that are not covered by the construction loan must be covered by a line-of-credit loan, guaranteed by the Equity Partners or by direct contributions from Equity Partners. These equity contributions should be made through an equity reserve that is funded at the beginning of construction. The equity reserves should also be adequate to cover the cashflow shortfalls during the lease-up period.

Building Development   111 Negotiate and close lease agreements Lease agreements can be very complicated in order to both meet the occupancy needs of the tenants, and the financial requirements of the Building Developer. However, there are two critical milestones: first, when the lease is executed; and second, when the tenant moves in and takes occupancy. All other dates in the lease are tied to these events. Sometimes the landlord will offer the tenant an inducement such as a rent-free period that is outside of the lease period. This is a mistake. All lease agreements should be documented within the lease. Negotiate and close sales contracts Property sales must be negotiated, executed, and closed in a fair and timely manner. A smooth transition from the Building Developer to the Building Operator is critical for the completion of a successful project for both sides. The transfer of ownership involves not only obtaining a legal title from a deed and leases, but also practical ownership in the form of vendor agreements, equipment warranties, escrow deposits, and other service agreements. Obtain appropriate green building designations Except for the existing building designations, all of the green building certification requirements must be documented and fulfilled during the Building Development Stage. This is a prime example of how Building Developers and the Building Operators need to work together during building construction, lease-up, and occupancy. Green building certification goals must be established in the design and engineering phase of construction and then implemented and documented during construction. Green building certifications may not be required by the local municipalities, by the investor or lenders, or even by the tenants, but they are rapidly becoming a competitive standard in the marketplace. Green and sustainable building practices are good business and good advertising. Create opportunities for Building Operators Building Operators require buildings that run efficiently, reliably, and profitability. These buildings must be attractive to potential tenants, end users, and lending institutions. Therefore, Building Developers need to provide those opportunities.

Building Development: controllable costs Acquisition costs Building Developers must determine the maximum price they can pay for the building site while still incurring the other development costs and staying within the development budget. This is sometimes referred to as the “Builders’ Justified Land Price.” Direct construction costs Building Developers often select a primary general contractor and negotiate a Guaranteed Maximum Price (GMP) for the building. General contractors and Building Developers then work to stay within that GMP through bidding to subcontractors, or scope of work

112   Part II adjustments. These contracts usually provide for the sharing of cost savings so that the general contractors receive a portion of the savings through “value engineering,” lower material prices, or lower subcontractor bids. Construction interest and financing fees The amount and terms of the construction loan are determined at the beginning of the project by the construction lender. However, the interest rate is usually variable and, therefore, uncontrollable; except that there are ways to control the interest rate variability especially for very large loans. Building Developers must also budget for and control financing fees or “points” that are charged by the construction lenders, and the permanent or take-out lenders.5 These fees are paid directly to the financial institutions or to the mortgage brokers who arrange the financing. Approval and permit fees There are fees for approvals/permits associated with the building construction. There also may be other fees associated with the master plan approvals that require “proffers” (payments to municipalities in exchange for the right to construct the building). These fees may be associated with parks and recreational facilities, affordable housing, public art, or transit facilities. Building Developers must identify and budget for these fees before construction begins. Architectural and engineering fees Architectural and engineering fees are often negotiated as a lump sum, but also with hourly rates for various categories of work. The lump sum maximum price usually specifies the expected hours to be worked during the contract period. Building Developers must be aware of how these professionals mitigate the risk of “scope creep” by specifying hourly rates if the maximum time limits are exceeded. Environmental costs Environmental testing may provide a good estimate of how much (if any) environmental work needs to be done. However, unforeseen environmental issues can be costly, so adequate financial reserves for contingencies should be budgeted for when environmental problems are expected. Change orders Change orders are changes to the construction contract that are usually caused by changing preferences of the tenants, users, or owners. These additional costs, if not controlled, can cause financial ruin. These cost changes must be controlled through proper documentation and billings. It seems as though some tenants do not consider their space needs until the building is already under construction and then request numerous changes to the approved plans and specifications. (The old joke among building contractors is that, “they bid the project at cost, and then make their profit on the change orders.”) A well-defined and carefully

Building Development   113 documented procedure is essential so that requests for information and actual building changes are appropriately priced and constructed.

Building Development: major risks The major risks for Building Developers are that they cannot accomplish the “critical Tasks” in a timely and efficient manner. Categorically, they are the same risks that Land Developers face, except that construction is mostly above grade and Building Developers are leasing prospective tenants and simultaneously selling to the Building Operator. Consequently, they are impacted much more by changes in the current market conditions. Delays in obtaining permits and approvals The public sector is not as time-conscious as the Building Developer, so the approval and permitting periods may take longer than expected, especially if the developer is not knowledgeable about the process, or the building has some exceptional or controversial features. This should not be a risk except when special uses or unique building features require a lot of time-consuming discussion and explanation. Delays in completion of improvements Delayed completion means that work simply does not get done on time. The staging of the construction materials and crews is extremely vital to maintaining the projected schedule. However, necessary materials or building components may become unavailable when needed, or subcontractors may have scheduling or financing problems. These delays can ripple through the entire development schedule. Finally, prospective tenants may change their move-in schedules or building finish requirements. Cost over-runs Building Developers using a Guaranteed Maximum Price (GMP) attempt to put the risk of higher costs on the contractor’s shoulders. However, for some large and longer-term construction projects, the material prices are based on price indices for various commodities. Cost over-runs may also be caused by the tenants’ space requirements. These additional costs need to be documented in change orders to the contractor and passed on to the tenant for reimbursement if possible. Finally, cost over-runs may be caused by estimation errors. Who checks the estimators? Poor quality of improvements Both the poor quality of the material and the workmanship can lead to poor quality improvements. From the very beginning of the project, Building Developers must insist that the material and the workmanship meet the highest standards. They are aided in this quality control by the construction lender’s requirement that all reimbursed improvements must be inspected. Inspecting architects and engineers must physically inspect the construction and certify that the improvements have been built according to the approved plans and specifications.

114   Part II Deteriorating market conditions Negative shifts in the marketplace will directly reduce the tenants’ demand for additional or new office space. These shifts could be caused by local, national, or international forces. Lowered demand will lead to a longer lease-up period, leases with lower rental rates, and higher concessions.6 Finally, the negative market conditions will cause other tenants in other buildings to reduce their space needs, and a shadow market of “leased but unoccupied space” will occur. Eventually, the unleased space will affect the open market, causing decreased occupancy levels across the market. Lower sales prices or higher cost of sales The deteriorating market conditions will cause lower rental rates and occupancies, which will decrease the sales prices of the completed building(s). Building Developers may be tempted to ride out the market downturn, but most Building Developers have short-term construction loans that are coming due and need to be refinanced. If the capital markets are not functioning, as in the case of the recent Great Recession, Building Developers are faced with defaulting on their loans and eventual foreclosure.

Case studies of the Building Development Stage Three case studies of the Building Development Stage of the Real Estate Development Process are presented here to demonstrate and illustrate many of the discussion points in this chapter. Below are Building Development examples of a transit-oriented development and two partially pre-leased office buildings. Crown Farm becomes “Downtown Crown” @REDM7 The Crown Farm development has been discussed in the last three chapters as it has progressed from the Land Banking Stage, to the Land Packaging Stage, to the Land Development Stage, as shown in Exhibits 9.7 and 9.8. In this chapter, the Building Development Stage of Crown Farm is discussed as a consortium of Building Developers construct the building to make Downtown Crown come to life. Sunbrook divided the overall Building Development Stage into three phases, and completed the Phase I infrastructure improvements in 2013, as shown in Exhibit 9.9. Sunbrook sold the retail zoned building pads to JBGR and the multi-family zoned building pads to Bozzuto with the provision that they construct all of the allowable density at once, thereby creating a place called “Downtown Crown,” a transit-oriented community. Exhibit 9.10 shows the higher density retail and multi-family building development on the right side of the photograph and the low-density residential development on the left side. Sunbrook sold the residential lots to several homebuilders who would construct different styles and models of homes to appeal to a wide variety of families, with varying income levels. The homebuilders included Ryland, KB Homes, Pulte, Wormald, and M.I. Homes. The Land Developer’s horizontal improvements set the stage for the Building Developer’s vertical improvements, which were built according to the conceptual master plan that was developed by the Land Packager. Exhibit 9.11 is a rendering of the Town Center Plaza that was approved by the City of Gaithersburg, and Exhibits 9.12 and 9.13 contain photos of the actual buildings that were constructed and completed in the fall of 2014.

Building Development   115

Exhibit 9.7 Crown Farm Land Banking Stage.

Exhibit 9.8 Crown Farm revised conceptual master plan.

The final built-out town center closely resembles what was proposed in the Land Packaging Stage by Sunbrook. The Crown Farm development then continued onto Phase II of the master plan by extending the land and building development to the eastern portions of the total site.

Exhibit 9.9 Crown Farm Phase I infrastructure.

Exhibit 9.10 Crown Farm Phase I building development.

Building Development   117 The retail Building Developer, JBGR, sold the completed retail buildings to RIPA in December 2014 for a 5.25% overall capitalization rate. Bozzuto, the multi-family Building Developer, continued to manage its projects and assumed the Building Operator role. Finally, the homebuilders sold out their Phase I inventory and have continued to build in Phase II.

Exhibit 9.11 Rendering of the approved Town Center Plaza.

Exhibit 9.12 Actual Town Center Plaza.

118   Part II

Exhibit 9.13 Completed streetscape of Downtown Crown.

Crown Farm is a good example of the first four Stages of the Real Estate Development Matrix. It demonstrates the various roles of the key players as each creates additional value by using special skills to achieve specific Tasks that require additional capital, and it highlights how the success of each Stage is imperative for the continuation and success of the next Stage of development. One and Two Potomac Yard: an environmental challenge in Arlington @REDM8 Potomac Yard was discussed in Chapter 7 as an example in the Land Packaging Stage as the Developer obtained master plan approvals in the City of Alexandria and Arlington County. In Chapter 8, the Land Developer struggled to meet the pre-conditions of the master plan ordinances. In Alexandria, a two-mile trunk sewer line had to be constructed before any land bays could be sold. In Arlington, the 40-acre North Tract had to be transferred, free and clear of all encumbrances, into Arlington County before the increased zoning densities were vested, except for Land Bay A. Land Bay A’s zoning density was already vested in the prior zoning ordinance, so it was exempted from the North Tract transfer condition. Consequently, while it was trying to resolve a bogus lawsuit by Charles E. Smith Company that caused a lien on the North Tract, Crescent Resources investigated the possibility of constructing 640,000 ft2 of office space on Land Bay A. In 2003, Crescent began the process of obtaining design and site plan approval in Arlington County for Land Bay A. In Arlington County, the site plan approval was called a “4.1 Approval.” The 4.1 Approval process was a very public and very extensive process that required approvals by numerous Arlington County Commissions before it was approved by the Planning Commission and then voted on by the County Board. This process involved numerous neighborhood association meetings and dozens of public meetings. Crescent assembled an impressive team of key players: architects, engineers, and construction and marketing professionals, that finally obtained the 4.1 Approval. The approved design of One and Two Potomac Yard is shown in Exhibit 9.14. The 4.1 Site Plan Approval added 71 requirements for the Building Development Stage that were in addition to the 46 requirements from the Arlington’s master plan approval, the Phased Development Site Plan (PDSP).

Building Development   119

Exhibit 9.14 Approved design of One and Two Potomac Yard.

During the PDSP approval process, Crescent responded to a U.S. General Services Administration’s (GSA) Request for Proposals (RFP) for a 405,000 ft2, ten-year lease for the U.S. Environmental Protection Agency (EPA). Crescent was awarded the EPA lease after the 4.1 Approval was granted, and the EPA lease had two unique provisions: 1

2

The buildings must meet United States Green Building Council’s (USGBC) Leadership in Environmental and Energy Design (LEED Silver Certified for new construction (NC) upon completion. Failure to meet the LEED Silver Certification would reduce the gross rent by 10%! The buildings must also meet the U.S. Government’s requirements for Level IV Security as determined by the U.S. Federal Protection Services.

The GSA lease contained 200 pages of requirements, and the EPA’s Program of Requirements (POR) added another 100 pages of requirements for the building construction and operation. The Building Developer’s challenge was to meet all of these requirements on time and on budget! Meanwhile, in 2005 the USGBC’s LEED requirements for new building construction were constantly changing, as the rules for awarding points were being defined and clarified. The buildings were originally designed as a “speculative” office project that only qualified for 17 points of the threshold of 33 points for a Silver rating. Crescent assembled a team of environmental professionals (LEED AP) that developed a strategy to capture the easy points (the low hanging points) and then to: • •

redesign the HVAC systems; monitor all construction techniques;

120   Part II • • • •

recycle 70% of construction waste materials; select appropriate LEED approved building products and recycled building materials; employ professionals to commission all buildings prior to occupancy; perform all necessary indoor air quality testing.

After this pre-construction LEED planning, the construction budget was increased to $4 million ($6.00ft2). Also, because all interior tenant spaces had to meet the LEED NC requirements, Crescent stopped all efforts to pre-lease additional office space until the LEED Silver rating was achieved. The Level IV Security rating required the six-storey parking structure to be redesigned so that automobiles could be restricted to pre-determined buildings and floors. Also, the building lobbies had to be redesigned to accommodate security equipment and personnel and to restrict public access to designated areas. This change was difficult for Arlington to accept because the county planners envisioned, “an exciting street-level retail experience” for its citizens. As a compromise, the county required large TV screens to be placed “face out” in each window that would constantly play “environmental programming.” In reality, these screens televised 24-hour cable news programming! The two buildings, One and Two Potomac Yard, had a total development budget of $129 million that was broken down into land costs of $8.8 million, hard costs of $91.2 million, and soft costs of $29 million. Exhibit 9.15 shows the proximity of Land Bay A to the Potomac River, Regan National Airport, and the CSX rail corridor, as well as to Crystal Drive and the Hyatt Hotel. The adjacent land impacted the actual construction of the two buildings on top of a six-storey parking structure with three levels above grade and three levels below grade. Several major risks were noteworthy: • • • • • •

Excavation of the below-grade parking structure that was also below sea level. Operation of the on-site, concrete batch plant for the post-tension concrete frame. Staging and installation of the precast panels from Crystal Drive beside the Hyatt Hotel. Meeting and documenting green building requirements. Advanced commissioning of all building systems. Accommodating and documenting 398 GSA change orders.

While the construction was done on time and on budget, there were several critical Tasks that caused stress with the adjacent land owners and tested the diplomatic skills of the Building Developer: • • • •

Pile driving activity during early morning hours woke up guests in the adjacent hotel. Removal of existing road bed of Crystal Drive caused flooding in the adjacent underground parking garage. The adjacent land owner started construction on an apartment building, so both projects closed the adjacent street while staging materials. A re-bar bundle “nicked” a passing Virginia Rail Express Train as the bundle was being lowered onto the building floor by an overhead crane.

Exhibits 9.16 and 9.17 show the closeness of the neighbors that were impacted by Crescent’s use of four overhead construction cranes. Consequently, Crescent had to negotiate construction crane agreements with the Hyatt Hotel, the Federal Aviation Administration (FAA), the

Exhibit 9.15 Photo montage of One and Two Potomac Yard on Land Bay A.

Exhibit 9.16 Top view construction crane swings.

122   Part II

Exhibit 9.17 Side view of the construction crane placement.

Washington Area Airport Authority, the CSX Transportation Corporation, and the Virginia Rail Express. In September 2005, Crescent entered into a pre-sale agreement with JP Morgan for One and Two Potomac Yard. The purchase price was $213.5 million with the following funding provisions: • • •

Funding at Shell Completion: $100 million Funding at GSA Lease Commencement: $95.5 million Funding at LEED-NC Silver Certification: $18 million

At the GSA lease commencement, JP Morgan took over the role of Building Operator in the fifth Stage of the Real Estate Development Process. The development of One and Two Potomac Yard is a good example of a Building Operator obtaining the necessary approvals and permits to construct the improvements, pre-leasing the space to a government agency (and learning all of the anagrams related to the lease), constructing a USGBC LEED Certified building, and pre-selling the building with phased funding conditions. International Plaza IV: a proposed eight-storey office building in Tampa, Florida @REDM9 International Plaza IV was a proposed eight-storey suburban office in the Westshore area in Tampa, Florida. In this case study, Crescent Resources is considering undertaking the project as the Building Developer on a site known as “Corporate Center Four,” which is next to the International Plaza Shopping Center and the Tampa International Airport. Opening in 2001, the International Plaza Shopping Center made the Tampa International Airport one of the few international airports to have direct access to a major shopping center.

Building Development   123 Crescent Resources has developed and sold over one million ft2 of office space around that shopping center since 1999: • • •

International Plaza I 1999; International Plaza II 2001; International Plaza III 2004.

Construction of International Plaza IV began in 2007 and was finished 17 months later. Exhibit 9.18 is the site plan for the eight-storey office building and accompanying fivestorey parking garage. Exhibit 9.19 shows an artist’s rendering of these two structures. “Back of the Envelope” analysis Proforma projections included a $32 per ft2 rental rate, 8% vacancy rate, and $11 per ft2 operating expenses. When these assumptions were used with the building’s net rentable area of 247,000 ft2, the Net Operating Income (NOI) is estimated to be $4.50 million or $18.44 per rental ft2. The land costs were estimated to be $4.94 million; hard costs were estimated to be $36.81 million; and soft costs were estimated to be $13.78 million. Consequently, the total costs were $50.53 million. The Building Developer compares the expected return on total costs to the market overall capitalization rate to evaluate the “spread,” or potential profits, when the property is sold to

Exhibit 9.18 Site plan.

124   Part II

Exhibit 9.19 Rendering of International Plaza and the parking garage.

the Building Operator. In this case, the return on total costs was 8.20% (NOI divided by Total Costs), and the estimated overall capitalization was 6.75%, so the spread was 1.45%. In other words, if the property is estimated to be developed for $50.53 million and sold for $67.5 million (NOI divided by market capitalization rate), the developer’s profit would be $11.95 million. The question facing the Building Developer is, “Is this enough profit to take the major risks incurred in the Building Development Stage?” Crescent usually looked for a minimum spread of 1.5%, and the projected spread was 1.46%. However, it had substantial experience building and leasing in this market. Crescent decided to revisit its market underwriting and due diligence studies, and then reconsider the project. Eventually, Crescent decided that its income and building cost projections were conservative, so the risks of the project were lower than other projects and the 1.46% spread (which rounded to 1.5%) would be an appropriate return for the risks taken in this project. International Plaza IV is a good example of the analysis and decision-making process Building Developers undertake when evaluating a project. Arrange financing: Phipps Tower joint venture memo @REDM10 There are many ways to engage in a joint venture partnership to finance a building development project, and each project and each partner will include their own requirements. Phipps Tower is one example of a joint venture strategy to finance a Building Development project. In this case, the Building Developer, Crescent Resources, was offering to provide the land as its equity contribution, and the joint venture partner would contribute the same value as the land in cash contributions to the equity stack, at which point the remainder of the costs would be financed through a construction loan. This case study also provides a possible fee

Building Development   125 structure to reward the Building Developer during the process, in addition to the distribution of the cash proceeds split with the partner. This is a good example of how Building Developers are always looking for project financing opportunities. Environmental professionals: One and Two Potomac Yard @REDM11 Environmental professionals include all those who design, construct, commission, and manage the facilities based on green building and sustainability criteria for the project. In the Potomac Yard case study, The USGBC sponsored a report that included interviews with the project manager, the tenant’s appointed project manager, the general contractor’s project manager, an outside consultant specializing in achieving sustainability certifications, engineers, a commissioning agent, and the future Building Operators. These were the key players and professions integrally involved in achieving the LEED Gold certification for One and Two Potomac Yard.

Summary Building Developers must acquire the site, finance and construct the improvements, and then lease and sell the completed building structure. Simultaneously constructing and marketing the property requires Building Developers to stage, manage, and control two very different processes. Because of the short-term nature of the construction loan, Building Developers (like Land Developers) are in a “beat the clock” situation. The current emphasis on green building construction adds another dimension of complexity to the process, as Building Developers must meet additional material, construction, and performance criteria that are established by various green building certifying organizations. The Crown Farm case study illustrates the simultaneous construction efforts of several Building Developers in an effort to create a new urban place, Downtown Crown. The One and Two Potomac Yard example demonstrates how a green certification pre-lease requirement is handled in the context of a pre-sale of the buildings. The International Plaza IV case study considers the Building Developer’s decision to “build or not-to-build” given the estimated construction costs, rental rates, and market capitalization rates. Similarly, the Phipps Tower case study shows how a Building Developer attempts to attract a joint venture partner to finance a contemplated office tower. Finally, eight environmental professionals are interviewed about their roles in building a certified green building from their very different perspectives.

Notes   1 Market Capitalization Rate is defined as the ratio between the Net Operating Income and the Sales Price.   2 Return on Total Cost is defined as the ratio between the Net Operating Income and the Total Development Costs.   3 Commissioning the building confirms the operating efficiency of the building systems by determining that all of the components and controls of the building system are working correctly and accurately before the building is occupied.   4 Mini-perm loans are basically construction loans that automatically extend for two to three years after the construction period. Interest accrues during the construction period, but must be paid currently during the extension period.   5 Take-out lenders agree to purchase the construction loan under certain conditions defined in a tri-party agreement with the borrower and construction lender. The fees for a take-out loan are typically 1–2% of the full construction loan amount.

126   Part II   6 Concessions are also known as tenant inducements and may include a free-rent period, above standard tenant improvements, or moving cost subsidies.  7 http://realestatedevelopmentmatrix.com/textbook/res/task1/stage4/Crown+Farm.pdf   8 http://realestatedevelopmentmatrix.com/textbook/res/task1/stage4/Potomac+Yard.pdf  http:// realestatedevelopmentmatrix.com/textbook/res/3._the_greening_of_one_and_two_potomac_yard_ v2.pdf   9 http://realestatedevelopmentmatrix.com/textbook/res/IP4+White+Paper+10+16.pdf 10 http://realestatedevelopmentmatrix.com/textbook/res/phipps_tower_memo.pdf 11 http://realestatedevelopmentmatrix.com/textbook/res/case_study_one_and_two_potomac_ yard.pdf

10 Building Operations

INTRODUCTION Building Operations is the fifth Stage of the Real Estate Development Process (see Exhibit 10.1). Once a majority of the building construction has been completed (core, shell, and common areas), the Building Operations Stage begins. Tenant occupancy occurs during this Stage and continues throughout the Stage as the constructed buildings are leased-up and released. Building Operations is considered a Stage in the Real Estate Development Process because economic value can be created by successful Building Operators in this Stage of development. Building Operators create value by converting the constructed building to a portfolio of leases with happy tenants and accurate record keeping. The Building Operations Stage is also the time during which major increases in value can occur through financing and refinancing activities, as well as the sale and resale of the property. There can be several Building Operators during this Stage, which may be as long as several decades. The Building Operators with the large property portfolios are usually referred to as “institutional investors” and may include pension funds, insurance companies, or public real estate investment trusts. Building Operators can also be owner-users who occupy the constructed

Exhibit 10.1 Real Estate Development Matrix.

128   Part II building as part of their business enterprises. Families that buy houses and make them into their homes can also be considered Building Operators.

Schematic diagram The schematic diagram in Exhibit 10.2 represents the entire Real Estate Development Process and highlights the Building Operations Stage. The Building Operations Stage follows the Building Development Stage as the Building Developer sells the completed (and perhaps partially leased building) to the Building Operator. Many times, Building Developers decide not to sell the completed building and to continue on to the Building Operations Stage. However, it should be noted that a new team of professionals must be assembled, as they face a new set of critical Tasks that require special skills. The property may be sold many times to many Building Operators during its economic life. However, when the property suffers from economic or functional obsolescence, it is

Exhibit 10.2 Building Operations Schematic diagram.

Building Operations   129

Exhibit 10.3 Building Operations Box diagram.

sold to a Building Renovator. Of course, if Building Operators take on the role of Building Renovators, to be successful they must form a new team with different skills.

Box diagram The box diagram in Exhibit 10.3 illustrates the fundamental rule of value creation in the Real Estate Development Process, “Buy one thing, sell another.” In this case, Building Operators purchase a fully constructed building from Building Developers, and then at the end of the building’s economic life, sell the underperforming, worn-out property to Building Renovators. This may appear to be a very grim proposal without much opportunity to create economic value. In fact, many Building Operators may own the property during the Building Operations Stage, just as many different lenders and equity investors may provide capital for the property. Building Operators are responsible for many kinds of “remodeling” work, as tenants move in and out and as public areas are refurbished or reconstructed. The question becomes, “When does remodeling become renovation? When is a pile a heap?” (so to speak). Generally speaking, the skills necessary to renovate a property are different than the skills usually considered necessary to operate a property.

Venn diagram As the Venn diagram in Exhibit 10.4 shows, the Real Estate Development Stages are not clearly defined, but instead overlap in the process. The Building Operations Stage is an opportunity to increase property value, rather than just a process for minimizing operating expenses.

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Exhibit 10.4 Building Operations Venn diagram.

A well-documented operating history is fundamental to reducing the perceived riskiness of the real estate investment. When riskiness is reduced, capitalization rates decrease, and consequently property values increase. Leasing is the most prominent example of the Stages of the Real Estate Development Process not having clearly defined boundaries. The leasing activity is the most important overlapping area between the Building Development and the Building Operations Stages. The leasing activities also include constructing the tenant improvements, moving in the new tenants, and activating and enforcing all of the provisions of the new lease agreements. Whoever leases the building captures the value created by reducing the lease-up risk and increasing the net income of the property. Some Building Operators try to avoid the lease-up risk by only acquiring properties that are already leased, while other Building Operators actually seek out unleased or partially leased buildings so they can gain the additional revenue by leasing up the property. The overlapping boundary between the roles of the Building Operator and the Building Renovator may cause serious problems (and opportunities) with the hold-over tenants; those tenants who continue to occupy space during the Building Renovation Stage. Hold-over tenants can positively affect the renovation efforts with their continued occupancy and support. On the other hand, the demands of the hold-over tenants can be disruptive and costly as the renovation activities must accommodate their continued occupancy and operations.

Circle diagram The circle diagram in Exhibit 10.5 illustrates how the Building Operators buy properties from Building Developers and eventually sell properties to Building Renovators in the larger circle of the Real Estate Development Process. The Circle diagram also shows how Building Operators sometimes buy buildings from Building Renovators.

Building Operations: what happens The Building Operations equation in Exhibit 10.6 illustrates how Building Operators incur the costs of acquiring the property; leasing up the property to assemble a “portfolio of leases,” and instituting and managing information systems that document the operations.

Building Operations   131

Exhibit 10.5 Building Operations Circle diagram.

Exhibit 10.6 Building Operations equation.

The Building Operator must submit timely and accurate reports to the following: • • • • •

tenants; mortgage lenders; equity investors; governmental taxing services; other stakeholders, such as environment rating agencies (USGBC LEED).

132   Part II This documentation not only provides current information to the existing investors, but also demonstrates to prospective investors how profitable and valuable the property really is. The difference between these costs and the expected increase in value is known as the “spread.” The spread is the value that is created in this Stage of development. Economists call this the “profit” earned in this Stage. This spread may occur quickly, or over many years. Typical capitalization of Building Operations includes a long-term, amortizing mortgage and equity capital partners. Building Operators also employ cash reserves, lines of credit, or gap mortgages to manage major capital expenditures incurred during the holding period.

Building Operations: key players The key players in the Building Operations Stage are as follows: Building Developers as property sellers When Building Developers complete their required tasks, they are motivated to sell their improved properties to Building Operators in order to capture the value that they have created. They also may be motivated to pay off short-term construction loans that are coming due, or to free up capital that can be employed in another development. In any case, their willingness to provide Building Operators with an opportunity to acquire the property with an attractive price and terms is critical for the success of the Building Operator. Sometimes, Building Operators may negotiate at “pre-sale” which means that the Building Operators agree to sell the property when some agreed upon benchmark is achieved, like the completion of the building shell or the attainment of a certain level of occupancy. Building Operators as property sellers Another group of motivated sellers are Building Operators who want to sell their properties for a number of reasons. These Building Operators may be motivated by pressure from equity investors who want to sell the property, or by expected property conditions that they do not want to deal with, such as a major lease expiration. Building Operators can benefit from the determination of other Building Operators to sell their properties: one developer’s problem is another’s opportunity! Sometimes, Building Operators who want to sell may be able to provide attractive financial terms, such as purchase money mortgages to facilitate the sale to the Building Operators who want to buy. Asset managers Asset managers view the property from the investment perspective and must constantly analyze the credit markets and investor markets for financial opportunities, such as refinancing the debt, selling the property, or attracting new equity investors. Asset managers are responsible for reporting to the equity investors and lenders, as well as managing the leases on a property. Asset managers also consider the individual property in the context of the portfolio of properties that they may be managing. Property managers Property managers oversee the operation of the facility, such as the collection of rent, the regular maintenance of building systems, and the construction of tenant improvements and

Building Operations   133 common area repairs and replacements. Property managers usually prepare monthly activity reports for asset managers. Tenants Rent paying tenants are Building Operators’ best friends because they are responsible for the economic viability of the property. The rights and responsibilities of the tenants are defined in the lease agreement. The Building Operators believe that the most important responsibility of the tenants is to operate a successful business, so they can pay the rent on time. The tenants’ business operations require certain hours of occupancy, which impact security systems, electrical and power consumption, building access and restrictions, and common area uses. Leasing agents Leasing agents negotiate lease terms and acquire new tenants as leases roll over. They are paid on a commission basis, and the commission payments for renewal leases are always controversial. The accurate market information that they provide Building Operators is critical for a successful leasing strategy. Building systems engineers Building systems engineers oversee and provide regular maintenance of the major building systems, such as heating, air conditioning, plumbing, elevators, electrical, and security. They also manage small building projects and common area construction projects. Increasingly complex operating systems require trained and skilled building engineers, who can work with and manage third-party vendors to keep the building systems running efficiently. Permanent mortgage lenders The “permanent mortgage lender” is really a lender who provides a mortgage loan with a 5 to 20-year term with an amortizing feature. Permanent loans are put in place for the acquisition of the property and usually last until the property is sold or the mortgage is refinanced. Equity capital partners Equity capital partners provide the capital that is subordinate to the mortgage loans and usually make a contribution to the partnership when the property is acquired. Sometimes equity investors may be asked to make additional capital contributions or partnership loans. There may be different classes or groups of equity capital partners. Some equity partners may get annual preferential returns, while others may receive capital distributions that are subordinate to these preferred returns. Adjacent land owners Good neighbor relationships need to be managed and attended to; Building Operators should know who owns and uses the adjacent properties. Disputes with adjacent property owners

134   Part II are exhausting and unprofitable. Good business relationships require good communication and mutual respect and courtesy. Environmental consultants Environmental consultants can assist in the inspection and remediation of potential environmental issues in the building, and they can also assist in applying for and certifying various environmental and sustainability certifications (Energy Star, LEED, and BOMA 360). “Healthy buildings” are necessary for good tenant relationships, low tenant roll-overs, and lower operating costs. A “sick building” is a nightmare and a stigma that is hard to erase. Municipal building inspectors Local authorities require regular inspections and certifications of building systems, such as fire protection, elevator safety, and indoor air quality systems. These inspections may be done by municipal employees or qualified third-parties. Also, many remodeling projects or building repairs need to be permitted and inspected upon completion. Tax assessors The determination of the property’s value for real estate tax assessment purposes may be done at the state, county, or municipal level. Tax assessors provide an estimate of the property’s value for real estate tax determination. Knowledgeable tax assessors, good building records, and engaged property owners are necessary if Building Operators want to challenge or appeal the property’s assessed valuation. Sometimes, tax assessors are overly optimistic or aggressive in their estimates of the property’s value; however, their valuations are also restricted by laws and regulations. Police officers, fire fighters, and emergency medical technicians Building Operators must maintain good relations with police officers, fire fighters, and emergency medical technicians by keeping them informed about the property’s security systems, life-safety and evacuation procedures, and emergency access points and conventions. These first responders should be aware of who occupies the property and what special conditions they may face in case of an emergency. Building Operators have a sacred responsibility to protect the health and safety of their tenants, and the police officers, fire fighters, and emergency medical technicians are fundamental to fulfilling those responsibilities. Neighborhood associations Neighborhood associations—sometimes called “building improvement districts”—are often responsible for maintaining quasi-public spaces around private properties that are not adequately maintained or serviced by municipal governments. These areas may include sidewalks, alleys, trash receptacles, and public loitering areas. These associations can also bring health and safety concerns to the attention of the police and fire protection departments. Building Operators should be supportive members of their neighborhood associations.

Building Operations   135

Building Operations: critical Tasks The following are the most critical Tasks in the Building Operations Stage, although they are not listed in order of importance. Lease-up and re-lease rentable space Building Operators must lease-up the property and then re-lease space as it is vacated by departing tenants. Leasing professionals must be managed, whether they are employees of Building Operators or outside leasing brokers. Leases must be negotiated at market rents with appropriated expense allocations and reimbursements. Also, the amount and nature of tenant improvements must be specified, again with appropriate allocations and reimbursements. Finally, rental inducements should be carefully negotiated to close the lease contract. Manage building leases Tenant leases must be carefully managed to keep them in full force and effect: rent payments need to be made on time; tenant improvements need to be constructed in accordance with the lease specifications; and operating expenses should be shared, capped, or allocated according to the lease. Tenants’ operating hours should be monitored and security systems should be fully operational. A particular tenant’s lease renewal and space expansion options need to be respected and coordinated with those of the other tenants. Finally, additional fees for service must be billed and collected as the lease provides. Overall, leases must be kept up-to-date and constantly checked for compliance on the part of both the landlord and the tenant. There are usually building rules and regulations that are included with the lease that outline building policies and procedures to help keep the peace among tenants, as well as between the landlord and individual tenants. These rules should be kept current and distributed regularly. Operate building systems Major building operating systems must be monitored and maintained on a regular basis. The use of third-party vendors to accomplish this task is recommended. Daily trash collection and interior cleaning services are critical to maintaining good tenant relations and a healthy environment. Recycling trash and waste is a good way to keep the tenants engaged in the upkeep and maintenance of their spaces, and it is good for the environment, too. Manage vendor contracts Not all third-party vendors are created equal, so Building Operators must constantly seek out the best service providers at competitive prices. Third-party vendors are used for trash collection and recycling, security, window cleaning, exterior building maintenance, and safety systems, as well as for landscaping, snow removal, and outside clean-up. Document building operations Building Operators must accurately record the financial transactions (income and expenses), as well as building maintenance and leasing activities. Successful Building Operators

136   Part II generate accurate and timely reports for investors, lenders, and government agencies. These reports require the joint cooperation of the property managers and the asset manager. If reports are not timely, they are considered inaccurate (and inadequate as well). Late or inaccurate reports are not good for: • • •

investors, because they can cause suspicion and distrust; lenders, because they can cause default; taxing agencies, because they can cause penalties, interest, audits, and additional taxes.

Ensure the health and safety of the building users For Building Operators, the health and safety of the tenants is paramount. Emergency evacuation plans should be developed, distributed, and practiced. In addition, “shelter in place” plans should be developed for use during terrorists’ attacks, earthquakes, and for disabled persons. Plans for weather emergencies, such as snow storms, hurricanes, or flooding must also be developed and distributed to building users. All of these plans should also be distributed to police and fire authorities for comment, approval, and general knowledge. Business continuity plans for what happens after an emergency can help tenants resume business operations as quickly as possible. Business continuity plans should be developed by individual tenants, as well as property managers. Obtain appropriate sustainability designations Not only do Building Operators want to get credit for their efficient operations in the marketplace, some leases and some jurisdictions now require that certain green building certifications are attained and maintained. These may include the Energy Star designation from the U.S. Department of Energy, or LEED EB-OM from the United States Green Building Council (USGBC).1 Find sources of low-cost capital Building Operators must always be on the lookout for sources of low-cost capital. This may be mortgage loans with lower interest rates, equity investors with lower return expectations, or financial institutions with new investment strategies. Of course, the existing lenders and equity investors need to be informed about these new opportunities, so Building Operators should evaluate the pros and cons of these recapitalization opportunities.

Building Operations: controllable costs For the Building Operator, all of the operating costs and expenditures should be controllable, except for the leasing and re-leasing risks. However, a judicious management of lease expirations will help to mitigate this risk. Property management The property management fee is usually based on the actual out-of-pocket expenses of the property manager, plus a percentage of the collected rents. Property management agreements should provide for pre-arranged termination of the agreement with appropriate notification and minimal effect on the tenants, investors, and lenders.

Building Operations   137 Operating expenses These expenses are annually budgeted, and then reported monthly with “actual to budget” comparisons. •







• •

Security services. Security services contracts can be designed to meet the level of security required by the tenants and by the neighborhood. Of course, the nature of the tenants and their business operations will dictate most of their security needs. Fees for tenant-specific security needs are usually paid by the tenant. Janitorial services. There are usually several third-party vendors who will provide janitorial and housekeeping services for the building and its users. These vendors will hire workers and ensure that their immigration status and security background checks are adequate. This can be a tricky business. In addition, the housekeeping services are now asked to comply with green-building standards. Landscaping services. Regularly scheduled landscaping services are vital in maintaining an attractive building. The services should include fertilizing, mowing, trimming, and cleanup, as well as the maintenance of the sprinkler systems (if used). Snow removal can also be provided by these vendors. A new wrinkle in landscaping is the proper installation and maintenance of green roofs and roof-top gardens. Waste removal services. Waste removal services can be provided by private or public vendors. Popular recycling practices require housekeeping/janitorial services to work closely with the waste removal vendors. To avoid conflicts, the pick-up time and the location of trash removal facilities must be clearly defined in the service agreement. Energy monitoring and testing. Energy monitoring and system testing will ensure the proper operation of energy systems to maximize system efficiency and minimize potential failures in the future. Utilities. Leases should specify the landlord’s and tenants’ responsibilities for electricity, waste, and gas usage. Separate meters for each tenant are valuable in controlling these costs. The landlord and tenants can control the usage, but the prices may fluctuate.

Financing costs The financing costs, which include interest and origination fees, as well as extension and prepayment fees, are determined when the property is acquired so they are easily budgeted. However, refinancing arrangements can change these items. Working capital reserves Working capital reserves should be agreed upon among Building Operators and their asset/ property managers and the equity investors. Reserve levels should be calculated monthly and replenished as needed. Reserves for wasting parts and replacements Financial reserves should be established when the property is acquired for “wasting parts.” These are major building components that need to be replaced during the expected holding period. These may include roofs, parking lots, HVAC equipment, or landscaping. Alternatively, reserves could be increased annually with payments from the cashflow. The reserves should be clearly identified in the financial reports so transparency can be maintained.

138   Part II

Building Operations: major risks The nature of the long-term holding periods that are common in the Building Operations Stage helps to mitigate many of the sudden changes that can cause ruin in other Stages of the Real Estate Development Process. With adequate reserves, staggered lease periods, credit-worthy tenants, long-term fixed-rate financing, and patient equity investors, Building Operators should be able to ride out sharp changes in market conditions. Here, though, some major risks are outlined. Delays in obtaining permits Tenant space improvements may require building permits, so construction cannot proceed without the approval of local authorities. Usually, these delays are not lengthy, but the authorities may ask for changes to the building permit request. Unusual or special-purpose improvements should be carefully explained to the permitting authorities. Poor tenant relationships Poor tenant relationships may occur for many reasons, including inaccurate or poorly drafted lease agreements. However, landlord/tenant disputes need to be quickly addressed and fairly resolved. Ideally, tenants in multiple-tenant buildings should get along as “one, big, happy family.” However, Building Operators may need to play the role of parents in the event of intra-building “family feuds.” Building Operators must realize that all tenants are quirky to some extent and want their special needs to be respected and accommodated. Completion delays and cost over-runs: tenant and common area improvements Completion delays and cost over-runs of the construction of tenant improvements or common areas are usually caused by shortages in material or labor. However, these delays may be caused by tenants changing their minds or expectations, or the architect not clearly communicating the nature of the common area improvements. Building Operators must quickly resolve these misunderstandings. Because of the nature of tenant or common area improvements, the cost over-runs should not be too serious unless there is a major misunderstanding. Soliciting and securing bids from contractors before starting construction is an important way to clarify the nature and scope of the work to be done. Poor quality of improvements The risk of poor quality improvements is mitigated by Building Operators using reliable contractors and suppliers of materials. However, it is still important for Building Operators to inspect the material and workmanship during every day of construction. Deteriorating market or neighborhood conditions Adequate financial reserves should help Building Operators survive sudden changes in the market conditions; however, neighborhood deterioration is very difficult to quickly remedy.

Building Operations   139 Building Operators must become neighborhood activists to champion positive changes in the neighborhood. Speaking at neighborhood meetings, testifying at public meetings, or contacting political leaders are all positive ways that Building Operators can make a difference. Unexpected environmental conditions Mold is the most common environmental challenge for Building Operators. Wet conditions caused by leaking pipes, inadequate window seals, poor outside drainage, or flooding events are all possible causes of mold. When discovered, mold must be eliminated immediately. Sometimes, environmental risks can come from government regulators redefining a “hazardous material.” For example, in the 1970s and 1980s, the Federal Government specified that vinyl asbestos tile must be used for flooring in government facilities. But in the 2000s, the Federal Government declared these tiles to be hazardous materials and forced landlords to remove them and replace them with non-hazardous flooring, according to the new definition of “hazardous materials.”

Case studies of the Building Operations Stage Five case studies of the Building Operations Stage of the Real Estate Development Process are presented here to demonstrate and illustrate many of the discussion points in this chapter. Below are Building Operations case studies of a new office project, a re-leased office building, and the conversion of an underground television studio into an educational facility. One and Two Potomac Yard: leased-up and re-sold @REDM2 This case study shows how One and Two Potomac Yard was acquired, operated, leased-up, and re-sold during the Building Operations Stage. It is located on Land Bay A in the Arlington County portion of Potomac Yard: a master planned, urban-infill, transit-oriented, mixed-use development (see Exhibit 10.7).

Exhibit 10.7 Potomac Yard master plan.

140   Part II

Exhibit 10.8 One and Two Potomac Yard.

The 640,000 ft2 One and Two Potomac Yard property (as shown in Exhibit 10.8) was bought by JP Morgan for $215 million from Crescent Resources in November 2004. The total purchase price was $213.5 million, and was paid in three fundings: $100 million at shell completion; $95.5 million when the U.S. EPA moved in and the lease commenced; and $18 million when the property received the USGBC LEED-NC Silver Certification.3 The property was put in one of JP Morgan’s real estate portfolios for pension fund investors. JP Morgan became the Building Operator when the EPA assumed occupancy, and the tenyear lease began. JP Morgan hired a third-party professional property management company to manage the property according to the lease requirements and the Green Building Guidelines that were approved by the USGBC. Beside the USGBC Silver LEED-NC certification, the EPA lease also required the property to achieve the Building Star designation that is awarded by the U.S. Department of Energy. The Energy Star designation is based on actual operating records to verify the operational efficiency of the buildings. JP Morgan hired a national brokerage firm to lease the remaining vacant space. The leasing efforts focused on federal government agencies that needed Level IV security, as well as USGBC LEED-NC certification. In 2008, One and Two Potomac Yard was awarded the U.S. Department of Energy’s Energy Star, and in 2009, the property achieved a USGBC LEED Gold Award for existing buildings (EB). Also, JP Morgan’s leasing strategy was successful, and the property was leased to over 90% with Federal Government tenants. At that time, USAA, a large insurance company, was assembling a portfolio of green, government-leased properties for pension funds and sovereign wealth funds that were

Building Operations   141

Exhibit 10.9 Investment Grade Value Index vs One and Potomac Yard.

seeking very low-risk real estate investments in the United States. Consequently, JP Morgan was able to sell One and Two Potomac Yard to USAA for $250 million in 2010. Exhibit 10.9 shows the value appreciation of One and Two Potomac Yard from 2005 to 2010 and compares it to Co-star’s Real Estate Investment Grade Value Index for the same time period. The value increase from 2004 to 2005 was due to the Building Developer constructing the property for $135 million and selling it to JP Morgan for $213.5 million. However, the value increase from 2005 to 2010 was entirely due to the efforts of the Building Operator, who leased-up the property and efficiently operated and maintained excellent records to document its performance to the USGBC and the U.S. Department of Energy. This 17% increase in property value is even more impressive when it is compared to Co-Star’s Investment Grade Index that experienced a 24% decrease in property for the same time period. This case study also shows the importance of finding Building Operators who have a lower cost of capital. In this case, USAA had a lower cost of capital than JP Morgan, as USAA marketed a portfolio of low-risk, green buildings with government leases to investors seeking very safe investments. 1400 K Street, Washington, DC @REDM4 The 1400 K Street case study discusses some common problems that Building Operators must address that include lease roll-over, green building certification, and new tenants with new uses. A 187,000 ft2 office building, 1400 K Street, is only three blocks from the White House and one block from a metro Station in Washington, DC. This area is commonly referred to as the Golden Triangle because political lobbying firms dominate the office market. The 12-storey building contains 178,000 ft2 of office space, 9,000 ft2 of retail space, and 87,000 ft2 of parking. Originally built in 1981, the building was renovated in 2005. In 2014,

142   Part II

Exhibit 10.10 1400 K Street.

the Building Operator faced the roll-over (lease expirations) of three major leases that represented 25% of the office space. The Building Operators (owners) also decided to apply for USGBC’s LEED Gold Rating for existing buildings (EB), and to lease to two restaurants on the first floor. Leasing Building Operators must have a marketing team to address the continuous challenges of renewing existing leases and re-leasing vacant space when it comes to market. In early 2015, the building was 83% occupied as some tenants renewed their leases and others moved out. Constructing the tenant improvements and moving in new tenants without disturbing the current tenants is always challenging. New restaurant spaces Tenants love the convenience of restaurants in their building, but restaurants often require additional equipment and building systems beyond what is standard in an office or mixed-use building. New restaurants are especially problematic when the original structure was built with no intention of housing restaurants. Therefore, new restrooms needed to be installed in each restaurant space, and new ventilation systems had to be constructed and integrated into the other building systems; also, one tenant required natural gas lines to be installed for the commercial stoves. Performing these building improvements required a contractor specializing in restaurant fit-outs and their collaboration with the building engineers on site.

Building Operations   143 Green certification LEED Existing Building Certification is an option for buildings that were constructed before the creation of USGBC and LEED. This process may require renovations or updates to building systems that might be costly; however, they also make the building more efficient and produce lower operating costs in the long run. For this case study, switching lighting to LED lamps immediately caused a drop in electricity usage. Green certification also becomes an important marketing advantage in attracting new, environmentally conscious tenants. For the Existing Building Certification, complete participation by tenants and contractors is crucial. For this case study, recycling was a major requirement, so a certain percentage of the total building waste had to be recycled. The janitorial contractor had to be committed to all recycling policies, and the tenants had to adhere to the recycling strategies put in place. Without complete dedication from both, the requirement was unobtainable and may have prevented certification. The good news is that the building was awarded Gold LEED-EB in October of 2014. Both restaurants opened and were successfully operating in 2015, and the building reached 95% occupancy in 2016. This is a good case study illustrating the many tasks that the Building Operators must meet to create value in this stage of development. 650 Massachusetts Avenue @REDM5 This case study demonstrates how a quirky, special-purpose, below grade space can be rebuilt, re-fitted, and re-purposed for a non-traditional tenant with special needs. It also begs the question, “When does a tenant improvement project become a building renovation in terms of the seven Stages of development in the Real Estate Development Process?” 650 Massachusetts Avenue, NW, sits at the northern-most edge of the Chinatown neighborhood in Washington, DC, and just south of the Walter E. Washington Convention Center (see Exhibit 10.11). Built in 1990, the building has eight floors above grade and three floors below grade, and contains 301,000 ft2 of office, 25,000 ft2 of retail, and 93,000 ft2 parking garage. In 2010, an audio/visual company vacated 90,000 ft2 of recording studio and office space, leaving three floors of below grade, column-free space. This space created a unique opportunity for re-leasing to a specialized tenant. In 2012, Georgetown University signed a lease for the space, and construction of the new tenant build-out began. The renovation included the addition of new concrete floor slabs, the demolition of existing concrete floor slabs, and the installation of a dedicated elevator for the tenant space, as shown in Exhibit 10.12. The entrance for the Georgetown University School of Continuing Studies featured a glass box design with a four-storey atrium inside (see Exhibit 10.12). The Building Operators had to construct the new space while continuing the undisturbed occupancy of the retail and office tenants in the remaining 236,000 ft2 in the building. The major challenges during the construction period included: controlling the dust and noise; temporarily shutting down entrances, sidewalks, and roadways; and installing a new dedicated elevator in the new tenant space. After the tenant improvements were completed and Georgetown University began operations, the major challenges became: operating and controlling separate entrances and security systems; accommodating increased public traffic to the building with opposite hours

Exhibit 10.11 650 Massachusetts Avenue.

Exhibit 10.12 Renderings of 650 Massachusetts Avenue.

Building Operations   145 of operations; and integrating and combining new systems in the university space with the existing building systems. This is a good example of the Building Operator creating value by finding a creative solution for non-traditional space and completing major tenant improvements and renovations to accommodate the new user. Hampton Courts – residential acquisition @REDM6 On the opposite side of Building Developers selling their completed projects, are Building Operators looking to buy, as in the Hampton Courts residential acquisition case study. The Building Operator, an investment fund, is seeking to acquire a two-year old, 95% leased apartment complex from the Building Developer to add to their real estate holdings. In this case study, the Building Developer has already leased the property and created a stabilized cashflow in order to capture a higher sales price from the Building Operator. 1812 North Moore Street @REDM7 What happens when a completed building is not leased, and what could cause that to happen? In the 1812 North Moore case study, a trophy-class building stood empty for four years after completion. This non-leased building was the result of poor market conditions and required rents that were too high. In 2017, Nestle agreed to move its headquarters to the building; however, at the time of writing this book, it has yet to move in.

Summary The Building Operations Stage may last five to ten years, or for several decades. Building Operators create economic value by leasing and re-leasing vacant rental space, by keeping accurate records, by submitting timely reports, and by minimizing the cost of capital through financing and refinancing activities. Building Operators sell their properties to other Building Operators or to Building Renovators if they need major repairs/additions, or need to be repositioned in the marketplace. The Potomac Yard case study illustrates the increase in property value that can be achieved by leasing the property, obtaining green certifications, and selling to another Building Operator with a lower cost of capital. The 1400 K Street case study examines the many challenges that Building Operators face: lease roll-overs, major tenant improvements, and green certification; while 650 Massachusetts Avenue demonstrates how Building Operators can increase value by finding a new tenant for unique vacated spaces. The Hampton Courts case study focuses on the acquisition of an existing property from a Building Developer, and the 1812 North Moore example considers the problem of leasing-up a newly constructed office tower.

Notes 1 LEED EB-OM is the certification achieved through U.S. Green Building Council (USGBC) for an existing, in-operation building that meets certain sustainability standards and practices. This acronym stands for: Leadership in Energy and Environmental Design Existing Building – Operations & Maintenance. 2 http://realestatedevelopmentmatrix.com/textbook/res/task1/stage5/One+&+Two+Potomac+Yard. pdf

146   Part II 3 One and Two Potomac Yard received the USGBC LEED_NC Gold certification in July, 2006. 4 http://realestatedevelopmentmatrix.com/textbook/res/task1/stage5/1400+K+Street.pdf 5 http://realestatedevelopmentmatrix.com/textbook/res/task1/stage5/650+Massachusetts+Avenue.pdf 6 http://realestatedevelopmentmatrix.com/textbook/res/apt_1988_hampton_courts.pdf 7 http://realestatedevelopmentmatrix.com/textbook/res/task1/stage5/1812+N+Moore.pdf

11 Building Renovation

INTRODUCTION Building Renovation is the sixth Stage of the seven-Stage Real Estate Development Process (see Exhibit 11.1). Building Renovators identify the physical and functional deficiencies of a property, correct those deficiencies, and re-market the property to a different submarket.1 Building Renovators maximize the value of the property by changing the users, but not the use. That is, office buildings remain office buildings, warehouses remain warehouses, or retail buildings remain retail buildings. However, Building Renovators increase the building’s efficiency and usefulness, and consequently increase the value of the renovated property.

Schematic diagram The schematic diagram in Exhibit 11.2 illustrates the Building Renovation Stage position in the Real Estate Development Process. Building Renovation usually occurs when an operating building is underperforming, compared to similar product types in the market. For example, the tenants of the subject property are paying lower rents than the market average, or unleased space is difficult to rent. Undergoing building renovations will hopefully secure higher rents and greater functionality of the building, without changing how the building is being used.

Exhibit 11.1 Real Estate Development Matrix.

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Exhibit 11.2 Building Renovation Schematic diagram.

Once the renovation is complete, Building Renovators can continue to operate the building or sell the property to a Building Operator. But when the building is no longer at its highest and best use, and the deficiencies can no longer be cured, the property is sold to a Property Redeveloper.

Box Diagram Exhibit 11.3 demonstrates the key activity in real estate development, “Buy one thing and sell another.” In this diagram, Building Renovators buy an underperforming asset, remedy the property’s deficiencies, and then either sell the re-marketed property to a Building Operator or hold it until the end of its economic life and then sell the worn-out property to a Property Redeveloper.

Building Renovation   149

Exhibit 11.3 Building Renovation Box diagram.

Building renovations are very common in shopping centers and hotels as consumers’ tastes and preferences alter, or as transportation systems change (thereby changing the property’s relative location). Also, an office building may be renovated to meet the needs of a different type of office user. For example, high tech companies may prefer an “open office environment” rather than the traditional enclosed office floor plans, or an office building that is designed for a single user may be renovated to accommodate multiple users.

Venn diagram Exhibit 11.4 demonstrates the overlapping nature of the Real Estate Development Stages. A Building Renovator may acquire a building from a Building Operator that has a “holdover tenant,” a renter with a long-term lease and additional renewal options. Clearly, Building Renovators must determine how to accommodate hold-over tenants while undertaking the required renovation activities. This often occurs in a shopping center where a major tenant

Exhibit 11.4 Building Renovation Venn diagram.

150   Part II has a very favorable lease and wants to continue operations even during the renovation and re-marketing of the property. When the property is worn-out and it is no longer economically feasible to renovate it, there may still be tenants with long-term lease agreements. These tenants become “interim users” when the property is sold to the Property Redeveloper, who is waiting for the right time to change the uses of the property in the redevelopment process.

Circle diagram Exhibit 11.5 shows how the Building Renovation Stage may cycle back to the Building Operations Stage several times before moving on to the Property Redevelopment Stage. Building renovations can occur multiple times throughout the lifespan of a building, as the cycle of operations, to renovations, to operations repeats. This cycle continues until the building is no longer an effective or viable space in the market, at which time the property moves into the Property Redevelopment Stage.

Building Renovation: what happens Building Renovators buy properties which have substantial economic and/or physical depreciation and create value by fixing these deficiencies then re-positioning and operating

Exhibit 11.5 Building Renovation Circle diagram.

Building Renovation   151

Exhibit 11.6 Building Renovation equation.

the properties until they are ready for redevelopment. The unique skills and risks for Building Renovators are often found in companies that specialize in historic renovation, for example. Building Renovators have a keen knowledge and understanding of the real estate market in which they work. They know which tenants are expanding and ready to move, which tenants are ready to go out of business, and which Building Operators are ready to sell their properties. They are able to see opportunities where others may only see worn-out property in need of repair. They epitomize the saying, “No problems; only opportunities.” They are truly the “turn-around artists” of the real estate world. Currently, many shopping center developers are looking for old shopping centers that need to be fixed-up and re-marketed to different retail tenants. Building Renovation developments can be capitalized in a variety of ways. Usually the project is acquired with equity capital or through a purchase money mortgage from the seller. Sometimes, the Building Renovator can assume the existing mortgage as part of the acquisition transaction. The required renovation improvements are usually financed with a shortterm construction loan, which is then replaced with a permanent or long-term loan when the renovations are complete and the property is re-leased to new tenants. The diagram in Exhibit 11.6 illustrates the Building Renovation equation. That is, the sum of the acquisition costs, holding costs, operating costs, and renovation costs should be less than the operating income and eventual sales price (property disposition price) after the renovations are complete. The difference between those two values is known as the “spread.” The spread is the marginal value that is created in this Stage of development. Economists call this the “profit” earned in this Stage. This spread should occur quickly in the Building Renovation Stage.

Building Renovation: key players Selling Building Operators The selling Building Operator must be motivated to sell the property that is performing poorly and in need of repair. This seller may be the source of seller-financing2 arrangements that allow the Building Renovator to acquire the property and begin the renovation process. Buying Building Operators Buying Building Operators are the Building Renovators’ best friends as the Building Operators are seeking opportunities to create value by leasing the renovated property.

152   Part II Sometimes, successful Building Renovators are able to negotiate a pre-sale agreement with Building Operators before or during the renovation construction so that the sale closes and title transfers at the end of the designated renovation period. Property Redevelopers Property Redevelopers are prepared to take control of the renovated property when it can no longer be renovated because of overwhelming physical deterioration or functional deficiencies. Property Redevelopers are like Land Bankers because they hold the property until the market conditions improve and the property is ready for new land uses. Existing permanent mortgage lenders Most existing properties are encumbered with a permanent mortgage of some kind that is in the first lien position. The seller’s permanent lender may allow the existing loan to be assigned to or assumed by the Building Renovator. The permanent lender may also agree to subordinate its first lien position, so the Building Renovator can give the construction lender a first lien position. New permanent mortgage lenders The new permanent mortgage lenders may fund the acquisition costs and later make an additional funding to cover the renovation costs as the construction occurs. Alternatively, new mortgage lenders may not fund the project until the renovation and leasing is complete. Construction lenders Construction lenders fund the renovation costs with an accruing interest rate over a specific time period. The construction loan would be repaid with a new permanent loan or through the proceeds from the sale of the renovated property. Because of the highly risky nature of the renovation process, construction lenders will require a first lien position and/or personal guarantees from Building Renovators. Experienced Building Renovators and experienced renovation loan lenders are invaluable in this delicate dance. Property managers Property managers are responsible for the collection of rents from the hold-over tenants, as well as the regular maintenance of the existing building systems. The property managers may or may not be replaced by project managers when the renovation begins, but in any case, coordination between the property managers and the project managers is critical for successful renovations. Project managers Project managers work for Building Renovators and oversee and manage the renovation construction and re-leasing on a daily basis. These are the most important players in the Building Renovation Stage because they must maintain building operations for holdover tenants, while overseeing the construction of the new renovations and moving in the new tenants in a timely and cost-effective manner.

Building Renovation   153 Tenants Hold-over tenants must be accommodated as the renovation takes place, so they can continue operations in the building or vacate the building when their leases expire. New leases with future tenants must be signed during the Building Renovation Stage. Hopefully, the future tenants will agree to higher rental rates once the property has been renovated and they take occupancy Leasing agents Leasing agents may help negotiate revised lease terms for hold-over tenants and simultaneously help find future tenants for the newly renovated space. Leasing agents may also assist in the underwriting process3 and the cost-benefit analysis of a potential renovation. Their expert knowledge of the local markets helps to determine what improvements will garner higher rental rates based on current trends, such as large lobby improvements or updated floor plans for open-space concepts. Building systems engineers Building systems engineers are responsible for the regular maintenance and minor improvements of the existing building systems. Their knowledge of the building specifics is critical for the integration of the new systems and the existing building systems. Also, since these engineers will be responsible for continuing the operation and maintenance of the new building systems implemented during the renovation, it is important that they are informed and educated about how to efficiently operate the new systems. Renovation contractors Renovation contractors construct the new renovation improvements and remove portions of the existing structure when they are no longer needed. They will hire the subcontractors with special knowledge and skills for the renovation project. Renovation contractors have special skills that are different from those required for new construction. In renovation projects, very little is “plumb, square, or level,” so renovation contractors must make numerous adjustments to accommodate the “as is” condition of the old property. In addition, renovation contractors must be sensitive to historical features of the existing structure. Local historians Local historians provide information on the building’s original intent or purpose and explain what historical significance the building may or may not have had in the community. Local historians may also help in navigating historical preservation requirements if applicable. Environmental experts Environmental experts perform an environmental analysis on the existing property prior to construction and then direct and oversee any required environmental remediation efforts, such as asbestos encapsulation or mold removal. Environmental experts are also critical to evaluate hazardous or suspicious conditions that can be encountered during construction.

154   Part II Neighborhood activists The neighborhood activists provide input on the needs of the community and lobby for community improvements or other projects that may either be part of the renovated property, or entirely off-site. Neighborhood support is critical for local political support, so Building Renovators must cultivate positive relationships.

Building Renovation: critical tasks While many of the Building Renovators’ critical Tasks are very similar to those of the Building Operators, the presence of hold-over tenants and the concern for historic and hazardous conditions cause special issues. Provide an accurate analysis of the market conditions Building Renovators must be able to see market opportunities and envision how the renovated property will capture these. This vision must be grounded in solid market evidence and a keen understanding of the market operations. Submarkets in a region react differently with each other; some directly and some indirectly. The relationship between downtown and suburban retail areas is a prime example. When a downtown shopping area has high crime rates, shoppers will choose to travel to the suburban shopping area. Building Renovators must determine the best way to exploit these shifts in consumer behavior. Understanding the needs of underserved market niches requires an intimate knowledge of the operational needs of existing and new tenants. Building Renovators must be specific and precise in their market judgments. This is why successful Building Renovators usually specialize in one product type, e.g. retail, in one market area, e.g. Northern Virginia. This is also why so many Building Renovators come from a brokerage background and have gray hair! Obtain construction permits and approvals Renovation improvements require applicable building permits from local authorities. There are often regulatory thresholds (size, cost, use) that determine what improvements can be made and what permits are required. The National Historic Preservation Act of 1966 (NHPA) focuses on the development and renovation of historic properties that are federally funded or permitted. The NHPA also authorizes State Historic Preservation Offices (SHPOs) to evaluate the effect of development on historic properties that are federally funded or permitted. SHPOs are very serious about protecting historic buildings and sites from rapacious real estate developers. Building Renovators must cooperate with and work with them. The National Environmental Policy Act of 1969 (NEPA) also included the evaluation of historic properties and places in the required Environmental Impact Statement (EIS). Over the last 50 years, the authority of the State Historic Preservation Offices and the U.S. Environmental Protection Agency has been expanded to include properties that may become historic properties, even if they are not yet designated. Again, Building Renovators must stay up-to-date with the latest requirements and required approvals.

Building Renovation   155 Negotiate various contracts within budget Building Renovators may negotiate a Guaranteed Maximum Price (GMP) with general contractors; the general contractor may then hire subcontractors for specific skills, as long as it is within the scope of work4 and the GMP agreed to by the property owner. Another possibility is to hire renovation contractors for a fixed fee, and then they will help the Building Renovators negotiate contracts and prices with multiple subcontractors as needed to satisfy all needs of the total scope of work. Allowances5 are often used in cost-line items in renovation projects when the exact nature or scope of the project is unknown. These allowances should be constantly reviewed and updated as better information about building conditions is obtained. Stage, manage, and control the construction projects and leasing efforts Building Renovators must stage, manage, and control both the construction and leasing of the renovated improvements so that they are on time and on budget. Simultaneously managing and controlling the construction and marketing of the renovation project is very difficult because the contractors and the leasing agents have different agendas in terms of access, timing, and budget priorities. Because of the nature of some renovation projects, the safety of both the workers and the public require very strict limitations on access to the property. However, the marketing people like to show their prospective tenants the excitement and energy of the new space. Building Renovators must help the construction teams and the marketing teams understand each other’s objectives, so they can work together in a complementary manner. Maintain good relations with the hold-over tenants If a portion of the building continues to operate normally during renovation, it is imperative to have excellent communication with existing, hold-over tenants, so their concerns about disruption to their space are addressed and the safety of their employees and customers are insured. Regular meetings to update these tenants, along with “hotline” telephone numbers, are advised. This is where the project manager is invaluable.

Building Renovation: controllable costs Given the uncertainty surrounding the timing and extent of many renovation projects, Building Renovators must control or limit costs to the best of their abilities. These costs may be difficult to identify and quantify prior to the acquisition of the property and commencement of the renovation, but they must be carefully monitored and managed during the renovation period. Allowance line items are especially problematic, but they must be controlled. Construction costs Building Renovators must work with engineering consultants, building engineers, environmental experts, and property managers to mitigate any possible unforeseen situations or building oddities that may arise during construction.6 Using allowances for any special accommodations to the original scope will prevent “scope creep” or additional change orders as work continues.

156   Part II Operating costs during construction Some basic building systems (electricity, plumbing, and heat) may need to continue during the renovation. If tenants move out of, or into, the building during renovation, the Building Renovator must include those costs in their renovation budget and have the cash on hand to pay those bills. Management costs Building Renovators may need to continue to pay a property manager during the renovation, as well as a project manager. These management costs are predictable and controllable and vital to a successful project. Marketing costs A marketing budget that includes advertising, promotional events, and leasing should be established at the beginning of the project, and then the marketing costs should be managed in accordance with the budget to avoid overspending.

Building Renovation: major risks The major risks in the Renovation Stage are the same major risks that occur in the Building Development Stage. However, the Renovation Stage tends to be shorter so the risks can be better controlled, except when unexpected building conditions are discovered during renovation. Delay in obtaining permits Renovation work cannot proceed without the approval of local authorities. This is usually not a problem until it is. If the neighborhood activists object to the project, their influence may be reflected in the approval process. Local authorities may ask for changes to the scope of the project or request additional conditions for its approval. Timeliness is paramount. Historic preservation approvals need to be addressed early on and diligently pursued. Completion delays and cost over-runs Completion delays can be caused by numerous conditions. Political opposition is the hardest to deal with, but shortages of material or contractors may also cause delays. Building Renovators need to carefully assess these risks before they take the first draw from the construction loan, and the interest clock starts to run. Cost over-runs, like completion delays, can be caused for numerous reasons. Initial budgets and monthly accounting reports comparing the budgeted costs to the actual expenses can keep these risks under control. Every renovation budget must have a “contingency” line item in the budget to offset these risks. Poor quality of improvements Both the quality of the material and the quality of the workmanship must be closely monitored from the beginning of the renovation. Once the inferior material has been installed, or the inferior workmanship discovered, the cost of removal and replacement can be ruinous. In this area, experience counts and daily inspections are a must.

Building Renovation   157 Deteriorating market conditions Because of the short nature of the renovation period, the market should not deteriorate too quickly. However, the market conditions that Building Renovators expect may not materialize, so the renovated property is not re-leased as anticipated. This is where Plan B is important. Renovators must determine how to re-lease the property to different tenants and address the deteriorating market conditions. Unexpected environmental or structural conditions Regardless of the amount of due diligence and pre-construction testing, environmental or structural conditions may be discovered or the conditions may be worse than expected. Asbestos insulation, lead paint, and mold infestation are the usual environmental culprits. Sometimes, rotten wooden structural members or unstable foundations may be encountered during renovation as well.

Case studies of the Building Renovation Stage Three case studies of the Building Renovation Stage of the Real Estate Development Process are presented here to demonstrate and illustrate many of the discussion points in this chapter. Below, are Building Renovation case studies of a regional shopping mall, a boutique shopping center, and a downtown office building. Tysons Corner Shopping Center: 45 years of renovations @REDM7 The three building renovations of the Tysons Corner Shopping Center are a good example of how a property can be renovated to respond to changing market conditions, especially transportation improvements: • • • •

1969: 1.5 million ft2 served by state and local highways. 1987: 1.8 million ft2 served by interstate highways. 2005: 2.3 million ft2 served by interstates, toll roads, and bus systems. 2015: 2.6 million ft2 served by a regional metro rail system.

Located in the Washington, DC, metropolitan area, Tysons Corner is located in the McClain portion of Fairfax County, one of the highest income areas in the United States. It was originally developed for office space, creating a major suburban office plaza. However, the addition of Tysons Corner Center Mall in 1968 and Galleria Mall in 1987 transformed the area into one of the largest major retail hubs in the United States. The recent completion of three metro stations accessing Tysons Corner provided the possibility of a larger resident population and an opportunity for mixed-use, transit-oriented development. The Tysons Corner area is defined by the Capital Beltway (I-495), Chain Bridge Road (U.S. Route 123), and the Leesburg Pike (County Route 7). The Silver Line of the Washington Metropolitan Area Transit Authority (WMATA) currently connects Tyson Corner to the Greater Washington Area, and it will soon connect Tyson corner to Dulles International Airport in Loudon County, Virginia. The Tysons Corner Shopping Center was originally built on a triangular, 85-acre site. At that time, the Center was billed as one of America’s largest interior malls as it had 1.5 million ft2 of retail space with all surface parking (see Exhibit 11.8).

Exhibit 11.7 Tysons Corner regional map.

Exhibit 11.8 Tysons Corner Center in 1969.

Building Renovation   159

Exhibit 11.9 Tysons Corner Center in 1987.

By 1987, the occupancy of Tysons Corner Shopping Center was 98.8%, and sales volume averaged a 10.5% growth rate from 1970 to 1987 (see Exhibit 11.9). A new development partnership acquired the Center in 1987 and combined both the land and building ownership.8 This partnership decided to renovate the Center and move from a Building Operator to a Building Renovator. The renovation plan added 240,000 ft2 of retail area by converting the truck unloading level to useable retail space and by adding five new anchor retail sites. The addition of five parking structures freed up 23 acres for a 250-room hotel and future office development (see Exhibit 11.10). The construction of these improvements began in 1988 and was completed in 1989. In 2003, new owners began the planning, permitting, and leasing for the largest major renovation at the Tysons Corner Center. Construction was completed in 2005 with the grand re-opening of the new 350,000 ft2 wing (see Exhibits 11.11 and 11.12). The new wing

160   Part II

Exhibit 11.10 Preliminary land plan for renovation (1987).

included a food court, restaurants, retail stores, and an 18-screen movie theater. The owners explained that with over 20 million shoppers per year, it made more sense to expand and renovate, rather than to redevelop the site. In 2007, a four-phase development plan was approved for Tysons Corner Center Property by Fairfax County that would expand the mixed-use development to six million ft2, with 2.67 million ft2 of retail. Today, this plan is almost fully built out (see Exhibit 11.13). The Shops at Georgetown: high-end boutiques to discount retailers @REDM9 This is a great example of how value can be created in the Building Renovation Stage by making minor tenant improvements and re-positioning the property in the market. The Shops at Georgetown Park was a high-end, indoor retail center in the middle of the Georgetown neighborhood in Washington, DC. Georgetown is known for its wealthy residents, luxury shops, and night life. Georgetown Park is located at the southwest corner of M Street, NW and Wisconsin Avenue, NW—M Street is the main throughway for both pedestrians and transit vehicles in

Building Renovation   161

Exhibit 11.11 Tysons Corner Center new wing in 2005.

Exhibit 11.12 Tysons Corner Center interior renovations in 2005.

Georgetown. The shops are set back behind street-front retail stores, and shoppers must come through limited entryways to the interior of the center for access. As retail market trends shifted towards outdoor, open-air retail centers, numerous boutique shops and major retailers moved out of Georgetown Park to the storefronts on M Street.

162   Part II

Exhibit 11.13 Tysons Corner Center future phased development.

Throughout the 2000s, demand for the interior retail space continued to decline. Consequently, the occupancy of the 20-year old, 305,000 ft2, three-storey mall continued to decline. The interior photos in Exhibits 11.14 and 11.15 show the inside of the mall during regular operating hours. There was a rumor that a large glass window pane fell on to the lower level during mall hours, and no one was hurt and no damage was done because no one was there! In 2010, the Vornado REIT bought the property at auction for $61 million. From 2010 to 2014, Vornado allowed the few remaining leases to expire, and it re-marketed the space to larger discount retailers (see Exhibit 11.16). Vornado signed leases with TJ Maxx, HomeGoods, Michaels, and DSW. Initially, the reaction from the Georgetown community was mixed; some were excited to have more retail options, while others worried about bringing in discount stores to an area that has historically been high-end luxury retail. However, Vornado continued to raise the occupancy by signing leases with credit tenants, including the DC Office of Motor Vehicles. In August 2014, Vornado was able to sell the renovated Shops at Georgetown to Jamestown Properties for $272.5 million! 2001 M Street: a rare opportunity @REDM10 This case study shows how a Class B office building can be renovated into a Class A office building. 2001 M Street is close to the White House and in the Golden Triangle office market in Washington, DC. Brookfield Properties acquired 2001 M Street as part of a multi-property purchase from a major, Washington-based REIT in 2010 (see Exhibit 11.17). The nine-storey building was

Exhibit ­­­11.14 Interior boutique shops.

Exhibit ­­­11.15 Interior boutique shops.

Exhibit 11.16 New front entrance.

Exhibit 11.17 Original 2001 M Street.

Building Renovation   165 built in 1986 and had 228,000 ft2 of office with 25,000 square floor plates. It was fully occupied by a single tenant. Shortly after the acquisition, in 2011, the single tenant moved out. Brookfield announced its intention to become a Building Renovator when its senior vice-president said, “It’s a rare opportunity where you get the full building back and have the opportunity to fully reposition it. We spent a lot of time and money looking at those options, and the conclusion we came to is that it’s a really good, visible location, and it makes sense to go ahead with a full renovation.” Brookfield’s renovation plan was to do the following: • • • • • •

gut the existing building; expand the floor plate size to 32,000 ft2; increase the building height to ten stories; increase the rentable area to 320,000 ft2; re-skin the building in glass; re-market it as a Class A office building.

The renovation began in 2011 and was finished in 2015 (see Exhibit 11.18). Today, the building is fully leased, and Brookfield has returned to the Building Operations Stage. This is a good example of the Building Renovator’s mantra, “No problems; only opportunities!”

Exhibit 11.18 Renovated 2001 M Street.

166   Part II

Summary Successful Building Renovators have a superior knowledge of the marketplace: they know what spaces/users are entering a market, and what spaces/users are leaving a market, and they have a keen sense of unmet needs in the real estate marketplace. Consequently, Building Renovators create value by acquiring under-performing properties with major un-leased spaces and then making major repairs, additions, and improvements that attract new tenants. Building Renovators don’t change the original use or zoning of the properties, but they improve the cashflows of the renovated properties. These properties are then sold to Building Operators or held and eventually sold to Property Redevelopers at the end of their economic lives. The Tysons Corner Shopping Center case study reviews the 50-year history of a major mall as it successfully adjusts to changing shopping practices, transportation improvements, and retail tenant’s needs. The Shops at Georgetown example illustrates how a property can be re-positioned in the marketplace by changing from smaller, high-end boutique tenants to large, discount retailers. The 2001 M Street case study demonstrates how a major renovation effort can change a vacant Class B office building to a larger, leased-up Class A office property.

Notes   1 Submarket – every real estate market is composed of several submarkets. Submarkets may be defined by quality (Class A, B, or C office), by physical size (neighborhood, community, or regional shopping centers), or by geographical area (central business district or suburban locations).   2 Seller-financing occurs when the seller agrees to finance part of sales price in the form of a note and mortgage on the property. This arrangement is usually called a “purchase money mortgage.” The seller may also be able to arrange the assumption of an existing mortgage by the Building Renovator.   3 Underwriting process refers usually to the determination of how much money can be borrowed to finance the project. The process is based on the earning power of the property, along with the current financial conditions in the debt market, such as interest rates, debt-coverage ratios, and loan-to-value ratios.   4 Scope of work refers to the amount and type of construction that is expected. Renovation improvements often start simple and then expand as unexpected conditions are met or new tenants want different improvements. In these cases, the scope of work must be expanded, and the cost estimates adjusted. This problem is usually referred to as “scope creep.”   5 Allowances are used when there is considerable uncertainty about the cost or description of certain budget items, such as tenant improvements or environmental remediation.   6 For example, a previous owner may have fixed a leak in the ceiling by attaching a plastic waste paper basket to the dripping pipe, thereby allowing the drip to continue and mold to grow.  7 http://realestatedevelopmentmatrix.com/textbook/res/task1/stage6/Tysons+Corner+Shopping+ Center.pdf   8 The Acquisition Memo is at the following hyperlink: http://realestatedevelopmentmatrix.com/ textbook/res/ret._1985_tysons_corner.pdf   9 http://realestatedevelopmentmatrix.com/textbook/res/task1/stage6/The+Shops+at+Georgetown.pdf 10 http://realestatedevelopmentmatrix.com/textbook/res/task1/stage6/2001+M+Street.pdf

12 Property Redevelopment

INTRODUCTION As shown in Exhibit 12.1, the Property Redevelopment Stage is the last Stage in the traditional Real Estate Development Process, but it is really the first Stage of the Redevelopment Process. Property Redevelopers are much like Land Bankers, except that Property Redevelopers buy properties with existing structures and a history of land uses. This Stage is also a relatively passive one, as Redevelopers, like the Land Bankers, must wait for external market forces to increase their properties’ values to the extent that they are ready to be re-zoned so that new and different land uses can be developed.

Schematic diagram The schematic diagram presented in Exhibit 12.2 shows the Property Redevelopment Stage at the end of the Real Estate Development Process. Property Redevelopers must analyze the current and future market conditions and then imagine new, productive uses for properties that have clearly outlived their existing physical improvements. Property Redevelopers may help the general public visualize or imagine the advantages and possibilities of these

Exhibit 12.1 Real Estate Development Matrix.

168   Part II

Exhibit 12.2 Property Redevelopment Schematic diagram.

properties in light of the expected market changes. These expected changes may be public infrastructure improvements, or private initiatives to reinvigorate the neighborhood. Once the potential of a worn-out property is recognized and it becomes more valuable, Property Redevelopers sell the property to Land Packagers who effectively become Property Re-Packagers and the Real Estate (Re)Development Process starts all over again. Most often, the role of Property Redeveloper falls to entities who inherit the properties in one way or another. For example, municipalities inherit properties because the owners have stopped paying the real estate taxes, or the owners have stopped maintaining the properties, which are then condemned as public hazards. In either event, the municipalities assign the properties to public redevelopment authorities who attempt to sell the properties to private entities who will become Land Packagers and begin the active redevelopment of the

Property Redevelopment   169 properties. In a similar manner, counties and states may also inherit abandoned properties that need to be redeveloped. In addition, corporations and public utilities may have properties that are no longer used and need to be re-purposed. Perhaps the U.S. Department of Defense’s Base Relocation and Closure (BRAC) is the best-known example of redeveloping obsolete or unused military facilities by leasing them to private developers.

Box diagram The box diagram in Exhibit 12.3 demonstrates the adage that to add value, the real estate developer must, “Buy one thing and then sell another.” In the Redevelopment Stage, Property Redevelopers buy a sorry, worn-out property with little potential and sell a sorry, worn-out property with great potential. This usually occurs when a property is underperforming and feasibility studies suggest that another type of real estate product(s) would a better use of the site. This differs from Building Renovation because the property not only undergoes the major renovation or reconstruction, but it also changes use as well. To clarify, Building Renovators may convert an old department store into a series of smaller boutique shops (the use stays the same); the Property Redeveloper takes the old department store and converts the property into student housing (change in use).

Venn diagram The Venn diagram in Exhibit 12.4 shows how the Property Redevelopment Stage overlaps with the Building Renovation Stage, as well as the Land Packaging Stage. The Building Renovation Stage begins with hold-over tenants and ends with interim uses, which may then be transferred to Property Redevelopers. These interim uses are helpful in reducing the Property Redevelopers’ holding costs. Many times, the governmental agencies or authorities will try to get the properties re-zoned or included in some type of governmental redevelopment

Exhibit 12.3 Property Redevelopment Box diagram.

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Exhibit 12.4 Property Redevelopment Venn diagram.

program, that may include financing opportunities or tax credits. Government Redevelopers are eager to induce private Land Packagers in the redevelopment process by providing lenient terms and prices. For example, private Land Packagers may not need to commit capital to the project until the appropriate zoning is obtained, or until project financing is available. These public-private partnerships are common in this Property Redevelopment Stage.

Circle diagram The circle diagram shown in Exhibit 12.5 demonstrates how the Property Redevelopment Stage moves to the Land (Re)Packaging Stage and the Real Estate Development Process begins again. Once Property Redevelopers create, clarify and focus the new vision of the property, the redevelopment of the property goes to the (Re)Packaging Stage, where the appropriate public approvals are obtained, and planning and market studies are conducted. Land Packagers commission various feasibility studies to show the viability and potential of the redeveloped property. The circle diagram illustrates that the Land Banking and Property Redevelopment Stages share similar characteristics regarding their relationship to the Land Packaging Stage. The main difference, though, is that Land Banking involves raw, undeveloped land and property. Redevelopment involves land that has already been developed and has a history of land uses with physical improvements. In other words, once a site has completed the Real Estate Development Process, it cannot go back to raw land in Land Banking. Instead, the site progresses from the Property Redevelopment Stage back to the Land Packaging Stage.

Property Redevelopment: what happens Property Redevelopers buy a property with such serious physical or functional deficiencies that the improvements must be torn down or redeveloped for another use—for example, changing from an office building to a retail center. This essentially begins the Real Estate Development Process all over again. Property Redevelopers are in the same role as Land Bankers, except that Land Bankers usually work with green field properties, and Property

Property Redevelopment   171

Exhibit 12.5 Property Redevelopment Circle diagram.

Redevelopers usually work with brown field properties. In every major city, governmentsponsored redevelopment agencies are probably the largest players in this Stage, even though they didn’t exactly “buy” their holdings from Building Renovators. Usually, the municipalities acquire the properties through tax foreclosures and assign these properties to the redevelopment agencies to be sold. The acquisition costs are sometimes zero as redevelopment agencies have properties assigned to them from municipalities with the direction to sell them or move them off the books. This is the same situation that real estate departments in a large corporation may find themselves in when properties are no longer needed and simply need to be liquidated or sold to other entities. The holding costs may be substantial or minimal depending on the size and nature of the property. Often, there are environmental concerns which must be identified and evaluated before willing buyers can be found. Finally, there may be safety issues associated with deteriorating or dilapidated buildings. The sale of the property to be redeveloped may be problematic and subject to numerous conditions to close. In any event, the sales price to the Property Redeveloper must exceed the

172   Part II

Exhibit 12.6 Property Redevelopment equation.

sum of the net holding costs, and the acquisition price by enough to justify the risks incurred in the development process. This difference is the required “spread” or profit (see Exhibit 12.6). How long it takes for the expected increase in value to happen is hard to predict as this is a major risk in the Property Redevelopment Stage.

Property Redevelopment: key players Some of the key players in the Property Redevelopment Stage are as follows: Private property owners Property Redevelopers need to identify private property owners who are motivated either to sell their properties, or just to get rid of them. They may include families that have inherited deteriorated properties or businesses that no longer can use certain facilities. Redevelopment authorities Redevelopment authorities typically control the distressed properties by having municipalities assign them the responsibility of selling or disposing of the properties. Many times, these authorities attempt to outline a redevelopment program that guides the disposition process. Zoning commissions and planning departments Municipal zoning commissions and planning departments are instrumental in setting the stage for a property to become an attractive prospect for the Land (Re)Packager. They need to embrace the new vision and encourage and support the re-zoning and re-purposing of the deteriorated property. Structural engineers Structural engineers need to evaluate the existing condition of the structure and surrounding infrastructure in terms of the feasibility of reusing them, or demolishing them in a safe and timely manner. Many times, deteriorated property can pose dangers for interim users or neighbors. Structural engineers can help devise safe holding plans.

Property Redevelopment   173 Demolition contractors Demolition contractors, who have experience in salvaging and demolishing old structures with environmental or structural problems, are very important at this Stage. This can be a very tricky business in dense urban areas, so demolition cannot be undertaken lightly. Surveyors and title insurers Surveyors and title insurers determine the size and area of the property to be redeveloped, who owns it, and how the property can be sold or transferred. Worn-out or abandoned urban properties often have serious boundary issues and title problems that can severely restrict the future uses of the property. Old easements and neighbor encroachments must be identified and resolved for redevelopment to be possible. Also, clouds in the chain of ownership can prevent the transfer of a clear title to Land Packagers. Environmental experts Environmental experts evaluate the redevelopment potential of a property as it relates to, or is affected by, its current environmental conditions, as well as possible hazardous conditions caused by previous uses. Besides the surface, subsurface, and atmospheric conditions, these old properties could have historic or cultural significance that would impact their redevelopment potential. Old grave sites are particularly challenging. Neighborhood activists The neighborhood or surrounding area will enhance or detract from the redevelopment of a property. It is critical to have neighborhood support for whatever redevelopment is contemplated. While, “you can’t fight City Hall,” City Hall doesn’t want to fight neighborhood associations. Political leadership Political leaders need to be champions for the redevelopment of the property; these are usually local politicians who want to improve the urban area. Without political support, the redevelopment will never happen. Local historians Local historians can help uncover possible historic attributes of the redeveloped property. This historic evaluation is important for public support. Often there are grants or tax credits for the renovation or redevelopment of historic properties. Attorneys Attorneys are critical for the drafting of the risk allocation provisions of the sale of the properties. Even though property sellers may want to “wipe their hands clean” of the property, buyers will want covenants, warrants, or guarantees that survive the sale of the property and continue the sellers’ liability and protect the buyers going forward. Environmental liability is particularly troublesome, as are unresolved lawsuits.

174   Part II Land (Re)Packagers Property Redevelopers need to identify the possible Land (Re)Packagers who can see the potential and are willing to lead the charge for redevelopment approvals. Land (Re)Packagers are usually in the private sector, and often there are discussions about public-private partnerships for redevelopment projects.

Property Redevelopment: critical Tasks Property Redevelopers face many challenges. Here is an incomplete discussion about some of the most critical Tasks. Negotiate the acquisition price and terms Property Redevelopers need to negotiate an acquisition price that does not need to be paid in cash to the seller at closing. Redevelopers attempt to minimize their out-of-pocket cash and maximize their control of the property. Option agreements, sales contracts with variable good faith deposit conditions, or management and consulting agreements can be used in accomplishing this task. The important part is to control the property—not necessarily to own it. Building Renovators want to control when and how the property is sold, and under what terms and conditions. Purchase-money mortgages1 are possible alternatives for Property Redevelopers to minimize their up-front cash obligations, but these mortgages should be non-recourse2 to the Property Redevelopers and have pre-negotiated deeds in lieu of foreclosure provisions.3 Arrange carrying costs The carrying costs for redevelopment properties include not only property taxes and insurance, but also the security and maintenance of deteriorating structures. Public safety is paramount, as is the safety of employees and interim users. Carrying costs can be minimized by leasing parts of the redevelopment property to interim users. However, interim land uses can complicate or delay the eventual redevelopment of the property, especially if the neighborhood likes the interim land uses better than possible redevelopment uses. Open space afforded by playing fields or vegetable gardens can become the highest and best use of the site in the neighbors’ eyes. Also, an apparently benign use, such as a used-car lot, can cause environmental concerns about battery disposal and oil leaks. Control legal and consulting expenses Redevelopment properties can be the subject of endless legal briefs and opinions, as well as the topic of numerous research projects, architectural studies, and market surveys. Property Redevelopers must control their enthusiasm for the property and be judicious in commissioning these reports. Co-opting the local government or neighborhood organizations to undertake both these reports, and the accompanying costs, is critical. Limit maximum loss Property Redevelopers need to find a way out of the deal if (and when) everything goes wrong. Redevelopment properties can have environmental issues that could become the responsibility

Property Redevelopment   175 of the Property Redevelopers; they must arrange protection from this liability before the property is acquired. Also, structured sales arrangements that involve seller financing may have personal guarantees that obligate the Property Redeveloper. The default provisions in these agreements should limit the Property Redeveloper’s continuing liability after the contract or mortgage obligation is terminated.4 Also, Property Redevelopers do not want to inadvertently inherit old fights and feuds along with the liabilities associated with them. Develop political and neighborhood support Property Redevelopers must develop political and neighborhood support for the redevelopment without encumbering the project with future use obligations or monetary commitments. Establishing flexibility within approvals and municipal obligations, in order to respond to changing market conditions, is imperative for a viable redevelopment plan. For example, promising to build recreational facilities such as a soccer field, or donating a monetary lump sum to the municipality, are tools often used by Redevelopers. Acquire additional land parcels Property Redevelopers may acquire additional land parcels to enhance the redevelopment potential of the larger site. This assemblage process can increase the original property’s development potential in several ways: • • •

Additional land acquisitions can provide increased accessibility or exposure. Additional property acquisitions can increase the size of the redevelopment property so that it meets certain threshold requirements for redevelopment. Additional property acquisitions may eliminate a noxious adjacent land use or a troublesome neighbor.

The Property Redeveloper can easily commit too much cash to these acquisitions: control is more important than ownership. Find interim land uses Property Redevelopers must find interim land uses to defray holding costs. The rule for interim land uses is, “First do not harm.” A children’s playground or a dog park may seem innocuous at the beginning and demonstrate that the Redeveloper is a good neighbor, but these interim land uses can become permanent in the eyes of the neighbors or politicians, thereby causing political opposition to the private redevelopment of the property. However, income-producing interim land uses can afford the Redeveloper time to wait for the positive market changes. Create opportunities for Land (Re)Packagers The Property Redeveloper’s main goals are to help the Land (Re)Packager see the vision and the possible economic value of the redevelopment property. This can be easy or difficult, but it must be done. Maps, drawings, endorsements, and letters of intent from future possible users are all part of the Property Redeveloper’s tool kit to help the Land (Re)Packager understand the potential reuse of the property.

176   Part II

Property Redevelopment: controllable costs Controllable costs and expenses are ones that Property Redevelopers can and must control or limit to the best of their abilities. These costs must be identified and quantified prior to acquisition and then carefully monitored and managed during the holding period. Redevelopers must be disciplined to control these costs and to parsimoniously dole out any available cash. Acquisition costs of adjacent land parcels Property Redevelopers may have fallen in love with their property and start to think that it just needs to be a little bit bigger to capture more of the additional value that they will be creating. Redevelopers must creatively use purchase options, sales contracts, leases, and management agreements to control the adjacent land parcels and reduce cash expenditures to budgeted amounts. Marketing expenses The Property Redeveloper’s challenge is to improve the development potential of the site in the public’s eye. This is usually done with news articles published in newspapers, reported on television, or distributed on the internet. However, Redevelopers should recognize that the Land Packagers must be the real target of any marketing effort. Consequently, Redevelopers cannot afford to spend too much cash on general advertising or promotion. Some Property Redevelopers have effectively used social media as a low-cost marketing medium.5 Sales and leasing fees Developers must avoid inadvertently paying sales commissions or leasing fees in the process of holding and promoting the property, finding interim uses, and acquiring additional sites. Properties with a long history usually have a long history of persons who would like to benefit from sales or leasing commissions. The seller should guarantee that there are no outstanding commissions to be paid. Consulting expenses Finally, the number of interesting studies and volume of valuable advice can overwhelm Property Redevelopers, so they must be judicious in engaging structural engineers, historians, environmental engineers, political lobbyists, designers, architects, and marketing consultants with a keen sense of how the study findings will enhance the property’s redevelopment potential.

Property Redevelopment: major risks Property Redevelopers face the same major risks as Land Bankers, only more nuanced and in a more politically charged environment. Acquired land parcels The acquired property may never become attractive to the general public or specific users because of economic changes, such as a recession. Demographic changes can also alter

Property Redevelopment   177 the attractiveness of the property, such as the “millennium generation” having a preference for living in loft apartments in old warehouse neighborhoods—changes in tastes and preferences may also be caused by new urban immigrants who don’t embrace golf or tennis facilities. Public infrastructure projects Under the best of conditions, public infrastructure projects take a long time to be completed. Unfortunately, infrastructure projects are constantly being announced by public authorities and then abandoned when the desired funding was not obtained. Also, new transit systems may not be considered desirable because of population changes, or a light rail-line project may be abandoned because of cost over-runs. Alternatively, the municipal water and sewer lines may not be extended because of lawsuits or inter-jurisdictional conflicts. Environmental issues Environmental issues are always problematic and should be researched and evaluated during the due diligence study period. Unfortunately, environmental issues can also be discovered after closing. Some examples of possible environmental issues may be: • • •

the underground water table was contaminated much more than initially thought; the building was constructed and insulated with hazardous materials throughout; a valuable archeological site was discovered on the property.

Neighborhood social issues or problems Urban neighborhoods are constantly changing, and sometimes not for the good. The city may have decided to abandon plans to improve or rehabilitate a neighborhood for any number of reasons. Increases in crime or murder rates inhibit the public will to invest in an area. Also, domestic riots or terrorism activities can stigmatize an area with a bad reputation. Property Redevelopers must be prepared for these changes and plan for a much longer holding period.

Case studies of the Property Redevelopment Stage Three case studies of the Property Redevelopment Stage of the Real Estate Development Process are presented here to demonstrate and illustrate many of the discussion points in this chapter. Below are Property Redevelopment case studies of an old insane asylum, a defunct municipal airport, and an abandoned railroad yard. Historic St. Elizabeth’s Hospital to become urban mixed-use development @REDM6 St Elizabeth’s Property Redevelopment case study is a good example of the District of Columbia attempting to start the active redevelopment of an under-used property by creating a concept master plan and then asking private sector developers to respond to its viability. The RFP selection process attempts to solicit new ideas and to convince the general public of the merits of the redevelopment.

178   Part II

Exhibit 12.7 Historic St. Elizabeth’s Hospital.

St. Elizabeth’s is an historic hospital campus in Washington, DC, which has been owned by the municipality since 1987. The District’s Redevelopment Authority is now exploring options for private developers to redevelop parts of the property to better serve the local neighborhood around St. Elizabeth’s and improve the economy of Washington, DC. The “federal sequestration” effort emphasized the need for Washington to diversify the local economy and reduce its reliance on the Federal Government as the major employer. St. Elizabeth’s is in the southeast quadrant of Washington, DC, the most economically underdeveloped part of the District of Columbia. It is within walking distance of the Congress Heights Metro Station on the East Campus, and within close proximity to the Anacostia Metro Station on the West Campus. There are also proposed transit ways by the District of Columbia in the area that will need to be taken into account for future land development. The East Campus was the parcel of land chosen for redevelopment. The original 600-acres tract of land was used as agricultural farmland. In 1855, the Federal Government opened the Government Hospital for the Insane (see Exhibit 12.7). The hospital operated primarily as a mental institution until the Civil War, at which time soldiers were treated there and referred to it simply as St. Elizabeth’s to conceal its traditional insane asylum reputation. In 1916, the name was officially changed to St. Elizabeth’s. The hospital continued to operate as a leading institution for mental health and expanded over the 1900s. In 2010, a new hospital was completed, leaving the other historic buildings outdated and in need of renovation. The District of Columbia has owned the St. Elizabeth’s site since 1987, so the question is, “Why redevelop now?” There are several compelling reasons for the property’s redevelopment:

Property Redevelopment   179 • •





Excess Land. Unused parcels were physically developable and were near a metro site, thus creating an opportunity for a transit-oriented, mixed-use development. Underperforming. The existing buildings were functionally and physically obsolete as medical facilities, so they were no longer the “highest and best use” of the site. New higher and better uses (more appropriate uses) would generate greater property taxes for the District. Need for greater connection and access. Southeast DC is often viewed as the “wrongside-of-tracks,” so creating a new city center or urban place to promote and build the community would benefit the existing residents and increase property values by encouraging better housing and employment opportunities in Southeast DC. Diversify employment centers. The Federal Government is the largest tenant in the real estate market in Washington, DC; it is also the major employer in the District. DC is hoping to diversify the economy to create a richer economic portfolio, as well as mitigate against the consequences of any future federal sequestrations or shutdowns.

Working with the District of Columbia poses many challenges, similar to those of the Armed Forces Retirement Home and Potomac Yard when the property moves to the Land Packaging Stage of Development. They include: • • • •

Retention and renovation of historic buildings. Lack of existing employment centers already in the area. Lack of incentive for potential retailers, due to existing low-income residents. Need to create incentives for employers and people to move into the area.

The District of Columbia engaged a planning firm to develop a Phase I Concept Plan which specified 1.6 million ft2 of potential commercial development which included: • • • •

an Innovation/Academic Hub (175,000 ft2); residential Village (200 units); office/retail center (604,000 ft2); interim uses for parking (350 spaces).

In early 2014, the DC Redevelopment Authority issued a Request for Proposals (RFP) for a Phase I development of St Elizabeth’s East Campus. Phase I would encompass infrastructure, an anchor institution, an event pavilion, interim land uses, and an innovation hub. The RFP’s Executive Summary stated:7 The District of Columbia (the “District”) is seeking proposals from developers or development teams interested in serving as a Master Developer (“Respondents”) for the first phase of St. Elizabeth’s East (“Phase I”). Phase I is a 1.6 million square foot, mixed-use and technology-focused development opportunity at the East campus of the former St. Elizabeth’s Hospital in Southeast Washington, D.C. At 183-acres, St. Elizabeth’s East is the largest remaining undeveloped parcel in the country’s top real estate market and has flexible new zoning in place for approximately 5 million square feet of development. Redevelopment presents an unparalleled opportunity in the nation’s capital to create a new technology-focused community, combining business, research, higher education and residential uses in a collaborative environment. As envisioned, St. Elizabeth’s East will combine a modern “Innovation Hub” with the graceful pre-war

180   Part II

Exhibit 12.8 Redbrick LMD’s Phase I Concept Plan (2.5 million GSF).

buildings adaptively reused for convenient urban living, just an easy walk from the Congress Heights Metro Station.” The Authority included a concept master plan for 1.6 million gross square feet (GSF) of building area to help the prospective master developers visualize the potential of this redevelopment opportunity. The request for a master developer indicated that the District was unsure of the Real Estate Development Process and was looking for a master developer to effectively do everything (Land Packaging, Land Development, Building Development, and Building Operations). This was an impossible task. The RFP for Phase I was released on March 31, 2014, and the deadline for responses was June 27, 2014. Five development companies responded. On September 30, 2014, the respondents presented their proposals to the general public, and on December 29, 2014, Redbrick LMD was chosen as the master developer. Exhibit 12.8 is Redbrick LMD’s winning concept master plan. The most striking part of this well-conceived plan was that the proposed density of 2.6 million ft2 of development is 56% greater than the District’s concept plan of 1.6 million. Clearly, from the private developer’s point of view, bigger was definitely better! Edmonton City Center Airport redevelopment: a quest for sustainability @REDM8 This is a good example of the Edmonton City Council desiring to redevelop its municipal airport, which was constructed in 1932 and is currently in the middle of town. The City Council has a vision of a cutting edge, world-class, sustainable development. As shown in Exhibit 12.9, Edmonton is in the Canadian Province of Alberta, and the closed Edmonton City Center Airport (ECCA) is just north of the downtown.

Property Redevelopment   181

Exhibit 12.9 Edmonton regional map.

Exhibit 12.10 is an aerial photo of the 536-acre ECCA land that the City Council has renamed Blatchford, and would like to redevelop as an example to the international community of a sustainable place—a place that is designed to make it possible, and easy, for residents to reduce their ecological footprint and their carbon dioxide emission by specified amounts, while improving their quality of life.9 The ECCA lands were envisioned to be home to 30,000 Edmontonians living in a carbon neutral community that uses 100% renewable energy. The Council used a two-stage approach to soliciting proposals. First, a Request for Information (RFI) was issued, which emphasized an understanding of the challenges, asked respondents to outline the quality, scope and experience of the resources of the team, along with evidence of creativity and innovation in the field of sustainability. The RFI also included the “Master Plan Principles” that were to guide the respondents. There were seven main design principles: 1 2

Design Excellence. The proposed development must capture the spirit of its place and showcase the best practices of exemplary world leading design. As it unfolds over time, this community must be seen as a model for local and global design excellence. Empower People. This community should meet its demands in ways that give it better control over what it consumes. This will be a model community that empowers individuals to change their collective habits to conserve, preserve, and mindfully consume what can be generated locally and within a net zero carbon footprint.

182   Part II

Exhibit 12.10 Aerial photo of the ECCA.

3 4

5 6 7

Reduce Consumption. Buildings must be designed for a long lifecycle and be suited to flexibility and reuse without resorting to large-scale disposal. Waste should be seen as resource to be reprocessed into something useful or treated to recover value or energy. Offer Lifestyle Options. This new community must be a place where people choose to live and work and where it is easy for residents to adopt a sustainable lifestyle. Choices must be offered across all aspects of living and working, and these choices need to be sustainable and affordable. Innovate. The vision is predicated on innovation in environmental practices, social experimentation, and in economic opportunities. Measure Achievements. A clear framework and appropriate metrics must be implemented to inform the ongoing process of design, construction, and occupation. Raising the Bar. Edmonton’s vision is to expand on the successes of the leading edge sustainable communities and raise the bar worldwide for those communities who will follow.

Thirty-two submissions to the RFI were received from all over the world. They were evaluated by a panel of judges who reduced the list to five respondents who were qualified to respond to the Request for Proposals (RFP). These “preferred responders” were each given a $50,000 honorarium to work with the city to undertake a master planning exercise over a 12-month period. In 2011, the City Council chose the Perkins and Will firm to prepare a master plan and began the detailed planning of Phase I in 2013. Exhibit 12.11 shows an oblique rendering

Property Redevelopment   183

Exhibit 12.11 Winning master plan proposal.

of the Perkins and Will master plan, and a video presentation of their plan can be found at @REDM.10 The City Council had an aggressive redevelopment schedule: the official ground breaking was in 2014, and building sites were to become available in 2017. However, the worldwide glut of natural gas and oil prices caused a precipitous drop in prices, as well as a severe recession in Edmonton. Ironically, the redevelopment of the ECCA land into a world-class sustainable place will have to wait until the fossil fuel prices recover. This case study is a good example of a city not only committing to sustainable development practices, but also going to the trouble of actually defining what sustainable development means, what sustainable outcomes will look like, and setting metrics and milestones to measure the success of these goals. Potomac Yard: railyard redeveloped to an urban infill development @REDM11 This example demonstrates how a private corporation became a Property Redeveloper when it strategically changed its operations and thereby made a special purpose land into a redevelopment opportunity. The circle diagram shown in Exhibit 12.4 demonstrates how the Property Redevelopment Stage moves to the Land Packaging Stage and the Real Estate Development Process begins again. Since the late 1800s, first the Richmond Fredericksburg and Potomac Railroad (RF&P), and then CSX Transportation Corporation (CSX), used the Potomac Yard Property as a switching yard to build southbound and northbound trains (see Exhibit 12.12). Located along

184   Part II

Exhibit 12.12 Potomac Yard circa 1980.

the Potomac River in northern Virginia, most of Potomac Yard was claimed from the Potomac River using fill material. When CSX decided to change its switching yard to a more flexible location, Potomac Yard became an excess land holding. CSX decided to decommission the 80-track rail yard and its Central Operations area. The CSX main rail corridor was moved from the west side

Property Redevelopment   185

Exhibit 12.13 Decommissioned Arlington North Tract.

of the Yard to the east side, and the train-making tracks were completely removed. The flood control bridges over Four-Mile Run were left in place. Exhibits 12.13, 12.14, and 12.15 show the decommissioned Potomac Yard. After the decommissioning was complete, speculation began about the future use of Potomac Yard. In 1992, Virginia Governor L. Douglas Wilder, and Redskins football team owner, Jack Kent Cooke, arranged a press conference on the Alexandria portion of Potomac Yard, complete with a helicopter arrival, to announce that there would be a professional football stadium constructed on Potomac Yard as the new home of the Washington Redskins. Unfortunately, neither the Alexandria nor the Arlington local officials were notified of this announcement. The public outcry against the stadium was overwhelming, and for the first time in modern history, the City of Alexandria and the County of Arlington joined together to oppose the stadium development. After several weeks of media bombasts and citizens’ letters to the editors, Jack Kent Cooke announced that the stadium project at Potomac Yard would be abandoned because of “environmental issues.”12 Clearly, neither the Governor nor the Redskins owner appreciated that real estate development was a public process. Following this Public Relations debacle, CSX created several interim land uses including a warehouse, a rental car facility, and a big box retail center. Coincident with these activities, CSX arranged a sale of all of its RF&P assets to the international investment banking firm, Lazard Freres. Thus, Lazard formed Commonwealth Atlantic Properties (CAP) to take over

Exhibit 12.14 Decommissioned Arlington South Tract with flood control bridges.

Exhibit 12.15 Decommissioned Alexandria Tract.

Property Redevelopment   187 the real estate development process and begin the Land Packaging Stage of Potomac Yard, which takes us back to the examples in Chapter 7.

Summary The Property Redevelopment Stage is similar to the Land Banking Stage because it is a rather passive investment position that relies on major market trends for success. However, the Property Redevelopment Stage is also unlike the Land Banking Stage because it must deal with a history of land uses and building structures, as well as numerous neighbors and stakeholders. Property Redevelopers must seek out Land Packagers to actively change the property zoning and prepare the site for Land and Building Developers. Consequently, Property Redevelopers must identify historic and environmental issues, structural conditions of existing structures, survey and title problems, and possible sources of capital through various public-private partnership arrangements. Property Redevelopers are different from Building Renovators because they actually change the use of the property. The St. Elizabeth’s Hospital case study demonstrates how the Property Redeveloper, the District of Columbia, can promote private involvement in the development by commissioning a preliminary master plan and then requesting proposal for development (RFPs) from several private developers. The Edmonton City Center Airport case study illustrates how the Property Redeveloper, the City of Edmonton, attempted to create a vision for the redeveloped property by establishing sustainability guidelines and then engaging several qualified planning firms to prepare competing land plans for the community to consider. Finally, the Potomac Yard example shows how the Property Redeveloper, CSX Corporation, can set the stage for Land Packagers by decommissioning an old railroad yard and relocating its major rail line.

Notes   1 Purchase-money mortgages occur when the seller agrees to finance part of the purchase price as a mortgage loan.   2 Non-recourse provisions state that in the event of default and foreclosure of the note, that the lender will only look to the property for repayment of the unpaid obligations. In other words, the borrower is not personally liable for repayment of the mortgage loan.   3 Deed in lieu of foreclosure provisions means that in the event of default, the lender will accept the deed to the property as full payment of the loan obligation.   4 See endnotes 2 and 3 above.   5 The redevelopment of Atlantic Station in Atlanta, Georgia has done this successfully.   6 http://realestatedevelopmentmatrix.com/textbook/res/task1/stage7/St+Elizabeth.pdf  7 https://dgs.dc.gov/sites/default/files/dc/sites/dgs/publication/attachments/RFP-St%20Elizabeths%20 Infrastrucutre%20Phase%201.pdf   8 http://realestatedevelopmentmatrix.com/textbook/res/task1/stage7/Blatchford+Edmonton+Canada. pdf   9 James Mckellar, Lecture presentation at Johns Hopkins Carey Business School, February 27, 2015. 10 www.youtube.com/watch?v=w33nLGlcYZ0 11 http://realestatedevelopmentmatrix.com/textbook/res/task1/stage7/Potomac+Yard.pdf 12 www.washingtonpost.com/wp-srv/sports/redskins/longterm/1997/stadium/timeline/1992/ alexaban.htm

Part III

13 Real Estate Development Tasks An overview

INTRODUCTION This chapter is an overview of the Real Estate Development Task groups that form the horizontal axis on the Real Estate Development Matrix (Exhibit 13.1), which will be discussed in detail in the subsequent eight chapters. The theme of the Real Estate Development Matrix is that property value can be increased in each cell by accomplishing certain tasks that require special skills. In Part II (Chapters 5–12), the critical Tasks for each Stage of development were briefly introduced as the most important Tasks to be accomplished in that Stage. However, there are other Tasks in each Stage of Development that must also be closely examined and resolved. The Tasks that were not listed as “critical” in Part II will become the most critical ones if they are ignored or not dealt with directly. To better understand this process, the Real Estate Development Tasks that must be addressed in each Stage have been broken down into eight major groups: I Acquisition II Financing III Market Analysis and Marketing Strategies IV Environmental Issues

Exhibit 13.1 Real Estate Development Matrix.

192   Part III V VI VII VIII

Approvals and Permits Physical Improvements Transportation and Accessibility Sales and Disposition

With the exception of the Acquisition Tasks and the Sales and Disposition Tasks, each Task category requires special skills that must be mastered by real estate developers to be successful. The Acquisition Tasks and the Sales and Disposition Tasks are very similar; they are really two sides of the same coin. The major difference between these two Task groups is the perspective of the developer. The Acquisition Tasks require developers to determine how they will create value for themselves in the current Stage, while the Sales and Disposition Tasks require developers to examine the next Stage of development and how value can be created for the Buying Developers. Again, with the exception of the Acquisition Tasks, and the Sales and Disposition Tasks, these Task groups are not ranked in chronological order. Each Stage of development begins with the Acquisition Tasks and ends with the Sales and Disposition Tasks. Effectively, the other Tasks are accomplished simultaneously. These Tasks are related to and dependent upon one another. Accomplishing these Tasks is messy and confusing work. Developers must master multi-tasking and time management as they work through the Real Estate Development Process, because they must tend to everything involved in completing multiple Tasks at the same time! For example, most of the Real Estate Development Tasks require permits and approvals as well as financing, and all of the Tasks are dependent upon economic market conditions. Finally Environmental Tasks, and Transportation and Accessibility Tasks, affect all of the other tasks as well. Which Task in the most important? The one that the developer didn’t do!

A metaphorical digression Metaphorically, accomplishing these Tasks can be thought of as a mathematical programming problem with an objective function that is optimized subject to a series of limiting constraints. The traditional setup for math programing problems is as follows: Objective function: optimize, minimize, or maximize Subject to: Limiting condition 1 Limiting condition 2 Etc. The Real Estate Development Process is constantly changing since it is very dynamic and poorly specified in the sense that limiting conditions are not exact or precise. Consequently, the objective of a real estate development is not to find the optimum solution, but to find a solution that satisfies all of the limiting conditions. The objective function is said to be a “satisficing” criterion, rather than an optimizing criterion. Therefore, the Real Estate Development Process can be stated as follows: Objective function: To find a development plan that can satisfy the requirements for each task group.

Tasks: an overview   193 Subject to meeting the following conditions: Acquisition Financing Market Analysis and Marketing Strategies Environmental Issues Approvals and Permits Physical Improvements Transportation and Accessibility Sales and Disposition The Task Groups are the limiting constraints that must be satisfied. When taken together, they will hopefully define a “Feasible Set” of solutions that will meet all of these conditions. The developer’s job is to find the Feasible Set and to stay in it. The ability of the real estate development plan to withstand changing market conditions and remain in the Feasible Set is a measure of the robustness of the development plan.

Part III outline In each of the next eight chapters, a Task category, or group, is broken down and discussed in terms of the subtasks that need to be addressed, accomplished, resolved, avoided, or transferred, as follows: Chapter 14: Acquisition Tasks a b c d e

Feasibility studies Underwriting requirements Contract negotiations Due diligence reviews Closing conditions

Chapter 15: Financing Tasks a b c

Financial projections Capital formation and accumulation Financial management and reporting

Chapter 16: Market Analysis and Marketing Strategies Tasks a b c d e

Conduct site level strategies Analyze current and future market conditions Analyze competitive properties Determine promotional and advertising programs Market forecasting strategies.

Chapter 17: Environmental Issues a b c d

Phase I, II, and III environmental site assessments Certifications Atmospheric, surface, and subsurface conditions Cultural and historical conditions

194   Part III Chapter 18: Approvals and Permits Tasks a b c d

Respect the natural tension in the approvals and permits process Communicate with understanding Expect and prepare for the worst Obtain the required approvals and permits

Chapter 19: Physical Improvements Tasks a b c d

Planning and design Engineering Construction Maintenance

Chapter 20: Transportation and Accessibility Tasks a b c d

Off-site transportation On-site accessibility On- and off-site construction On- and off-site maintenance

Chapter 21: Sales and Disposition Tasks a b c d e

Seller’s due diligence Market the property for sale Negotiate and execute a sales contract Development agreements Closing transactions

Summary In each Stage of the Real Estate Development Process, all of the development Tasks must be addressed, not just the critical Tasks discussed in Part II. Each Stage begins with the Acquisition Tasks and ends with the Disposition Tasks. The other six Tasks are not listed in chronological order, nor in order of importance—rather, they are accomplished in an iterative manner, so that in the end, these Tasks are achieved almost simultaneously.

14 I. Acquisition Tasks

INTRODUCTION Each Stage of the Real Estate Development Process is comprised of eight groups of Development Tasks. To accomplish these Tasks, the developers must have a keen sense of their goals and objectives. They must answer the question, “What are we looking for?” Like the old saying goes, “If you don’t know where you are going, any road will get you there.” To understand what a good deal or opportunity would look like, developers must establish criteria with which to evaluate the opportunities, and employ a strategy to seek out and identify attractive properties. The developers must think of the Acquisition Tasks as an opportunity to do the following: • •

Acquire a property with an attractive price and acceptable terms and conditions; developers must evaluate the transaction costs. Add economic value to the acquired properties by successfully completing critical Tasks. Developers must identify exactly what critical Tasks can create value and determine if they can accomplish those tasks.

Exhibit 14.1 Real Estate Development Matrix.

196   Part III • •

Sell the improved properties to willing buyers. From the moment of acquisition, developers must look for the next owners of the properties: that is, to new developers who will undertake the challenges of the next stage of real estate development. Capture the “spread” between the cost to create1 and the value created.2 Spread is defined as the economic profit that the developer is seeking as the reward for successfully completing the Acquisition Tasks and creating additional economic value. The “spread” can also be defined as the “marginal value.”3

The Acquisition Tasks require developers to determine if they have the abilities, resources, and temperament (physical, emotional, and financial), to assemble a team to accomplish the required Tasks, as well as the wherewithal to bear the risks associated with these tasks. To clarify, the Acquisition Tasks may cause developers “to pass” or not to buy potential development properties, but the process of evaluating these properties as possible acquisitions is important. In the same manner, the Disposition Tasks (the last Task group in every stage of the Real Estate Development Process) may lead to the decision to not sell the properties and to carry forward into the next stage of development. Again, it is important to evaluate the disposition of the properties and the capturing of the value created. Even if developers do not want to sell the property, they must undertake the Acquisition Tasks for the next stage and objectively answer the question, “Would I buy this property if I didn’t already own it?” Often, the Acquisition Tasks are broken down into five subtasks: a b c d e

Feasibility studies. Underwriting requirements. Contract negotiations. Due diligence reviews. Closing conditions.

Many real estate professionals use the terms “feasibility studies,” “underwriting requirements,” and “due diligence reviews” interchangeably. However, this can be confusing, and the buyers and sellers need to agree on what they are talking about. In general, “feasibility studies” are done in conjunction with nonbinding letters of intent; “underwriting requirements” relate to the financing of the real estate; and “due diligence reviews” are conducted after a contract has been negotiated, but before closing occurs.

a. Feasibility studies The “feasibility” of a project is determined by many different studies. These studies are done by many different kinds of professionals, all of whom like to declare whether or not the project is feasible. Feasibility studies of all kinds are usually done early in the acquisition process. Often in a nonbinding Letter of Intent (LOI), prospective developers who want to buy a property are given a “free look period,” during which time they are expected to undertake the various types of feasibility studies. Physical and engineering feasibility The physical characteristics of the land and existing improvements, such as the shape and size of the lot, the site topography, the subsurface conditions, and the age and condition of

I. Acquisition   197 the improvements, are evaluated to determine if they can support the proposed development plan. Colloquially, the developers must determine if they, “can put ten pounds in a fivepound bag.” The costs to construct the proposed new improvements and implement the development plan are also determined and evaluated in terms of the adequacy and availability of the materials, as well as the availability of general contractors and major subcontractors. The simple questions are, “Can it be done?,” “How long will it take?,” and “How much will it cost?” Market feasibility Current market conditions must be determined and evaluated as a baseline from which to evaluate what future market changes can make the proposed project successful, or unsuccessful. The basic metrics include: • • • • • •

current employment levels; current rental rates of competitive properties; current vacancy rates of competitive properties; current sales prices of competitive properties; current supply (or stock) of existing competitive properties; current competitive properties that are under development.

While this market data is imperative, the real challenge is to estimate and predict future market conditions. The market feasibility study must determine how much the future market conditions must improve to make the proposed development successful and/or how much the future market conditions can deteriorate, before the proposed development is unsuccessful. Financial feasibility The financial feasibility of a proposed real estate development combines the estimated costs from the physical and engineering studies, with the expected future market conditions, to determine if the anticipated profitability meets the developers’ financial profit and investment criteria. There are many measures of profitability. The Gross Profit or Gross Margin is simply the difference between the expected Total Revenues generated by the development, and the Total Costs of the development divided by the Total Revenues: Gross Margin =

Total Revenues - Total Costs Total Revenues

This is a measure of the total return without adjustment for the time value of money. A similar return is the Overall Return, which is defined as the difference between the Total Revenues and the Total Costs divided by the Total Costs: Overall Return =

Total Revenues - Total Costs Total Costs

This Overall Return is often referred to as unlevered cash-on-cash returns. It is also compared to a market-derived Overall Capitalization Rate. The difference between the Overall Capitalization Rate and the Overall Return is called the “spread” by Building Developers.

198   Part III Developments with relatively short time periods, such as 24–36 months, are usually evaluated using Gross Profit measures or Overall Returns. Developments with longer time periods are often evaluated using time-weighted annual returns, such as internal rates of return4 or net present value calculations.5 The basic question to be addressed is, “Do the anticipated future benefits exceed the expected future costs?,” or in other words, “Do the expected returns justify the risks incurred?” An interesting controversy is the role played by the developer’s profit and whether or not it should be considered a return on investment, or a return on labor, or the cost of doing business. The point of view of this book is that developers need to earn a profit, which means that the cost of capital (both debt and equity) is a cost just like the cost of lumber. Therefore, the present value of the future benefits must exceed the present value of the future costs so that a minimum developer profit is achieved. If the Net Present Value equals zero (cost = benefits), then the project would be deemed “not feasible” since the developer’s profit would be zero. Feasibility study examples Feasibility studies6 can be very formal and lengthy or relatively short and sweet, depending on the nature of the property or the interest of the developer. Formal feasibility study: Greensboro Grove @REDM7 An excellent example of a very formal feasibility study is that of 8350 Leesburg Pike in Vienna, VA, which is currently in Stage 7, Property Redevelopment. The feasibility study evaluates the feasibility of redeveloping the 12.8-acre site, which is currently a 157,000ft2 strip shopping center, into a 2.5 millionft2 for mixed-use development. The proposed redevelopment would be a transit-oriented development that will take full advantage of multi-modal transportation accessibility options by incorporating residential (1.5 million ft2), office (700,000 ft2) and retail uses (300,000 ft2). There will be four parcels on top of two parking structures, built over the course of four phases. All towers constructed on the parking podiums are centered around the intersection of Peach Street and Grove Street, and green plazas created by the contiguous park space throughout the site, as shown in Exhibit 14.2. The study examines the current and projected market condition for each use, estimates the direct and indirect development costs of the phase-development schedule, evaluates several financial scenarios, and even suggests a partnership structure. The scope and detail of this impressive report represents the “Cadillac” version of feasibility studies. It was done by a team of real estate graduate students, with the guidance of numerous professional consultants, for the NAIOP-sponsored Capitol Challenge. Most developers could not afford nor risk the time and money that this feasibility study would require in the private sector. By the way, this study won the NAIOP competition, and the Property Redeveloper is still evaluating the possibility of undertaking this redevelopment effort. “Back of the Envelope” feasibility studies Often, Building Developers will use an abbreviated, yet revealing, format to examine the preliminary feasibility of a proposed project. In this book, this format is called the “Back of the Envelope” (BOTE) approach in memory of R.W. Finley, an Oklahoma developer who

I. Acquisition   199

Exhibit 14.2 Greensboro Grove massing study.

was discussed in Chapter 2, and who literally worked out his developments on the back of used envelopes that he carried in his vest pocket. This BOTE approach compares the expected Net Operating Income to the Total Development Costs by calculating the “Return On Total Costs” and then compares this rate to the Overall Capitalization Rate that similar and completed properties are selling for in the market. The Building Developer compares the spread, or difference between these two rates, to determine if the expected profit justifies the risk of undertaking the development. One and Two Potomac Yard @REDM8 The Back of the Envelope format was used to evaluate the construction of One and Two Potomac Yard when Crescent first considered building the office building on Land Bay A in the Arlington Portion of Potomac Yard, as discussed in Chapter 9. Crescent expected a $30 per ft2 rent, a 5% vacancy rate, and an $8.50 per ft2 operating expense, which produced a Net Operating Income (NOI) of $21.79 per ft2. When the NOI is divided by the expected total development costs of $198.59 per ft2, Return On Total Costs is 10.97%. If the market Overall Capitalization Rate (OCR) is 9.25%, then the “spread” of difference is 1.72%. Since the desired minimum spread was 1.50%, this feasibility analysis would suggest that the building development will be pursued (see Exhibit 14.3). However, when Crescent included the rental rates and expected costs associated with the Environmental Protection Agency pre-lease proposal, the NOI increased from $13.5 million

Exhibit 14.3 One and Two Potomac Yard Back of the Envelope feasibility.

I. Acquisition   201 to $13.98 million, but the expected total development costs increased from $123.4 million to $163.2 million. Consequently, the Return On Total Costs fell from 10.97% to 8.56%, and the proposed project was clearly not feasible. This is not an unusual situation as the developers get more accurate income and cost estimates. When this happens, developers need to “return to the drawing board” and re-evaluate the three commandments of real estate development: Know Thy Costs, Know Thy Market, and Know Thy Self. International Plaza @REDM9 The three-storey International Plaza IV Office project, discussed in Chapter 9, is another example of the use of the Back of the Envelope feasibility analysis (see Exhibit 14.4). In this case, the Return on Total Costs was 8.14% and the desired spread was 1.25%, so the required disposition overall capitalization rate was 6.89%. Luckily, the overall market capitalization rate is 6.75%, which when deducted from required disposition capitalization rate, indicates a net disposition capitalization rate of .14%. This would indicate a “go” decision, but in fact, because the net disposition rate is so small, the developer should go back and check all market and cost assumptions. Phipps Tower @REDM10 Crescent Resources, through a series of tax-deferred exchanges, acquired land next to the prestigious Phipps Shopping Center in the Buckhead area of Atlanta, Georgia, that was permitted for a 500,000 ft2 office tower (see Exhibit 14.5). Exhibit 14.6 is a collage of beautiful building renderings that were designed for the site. Unfortunately, the preliminary feasibility study, using the Back of the Envelope approach, indicated that the project was not economically feasible. The Return On Total Cost and the market overall capitalization rate only produced a spread of 1.31%, but the required spread was 1.50% due to the amount of risk involved. The estimated market value of the land and the direct construction costs were too high.

b. Underwriting requirements The underwriting process usually focuses on the ability of the project to attract enough capital, both debt and equity, so that it can be adequately financed. The basic question to be answered is, “Can sufficient capital be attracted to this project given the risk and returns of the development?” The underwriting process requires developers to consider both the required financial rates of return on capital and the availability of the capital. The required rates of return on debt capital include interest rates on the following types of debt capital: • • • •

fixed-rate long term mortgages; variable-rate second mortgages; variable-rate construction loans; variable-rate line-of-credit loans.

Lenders can raise the “effective” interest rate by requiring the borrowers to pay origination fees or “points.” This is a common practice and should be considered by developers.

Exhibit 14.4 International Plaza IV Back of the Envelope feasibility.

Exhibit 14.5 Phipps Back of the Envelope feasibility.

204   Part III

Exhibit 14.6 Phipps tower site plan, entrance, and tower renderings.

The availability of debt capital is usually determined by the lenders’ specified debtcoverage ratios and loan-to-value ratios. Also, lenders may require developers to provide personal guarantees or other credit enhancements. The required rates of return on equity capital are usually quoted as annual cash-on-cash rates of return11 or as internal rates of return that include each year’s cashflow, as well as the anticipated sale proceeds at the end of a specified holding period.12 The amount of available equity capital may be determined by the percentage of equity capital compared to percentage of debt capital, the expected equity payback period, or the possibility of preferred returns on specific classes of equity capital. In the underwriting process, the developer must also identify various sources of capital to determine their willingness to invest in the project. The sources may include: • • • • • •

commercial banks; life insurance companies; pension funds; venture capitalists; wealthy individuals; property sellers.

Underwriting example: Phipps Tower @REDM13 Crescent went to the capital market to see if a joint venture partner could be brought into the Phipps Tower deal to bear some of the risk. A “joint venture memo” was circulated to

I. Acquisition   205 prospective equity partners that suggested a simple joint venture structure, where Crescent would contribute the land and the new equity partner would contribute a like amount of cash to the deal. Proceeds would be split 50/50 until both partners received an 8% cumulative return and the return of their contributed capital. At that time, Crescent would receive 67% of the cash proceeds and the equity partner would receive 33%.

c. Contract negotiations The negotiations between Buying Developers and Selling Developers usually begin with a nonbinding Letter of Intent (LOI) which sets out the price of the properties being acquired, as well as the general terms and conditions of the transactions, including a “study period” that allows Buying Developers to complete their feasibility studies, as well as the underwriting process. These are non-technical and simply written documents, but they should capture the areas of agreement, as well as the areas of disagreement, and suggest a basic timeline for the deal. LOIs can be prepared by either the buyer or the seller. The more formal purchase contract (or Purchase and Sales Agreement) for a property requires the buyer to consider many additional factors surrounding the contemplated transaction, as well as a good faith deposit. The purchase contract defines how the title, control, monies, and associated risks are transferred from the seller to the buyer. Contract negotiation examples Westfields Letter of Intent @REDM14 Crescent prepared a Letter of Intent to begin the negotiations for the acquisition of 101.4 acres in the Westfields Corporate Center. This was a rather complex transaction, but it was boiled down to three pages of the most critical deal terms, including the seller’s cooperation to structure a transaction that qualifies as a “tax-deferred, Section 1031 exchange.” This nonbinding LOI did include one binding provision: the “Stand Still” provision required the seller to stop marketing the property for sale for 30 days. West Virginia Land Letter of Intent @REDM15 Acting as a prospective Land Developer, Crescent submitted a draft LOI to buy 1,348 acres of land in West Virginia. The contemplated transaction was a three-stage purchase of specified land parcels over five years. It also included a post-closing obligation that would provide the seller with a percentage of future lot sales, when and if they occurred. The salient terms of this transaction were reduced to four pages. Define the rights that are being transferred The real estate purchase contract must define which ownership rights, out of all of the “bundle of rights,” are actually being transferred from the sellers to the buyers. It is also important to define how these rights are being disclosed by the sellers. Buyers would like the sellers to fully represent and warrant the rights and conditions of the property, while on the other hand, the sellers would like to sell their property “as is” without any disclosures or guarantees. This part of the contract is usually highly negotiated, and the buyers and sellers must decide what kind and what level of risks they can tolerate. The sellers’ positions are often surprising and revealing to the buyers.

206   Part III The basic categories of representation and warranties that may be used in real estate contracts are outlined below. Status and authority of the seller: • • • • •

Seller has the legal authority. There are no prohibitions to seller’s authority. No other consents are required. There are no bankruptcy proceedings. The seller is not a foreign person.

Status of the real estate property: • • • • • • • • •

Ownership and conveyance. There are no condemnations. There are no violations of applicable law. There is no pending litigation. There are no existing liens on the property. Parties are in possession of the property. Access to the property is clear. Taxes and assessments have been paid. There are no environmental violations.

Operation of the property: • • • •

Tenant leases. Operating agreements. Books and records. Maintenance agreements.

Because of the extensive nature of these representations and warranties, such as the representation that “there are no violations of federal, state, or local environmental law or regulations,” the sellers often use qualifying language that includes “to the best of my knowledge.” To whom; from whom: • •

The contract must clearly define and identify the selling entities, as well as the buying entities. The contract must address if the contract can be transferred or assigned to other parties. Many times, these entities may change during the contract period.

Pre-closing conditions The contract must specify what conditions need to be met before the closing will occur, as well as what happens if these conditions are not met. The contract may require the completion and approval of inspection reports, property surveys, title insurance with exceptions, and financing arrangements.

I. Acquisition   207 Examples of pre-closing conditions A common and recommended condition to close a transaction is the approval by a review board of some kind. This may be a Board of Directors, an Investment Committee, a Partnership Review Committee, or an Advisory Board. While this may seem like an additional bureaucratic hurdle to close a transaction, it is rational and prudent to review the entire transaction in a considered manner with a documented report. Small development companies may resist this formality, but their larger competitors will use these boards to protect their owners, investors, and stakeholders. Crescent Resources used an Investment Committee to approve small and medium-sized deals, and large deals had to go to Duke Energy’s Board of Directors. “White Papers” were prepared for these approvals. The USF&G Insurance Company employed an Investment Committee to review and approve proposals for equity and debt proposals. These were simply referred to as “Investment Reports.” Potomac Yard Acquisition Board Approvals @REDM16 For example, the Potomac Yard acquisition for $122 million required a White Paper approval from both Crescent’s Investment Committee and Duke’s Board of Directors. Other Crescent Resources Investment Committee Approvals @REDM17 The acquisition and development of International Plaza IV required the approval of a relatively simple White Paper. However, the much larger and more complex Phipps Tower development required a very extensive White Paper for review and approval. Silo Bend Investment Committee Approval @REDM18 The investment in the 146-acre Silo Bend Industrial Park Development in Tampa, Florida, was initially approved by USF&G’s Investment Committee as a $14.8 million mortgage on three existing properties and $11.39 million equity investment in 98.2 acres in undeveloped land. One year later, USF&G was asked to make a $10.9 million mortgage on two buildings that were under construction and in which USF&G already had a 25% equity interest. These were complicated developments and complicated investments, but the transactions were laid out in a systematic format that allowed the investors to understand the risks and returns of the acquisition decision. Greenbrier Tower Acquisition Committee Approval @REDM19 The final approval of the acquisition of two matching, six-storey office towers in Chesapeake, Virginia, was presented to the Acquisition Committee of a public limited liability company. The acquisition price was $11,839,000, and the acquisition memo described the transaction, as well as the expected market condition and financial returns. Again, the acquisition transaction was highly structured, with seller financial guarantees and physical holdbacks, and there were several post-closing conditions. The acquisition memo lays out the transaction and the future operation in a systematic format to enable the Acquisition Committee to make judicious and responsible decisions.

208   Part III Deadlines, milestones, deposits Every sales contract must clearly define what time constraints are involved and clearly specify the following: 1 2 3

The deadlines and extensions. The milestones that must be met. How the good faith deposits are distributed if the time constraints are not met.

Some of these time constraints may involve a “free look” time period for feasibility studies, a time period for the buyer or seller to obtain certain permits or government approvals, or time periods for the seller to reach certain leasing or occupancy thresholds. Post-closing conditions Many times, there are contract conditions that extend beyond the closing date. For sellers, these may include the completion of certain infrastructure improvements such as roads, sewers, or a storm water management pond. For buyers, these post-closing conditions may include providing certain performance guarantees to public authorities or to private entities, as well as possible future financing obligations.

d. Due diligence reviews Due diligence reviews are usually done after the contract has been executed, but before closing occurs. (Otherwise buyers may suffer from “over-due” diligence20 or, even worse, “do-do” diligence!21) The due diligence review must confirm that the assumptions about future development and property expectations are valid and reasonable. The due diligence review is a multi-disciplinary exercise that should employ multiple professionals and multiple “sets of eyes.” In a perfect world, the due diligence review is not conducted by the people who put the deal together, or who did the original feasibility studies. The due diligence reviews must include the following areas: • • • •

Legal. Includes surveys, title encumbrances, title insurance exceptions, leases, option contracts, zoning, and subdivision restrictions. Physical. The physical dimensions of the land and improvements, number of units, structural capacities, soil conditions, environmental issues, building inspections, and plans and specifications (including “as-built” drawings). Financial. Loan commitments, note and mortgage documents, estoppels, letters of credit, and existing and required bonds. Market. Current and future rental rate projections, current and future operating expenses, projected capital expenditures, market capitalization rates, selling prices, and leasing and sell-out absorption schedules.

Effective due diligence reviews do not make assumptions; they verify and confirm them. While limiting assumptions are a common practice by professionals conducting feasibility studies, no limiting assumptions are allowed in an effective due diligence review. Therefore, effective due diligence reviews do not allow excuses such as “not enough time,” “didn’t know the difference,” or “not my field.”

I. Acquisition   209 Effective due diligence reviews confirm that there is a reasonable probability that this acquisition will meet or exceed buyers’ real estate development expectations and investment objectives. Ideally, the due diligence review is completed before the good faith deposit becomes non-refundable. Due diligence checklist @REDM22 As discussed earlier in this chapter, due diligence reviews are a multi-disciplined evaluation of the assumptions upon which the acquisition based. While every due diligence review is unique, Crescent used a 16-page checklist for the physical due diligence review. Checklists are convenient and dangerous, but they are a start. The acquisition team must also review the legal, financial, and market assumptions for accuracy, verification, and completeness.

e. Closing conditions Prior to closing, all the required conditions to close must be met, such as title insurance, surveys, reports, studies, and governmental approvals. Also, all the required documents must have been prepared, reviewed, and executed, such as deeds, notes, mortgages, guarantees, and closing statements. Prior to closing, it is imperative that the post-closing obligations for buyers and sellers are defined, documented, and guaranteed, such as road completions, utility extensions, municipal proffers, and performance assurances. Finally, the required capital for closing must be transferred, such as loans to be funded, equity commitments to be deposited, and existing loans to be repaid. Wiring instructions (to whom and when the capital is transferred) must be accurate and confirmed. There are always glitches in the transfer of funds, which is why closings are never scheduled on Fridays!

Alternative acquisition strategies Developers may have alternative acquisition strategies to the outright purchase of a property. The goal is to control the property and to capture the increase in the property’s economic value during the Real Estate Development Process. One strategy is a land lease with a purchase option. This strategy allows developers to control the land without paying the full land price all at once and instead pay an annual rental fee. Sometimes, long-term land leases (such as 99 years) are considered the same as purchasing the land, except that the lease payments allow for the developer to effectively finance the entire land cost. However, the subordination of the land lease to new mortgages can be very tricky and even prohibited in the lease agreement. A land lease can allow the lessee (buyer) to sublease the land and make improvements as permitted by the land lease. However, the lessor (current land owner) maintains ownership, title, and control of the property, subject to the land lease, while collecting annual rent from the lessee. A purchase option can be a standalone agreement or included as a provision within a land lease. The purchase option allows the optionee (the potential buyer) to acquire the property at an agreed upon price and terms. Options can very complicated and are sometimes combined with a right-of-first-offer agreement.

210   Part III

Exhibit 14.7 Feasibility schematic.

Seller financing is another strategy for developers to acquire properties with a limited amount of capital and limited liability exposure. Seller financing is an arrangement between the seller and purchaser, where the seller accepts a note and mortgage from the purchaser as part of the sales price. Often the note and mortgage provide for default arrangements that include a deed in lieu of foreclosure. Seller financing is often referred to as a “purchase money mortgage.”

Summary The Acquisition Tasks force developers to look forward to the future and determine whether or not the three commandments of the Real Estate Development Process are being met: 1 2 3

Know Thy Costs. Know Thy Market. Know Thy Self.

As Exhibit 14.7 shows, the Acquisition Tasks require a “top down” and a “bottom up” decision algorithm. That is, developers’ goals and objectives are used to identify specific properties for possible acquisition, then the properties’ characteristics and development plans must be measured against these goals and objectives. Throughout the acquisition decision process, the developers must continually ask themselves the question, “Can we really do this?”

I. Acquisition   211

Notes   1 The “cost to create” is defined as the sum of acquisition costs, holding costs, and development costs that the developer incurs.   2 The “total value created” is defined as the present value of the future benefits that the developer expects to receive. In real estate, value is further defined as the sum of the present value of annual benefits and the present value of the reversionary benefits.   3 Marginal value is defined as the total value created, minus the total cost to create that value.   4 The Internal Rate of Return is that rate of discount which will equate the original cost of the investment to the present value of the expected future benefits.   5 The “net present value” of a project is calculated by subtracting the present value of the cost of the project from the present value of the benefits of project, where the present values are calculated using an appropriate risk-adjusted rate of discount.   6 The annual “cash-on-cash return” for equity capital is also referred to as the “equity dividend rate” by real estate appraisers. It is calculated by dividing the annual cashflow after financing by the outstanding equity investment.   7 http://realestatedevelopmentmatrix.com/textbook/res/3.9.14_greensboro_grove_report.pdf   8 http://realestatedevelopmentmatrix.com/textbook/res/bote_for_land_bay_a.xls  http://realestate developmentmatrix.com/textbook/res/bay_a_fin_info__may_26.xls   9 http://realestatedevelopmentmatrix.com/textbook/res/bote_international_plaza_four.xls 10 http://realestatedevelopmentmatrix.com/textbook/r0es/phipps_bote.xls 11 The annual “cash-on-cash return” for equity capital is also referred to as the “equity dividend rate” by real estate appraisers. It is calculated by dividing the annual cashflow after financing by the outstanding equity investment. 12 The “internal rate of return on equity” is defined as that rate of discount that will equate the present value of the annual equity cashflows and the equity reversion to the initial equity investment. 13 http://realestatedevelopmentmatrix.com/textbook/res/phipps_tower_memo.pdf 14 http://realestatedevelopmentmatrix.com/textbook/res/westfield_loi.pdf 15 http://realestatedevelopmentmatrix.com/textbook/res/9-4-07Letter_IntentCabin+Mountainclean. pdf 16 http://realestatedevelopmentmatrix.com/textbook/res/potmomac_yard_acquisition_oct_2000.pdf 17 http://realestatedevelopmentmatrix.com/textbook/res/int._pl._iv_white_paper_10_16.pdf  http:// realestatedevelopmentmatrix.com/textbook/res/Phipps+Investment+11-5-07.pdf 18 http://realestatedevelopmentmatrix.com/textbook/res/war_1988_silo_bend.pdf  http://realestate developmentmatrix.com/textbook/res/war_1989_silo_bend_ii.pdf 19 http://realestatedevelopmentmatrix.com/textbook/res/ofc_1988_greenbrier_towersiii.pdf 20 Over-due diligence occurs when the buyers regret their acquisition decision by lamenting, “I wish I knew then what I know now!” 21 Do-do diligence occurs when the buyers or their team must clean up the messes (or do-dos) that occur after closing when the due diligence review was not conducted properly and thoroughly. 22 http://realestatedevelopmentmatrix.com/textbook/res/Due+Diligence+Checklist+.pdf

15 II. Financing Tasks

INTRODUCTION The Financing Tasks are highlighted in the Real Estate Development Matrix in Exhibit 15.1. While each Stage of the Real Estate of Development Process begins with the Acquisition Tasks and ends with the Disposition Tasks, the groups of Tasks in between are done simultaneously and in no particular order. Thus, while the Financing Tasks are listed second, they are not necessarily the second most important, nor the second group of Tasks to be completed. All of the Tasks are related to each other in one way or another. The Financing Tasks are closely related to the Acquisition Tasks because the property cannot be acquired unless the required capital is raised for the acquisition. The Financing Tasks require developers to determine the amount and type of capital required to fund the initial acquisition, as well as the interim holding costs, the completion of the required tasks, and the eventual disposition of the development property. Developers then must determine the most efficient method to raise the required capital and then actually raise the capital. Finally, the funds must be accurately accounted for. It should be noted that each Stage of development requires specific Financing Tasks to accommodate the specific critical

Exhibit 15.1 Real Estate Development Matrix.

II. Financing   213 Tasks and the risks involved, but the following discussion generally applies to all stages of development. The Financing Tasks can be divided into three broad categories, each consisting of many subtasks: a b c

Financial projections. Capital formation and accumulation. Financial management and reporting.

a. Financial projections Developers must estimate the amount and timing of projected capital expenditures and expenses. This discussion does not differentiate between expenditures and expenses as used in tax-accounting terms. Rather, these are all uses of funds that must be considered. Financing and accounting professionals usually compile a financial table called a Sources and Uses of Funds Statement. Real estate developers must first determine how the funds will be used and next determine appropriate sources from which to obtain these funds. Expected capital expenditures The uses of funds include acquisition costs, hard and soft construction costs, interim holding costs, and operating costs and expenses. Acquisition costs include the cost to acquire the property in the first place. This may include land, buildings, licenses, easements, municipal proffers, and/or contributions to infrastructure improvements. Developers may also need additional capital to acquire critically important adjacent properties (assemblage). If physical construction is expected, the developer must estimate both the hard costs (direct construction costs) and soft costs (indirect construction costs). Also, there will be interim holding costs between Acquisition and Disposition Stages, such as real estate taxes, property and liability insurance, as well as the maintenance and repairs of any existing structures on the property. During the Building Operation Stage, the developer must continue to pay real estate taxes, property and liability insurance, and maintenance expenses, such as utilities, common area maintenance, and other expenses defined in the lease agreements. Projected income and revenues Developers must estimate the amount of income or revenues they can reasonably expect to receive during the Real Estate Development Process. These include sales of subdivided land parcels, excess land, or the final disposition and sale of the property at the end of the holding period. The rental income should be projected from property operations, as well as from interim land uses. And finally, other income from concessions, royalties, or licenses must be estimated. Projected annual cashflows before financing At this point, the stabilized proforma income and expense statements, calculated for use in direct capitalization models as part of the underwriting review in the Acquisition Tasks, are not sufficient. The financial projections should be estimated on a yearly basis, at least.

214   Part III Construction period projections for land development, building development, and building renovation should be calculated monthly (quarterly at a minimum). Development budgets can be summarized for the expected holding period only if there are detailed periodic budgets upon which the summary is based. Monthly projections for construction expenses are necessary for the estimation of accrued construction period interest. Also, financial reports to lenders (also known as “draw requests”) during construction will need to show “actual vs. budget” comparisons on a monthly basis. The Expected Revenues and the Expected Capital and Expenses are combined into estimates of annual cashflows that are needed for the real estate enterprise to create economic value. If accurate annual cashflows cannot be estimated, then developers should not commit to the project. Usually, if the real estate development won’t work out on paper, then it won’t work out in real life. It is important to note that estimated cashflows are the basis for future accounting reports. Projected negative cashflows are fatal if not properly addressed. Negative cashflows in a development budget are very problematic, and they cannot be ignored. There should be equity reserves, lines of credit, or working capital reserves to cover them. Remember, developers make money in the long run and go broke in the short run. If you can’t make your monthly payments, then you are out of business! Financing schemes must support and complement the real estate enterprise activities that are projected above. Too often, developers try to make the development enterprise fit the available capital sources. This is usually a mistake because the financing scheme or capital structure must support the real estate enterprise, rather than vice versa. Aggressive lenders will ignore this axiom in their desire to lend money; however, developers must bear the consequences of a mismatch. For example, highly levered, short-term loans with variable interest rates for land acquisition are an unsustainable capital structure. Remember the Great Recession when developers were unable to refinance their short-term loans and consequently defaulted on the mortgages and lost their properties in foreclosure! Negative cashflow before financing and equity contributions must be addressed As Exhibit 15.2 shows, most real estate development projects have negative operating cashflows before financing and equity contributions are considered. With the exception of

Exhibit 15.2 Typical cashflow patterns in real estate development.

II. Financing   215 the Building Operations Stage, and possibly the Building Renovation Stage, the only time the positive cashflows are experienced are at the time of sale(s), which is usually at the end of the holding period. Debt capital funding and equity capital contributions need to be sufficient and available to cover these cash shortfalls. The creation of a development budget may require developers to estimate building costs, construction schedules, lease-up and sell-out periods, as well as accrue interest. These tasks are technical in nature, and developers must engage skilled professionals to join their teams. A Special Skills tab in the Real Estate Development Matrix website includes a more complete description of these skills. @REDM1 Financial projections examples Belgate @REDM2 The Belgate Land Development project in Charlotte, North Carolina, is a good example of how specific, key assumptions drive financial projections. Belgate is a 164-acre land development at the corner of I-85 and City Boulevard in Charlotte, North Carolina. The projected sales, holding costs, and development expenditures are shown on the website. The construction of the land development improvements and the sales of the finished lots are expected to occur over a five-year period. Financial projections for land developments begin with projected sales timing and amounts. The Land Developer expects to sell an inventory of finished lots, and the expected timing of the sales drives the construction schedule of the infrastructure improvements. In this example, a building lot has been pre-sold to the

Exhibit 15.3 Belgate Land Development.

216   Part III

Exhibit 15.4 Belgate preliminary projections.

Swedish retail firm, IKEA. This is the first land sale that will stimulate the future sales. The other building lots must be served by roads and utilities before they can be sold, so the physical construction must begin prior to the expected sales date. These are key assumptions that drive the financial projections. Also, marketing costs are directly related to the sales events, and the interim holding costs are determined by the outstanding land balance. The projections in the example are before any financing considerations, so the Land Developer uses an internal rate of return on total capital (IRRTC  ) as the time-weighted measure of profitability. The expected IRR TC in this case is 20%, which is considered an acceptable rate of return for the amount of risk. Essentially, the developers are looking for a spread between the IRR TC and the developer’s (weighted average) cost of capital. The developers also use a simpler measure of profitability, the Gross Margin.3 In this case, it is also acceptable, at 15% (see Exhibit 15.4). Potomac Yard Land Development @REDM4 The reference proforma in this example illustrates the complex factors that make financial projections so tricky. The 300-acre Potomac Yard land development, located in Northern Virginia, is much larger than Belgate, and the overall development period was expected to be 12 years. However, the financial projections of the land development must be attempted with the understanding that there is a tremendous amount of uncertainty in the projections. Essentially, the financial projections provide the real estate developer with a roadmap to complete the development.5 As shown on the spreadsheet, the analysis begins with the timing of the projected land sales. Then the construction of the required infrastructure is scheduled prior to the land sales. The marketing costs occur simultaneously with the land sales, while the holding costs are determined by the remaining inventory of land that the developer owns. In this case, the internal rate of return on total capital (IRRTC) is estimated to be 15%. These extensive and complicated projections are hard to grasp by possible investors, so again a simpler profitability measure is used. In this case, the Land Developer buys the land for $12.50 per building square

II. Financing   217 foot (BSF), then constructs the infrastructure for $8.50 per BSF, and finally sells the land to Building Developers for $30 per BSF over a 12-year period. Thus, the Land Developer is projecting a 33% profit margin. Of course, the detailed financial back-up and solid market research needs to be completed before these profitability measures are meaningful for decision-making. When the 15% IRR TC over the 12-year holing period was compared to the developer’s weighted-average cost-of-capital of 12%, the Board of Directors approved the acquisition. Piedmont Town Center @REDM6 The Piedmont Town Center is an example of how the preliminary financial projections are calculated. Piedmont Town Center is a mixed-use development in Charlotte, North Carolina. Building developers were evaluating the acquisition and construction of the retail and office portions of the project using the spreadsheet. The three-year projections considered the site acquisition (land cost), the construction costs (hard costs), and sales, marketing and professional costs (soft costs) that were incurred, as well as the lease-up period and the eventual sale of the office and retail space at the end of three years. These projections also included the interest on, and the repayment of, the construction loan. Because of the short development period, the use of time sensitive IRRs is not particularly meaningful. Often, Building Developers use a simple multiplier analysis to evaluate the profitability of the project. In this case, when the total cash proceeds after financing of $64,000 is divided by the total equity investment of $31,000, an equity multiple of 2.06 is indicated. This means that the Building Developers double their money doing the development. If the project takes two years, the annual return is approximately 50%, and if the project takes three years to complete, then the annual return is approximately 33%. In other words, the 2.0 equity multiplier is deemed an adequate spread for this development.

b. Capital formation and accumulation Debt vs. equity Given the risks, returns, and timing of the capital flows of the development, developers must determine the appropriate capital structure and sources. The capital structure, which is usually a combination of debt and equity, must support the real estate enterprise. For example, long-term mortgages with fixed monthly payments need to be supported by long-term leases. Also, short-term mortgages with variable interest rates and variable payments can only be sustained for special situations or projects, such as a construction loan for a specific project. Leverage is defined as the use of debt capital to finance a project. Leverage causes financial risk, and the higher the leverage (the higher the loan amounts), the greater the financial risk. Financial risk is defined in two dimensions: first, the required debt payments increase the variability and the chance of monetary default; and second, the higher loan amount increases the chance that the loan may exceed a maximum percentage of the property value (the loanto-value ratio) and cause a status default of the loan.7 Consequently, the higher the financial risk, the higher the required interest rate. This is a rule. Equity capital invested in a real estate development usually does not require fixed payments (nor distributions of money) by the developer to the equity capital holders, and it is subordinate to the mortgage loan payment. Therefore, the equity returns (or distributions) are considered riskier, and equity investors require a higher expected rate of return.

218   Part III On the other hand, equity capital will reduce the financial risk, but equity is precious and hard to come by. Equity capital will support more uncertain and variable returns from operations that are typically referred to as business risk. Therefore, the classic trade off becomes: higher leverage may increase the equity returns, but it always increases the financial risks that the equity capital must bear. Interest rates: fixed rate vs. variable rate Mortgage loans with fixed interest rates transfer the interest rate risk from the borrower (developer) to the lender. However, mortgage loans with variable interest rates transfer the interest rate risk to the borrower (developer). Consequently, lenders view variable rate loans as less risky; therefore, they usually have lower interest rates than fixed-rate loans. Variable interest rates can be managed by the borrower (developer) with caps,8 and floors,9 but this requires special skills, expertise, and diligence on behalf of the borrower. These risk management techniques are usually used only on the very largest variable-rate mortgages. The general public is familiar with real estate mortgages that are long-term, self-amortizing, fixed-rate, fixed-payment financial instruments, known as conventional home mortgages. However, in the Real Estate Development Process, these long-term, fixed-rate, fixed-payment mortgages are only appropriate for debt financing in the Building Operations Stage because the required stable income is backed by long-term leases. Mortgage term: long-term vs. short-term Long term loans are usually considered riskier to the lender because the capital is committed or invested in the project for a longer period while the shorter-term loans are less risky for the lenders. The cost differential between long-term and short-term loans is referred to as the “yield curve.” The most frequently reported yield curve compares the three-month, twoyear, five-year and 30-year U.S. Treasury Department Bonds, which are used as benchmarks for real estate mortgage rates. The yield curve is always changing, but usually the long-term loans have higher interest rates than shorter term loans. Construction loan vs. permanent loan Exhibit 15.5 compares the features of construction loans and permanent loans. Developers usually have construction loans during the Land Development, Building Development, and Building Renovation Stages in the Real Estate Development Process. These construction loans are usually then converted to, or paid off by, permanent loans when the building moves into the Building Operations Stage. These loans are very different in many aspects, as discussed below. Note: these are typical characteristics of the loan categories, but each of these factors may change or be amended to fit the specific project. Sources of loans • •

Construction loans: provided by commercial banks or savings and loan institutions that have a specialized Construction Loan Department. Permanent loans: provided by insurance companies, pension funds, sovereign wealth funds, or other long-term investors.

II. Financing   219

Exhibit 15.5 Construction loan vs. permanent loan.

Interest rates • •

Construction loans: variable interest rate that accrues during the term. Permanent loans: fixed interest rate that is paid currently as it is earned.

Loan amount • •

Construction loans: based on observable and verifiable physical improvements. Permanent loans: based on loan-to-value and a debt coverage ratios.

Payments • •

Construction loans: payments are not made until the loan matures (hopefully the end of the construction period). Permanent loans: payments are paid monthly at a fixed amount that includes an amortization (repayment) factor.

Loan balance • •

Construction loans: the loan balance increases as draws are made and interest accrues during the loan term. Permanent loans: the loan is partially amortized (reduced) over the term of the loan.

220   Part III Terms • • •

Construction loans: terms are measured in months and are based on the construction period and the lease-up (or sell-out) periods. Permanent loans: terms are measured in years, usually ten years or more. Mini-perm loans are construction loans that convert to permanent loans for two–five years after the construction is complete.

Guarantees • •

Construction loans: require a personal guarantee or a completion guarantee at a minimum. Permanent loans: secured only by the property (non-recourse) and limited personal guarantees, if any.

Funding holdback • •

Construction loans: funds are dispersed after inspections in conjunction with a construction schedule and in accordance with approved plans and specifications. Permanent loans: after initial funding, common holdbacks include tenant improvements and commissions for unleased space, as well as economic earn-outs based on income thresholds.

Commencement • •

Construction loans: commence immediately as construction draws are approved. Permanent loans: are forward committed to future performance levels, like construction completion or lease-up levels.

Tri-party agreements •

Often the developer, the construction lender, and the permanent lender enter into a binding three-party agreement that commits the permanent lender to fund the permanent loan when certain conditions or milestones are met. Tri-party agreements are most common when the Building Developer expects to continue to the Building Operations Stage.

Possible conflicts When the construction loan is replaced by the permanent loan, three conditions may occur: 1 2 3

If the amount of the construction loan equals the permanent mortgage, then the construction loan is paid off and the developer begins to make monthly payments. If the construction loan is greater than the permanent mortgage, then the developer must use outside funds to pay off the construction loan. These additional funds may come from gap mortgages, mezzanine loans,10 or equity contributions. If the construction loan is less than the permanent loan, then the developer may use the excess funds to establish operating reserves, pay cumulative preferred returns to the equity partners, repay the equity partners, or distribute the proceeds to the equity partners.

II. Financing   221 Seller financing alternatives Developers, especially those in the Land Banking, Land Packaging, and Property Renovation Stages should look to the sellers as a source of funds to acquire the property. This is particularly appropriate if the property is difficult to finance, or the developers have limited equity capital sources. There are numerous ways for sellers to provide financing for developers. Each financing scheme has positive and negative aspects, but developers should be aware that their legal status and corresponding liability can change dramatically with each scheme. Purchase money mortgage The purchase money mortgage occurs when the seller accepts part of the purchase price as a note from the Buying Developer, along with a mortgage on the property. The Buying Developer becomes a borrower, and the seller becomes a lender. Land lease A land lease can be used to effectively finance 100% of the leased property. The Buying Developer becomes the lessee (or tenant), and the seller becomes the lessor (or the landlord). The lease agreement defines the rights and responsibility of each party. Option agreements The option agreement can be part of a land lease or a standalone document which gives buying developers (the optionees) the right to purchase the property from the sellers (optionor) at a specified time or time period, and at a specified price and terms. The option price may be fixed, defined, or set formulaically. Often, a first right-of-offer accompanies an option agreement. Land contract A land contract specifies what the buyer’s payments will be and under what circumstances the title to the property will pass from the seller to the buyer. Purchase and sale agreements A purchase and sale agreement can essentially provide long-term financing if the contract period is several years in duration. In this case, buying developers are usually required to increase the amount of good faith deposits that are nonrefundable if the transaction is not consummated. Equity capital The required amount of equity capital for a real estate development is basically the difference between the total uses of funds and the available debt capital. Developers do not necessarily need to be the source of equity capital; rather it is the developers’ task or responsibility to raise the required equity capital. Developers may choose to be equity capital contributors, but the development should be viable without the developers’ equity capital.

222   Part III Developers usually raise equity capital by contacting various possible equity investors. These may include past investors, wealthy individuals, pension funds, venture capital firms, cashrich companies, or as a last resort, friends and families. The critical factor is to match the equity investors’ objectives to the real estate enterprise’s expectations. For example, an elderly couple requiring regular monthly checks to live on would not be a good candidate to be an equity investor in a Land Banking Stage of development because of the lack of regular, periodic payments. Equity investors typically invest in real estate developments through some kind of partnership agreement(s). These agreements may be general partnerships, limited liability partnerships, or limited liability companies. These agreements state how and when the equity capital is contributed to the partnership and under what terms and conditions the equity returns are distributed to the equity partners. There may be different classes of partners with different distribution preferences, and there may also be requirements for the partners to contribute additional funds or make loans to the partnership Developers should seek out knowledgeable, skilled, and experienced equity partners and always remember that there is such a thing as “patient money.” Capital formation and accumulation examples One and Two Potomac Yard @REDM11 One and Two Potomac Yard, located in Washington, DC, is an excellent example of Financing Tasks that involve joint venture proposals. One and Two Potomac Yard are two office towers containing 619,920 rentable square feet (rft2), of which 405,087 rft2 are pre-leased to the U.S. General Services Administration for the use of the U.S. Environmental Protection Agency. If the Building Developer were to invest all of the capital to construct the project ($150 million) and then sell the leased property at an 8% capitalization rate, the developer would make a net profit of $21.2 million. Essentially the Building Developer would be building at a Return On Total Costs of 9.3% and selling at a Market Cap Rate of 8%, or a 1.3% spread. However, rather than wait 36 months, the Building Developer would prefer to attract a joint venture partner today, who will provide the required capital for the hard and soft costs and pay the Building Developer a joint venture fee to receive a percentage of the after-financing sale proceeds. In this manner, the Building Developer would be minimizing their financial exposure, accelerating their cash payment, and still retain a percentage of the net proceed from sale. For example, if the new joint venture partner paid the Building Developer $15.1 million today and provided the capital for the hard and soft costs, then the joint venture partner would share 70% of the Net Proceeds from the sale. This would give the new joint venture partner an IRR on Total Capital of 10%. Essentially, the joint venture partner is paying the Building Developer for the land up front while keeping the building in the deal to construct, lease, and manage the real estate development. This joint venture formula could be adjusted, so the joint venture partner could pay less money for the 70% share, or take a larger share of the proceeds. Building Developers need to understand the capital needs of the project, as well as the required returns of potential joint venture investors. Bent Tree Tower @REDM12 Bent Tree Tower illustrates the mortgage proposal for a mixed-use development in Dallas, Texas.

II. Financing   223 This an example of a Building Developer who expected to become a Building Operator after the project was constructed and leased. In Dallas, Texas, he was planning to build a mixed-use project on land that he already owned. The proposed project included an 11-storey office building, a two-storey bank building, a one-storey retail building, and a 713-space above-grade parking garage. He could significantly reduce his construction loan cost (interest rate and front-end points) if he had a permanent mortgage commitment that would pay off the construction loan at the end of construction period of 36 months. Consequently, he negotiated a $41 million mortgage loan commitment with a major insurance company that would take out (or pay off) the construction loan in 36 months for a one point (1%) commitment fee and a binding tri-party agreement. The initial funding of the permanent loan would be subject to loan proceed holdbacks for tenant improvements and leasing commissions for unleased space. This holdback would be funded as space was leased and built-out, and leasing commissions were due and payable. Also, there could be an economic loan proceed holdback if the gross income did not reach a threshold level of $5.8 million. However, this holdback would be funded on the basis of $2.94 for every $1 over the threshold. The Building Developer also provided a master lease that would cover negative cashflows of the project during the first 30 months of the loan. As the developer prepared to break ground for the project, he decided that the market conditions were too overheated, especially with the recent downturn in oil prices. He decided to forfeit his one point commitment fee and wait for the market to adjust to excess space and declining demand. Howell Mill Square @REDM13 The mortgage proposal for a neighborhood shopping center, Howell Mill Square, in Atlanta, Georgia, is another example of how developers must determine the appropriate capital structure and sources. The Building Developer had been constructing neighborhood shopping centers in the Greater Atlanta area. He usually sold the completed centers to investment groups, for whom he would provide property management services. However, he had found a great site (with some fill issues) and had pre-leased the 45,528 ft2 of the 86,060 ft2 total to Kroger Grocery Company; several small shop retailers had contacted him about the remaining shop space. His total development costs were $5.54 million, and he could borrow $5.45 million from a closed-end pension fund that was comprised of forward committing participating mortgages. He could borrow all of his development costs when he funded the permanent mortgage. He rationalized that this “debt joint venture” was essentially the same as selling the completed property to an investment group, except that with the participating mortgage, he owned the property and would share 45% of the increases in annual income and 50% of the proceeds for sale. This loan structure would also fund the cost of the excess land that he would buy. The permanent loan would take out the construction loan with a binding tri-party agreement, and the initial funding would be subject to holdbacks for tenant improvements, leasing commissions, and a gross income threshold. As the Building Operator, he would master lease the property until the annualized lease contracts exceeded $685,375. The loan proposal outlined was approved by the Investment Committee of the closed-end pension fund, and the center was constructed, leased on schedule and on budget. Ten years

224   Part III later, the shopping center was refinanced, the participating loan was paid off, and the additional interest was paid. A happy ending for everyone. Duke Industrial Project @REDM14 The Duke Industrial Mortgage Refinancing Proposal illustrates another solution to the problem of how to accumulate capital for real estate development projects. This example addresses the problem of a major warehouse/industrial developer who needed to refinance 1,189,214 ft2 of recently constructed properties, located in 15 buildings in four business parks that included nine warehouses, five office-showrooms, and one singlestorey office building. The proposed financing solution was to divide the portfolio into four mortgage loans that were cross-collateralized and cross-defaulted. The total loan was divided as follows: Nashville Indianapolis: Hillsdal Indianapolis: Park 100 Cincinnati Total

$10 million $12.8 million $7.7 million $22.35 million $52.85 million

Because the portfolio was 87% occupied, there were tenant improvement and leasing commission holdbacks for unleased, first generation space. The loan prohibited secondary financing on the collateralized properties, and if an individual building was sold, the “partial sale clause” required that all proceeds had to be used to pay down the portfolio loan balance. The loan agreement also provided for a yield maintenance provision in the event that an entire loan was sold or refinanced. This is also a good example of a Building Operator creating value by refinancing mortgage loans and reducing the interest expenses, thereby increasing the after-financing cashflow to the equity provider. Hilton Waterfront Hotel @REDM15 The Hilton Waterfront Hotel Mortgage Proposal illustrates other ways to accumulate capital. The new owners of the Hilton Waterfront Hotel in Annapolis, Maryland, wanted to renovate the 20-year-old hotel and change the hotel franchise to a Marriott Hotel. The Building Renovators were experienced hotel operators who designed a three-phase renovation plan that included an asbestos abatement program. After the renovations were complete and the new Marriott franchise was executed and in place, the Building Renovators agreed to a $20 million permanent mortgage with a large insurance company. The loan had a “pay and accrue” interest provision that stated if the minimum required pay rate was less than the actual interest earned, then the unpaid interest would accrue to the mortgage loan balance. The loan also included a “minimum yield provision” that provided the lender with an additional payment in the event that the property was re-financed or sold and the minimum interest rate was not paid. Hotel renovation projects are very difficult to execute successfully. This renovation project has been very successful, and is now an integral part of the historic Annapolis waterfront.

II. Financing   225

c. Financial management and reporting Future capital flows, both into and out of the development, must be managed, funded, distributed, accounted for, and reported in a timely manner. This is where “the rubber meets the road” in terms of being a credible, reliable, and trustworthy developer. Developers have fiduciary responsibilities when handling other people’s money. This is a sacred trust which must be respected. A general rule for developers is, “Good real estate projects have good accounting; bad real estate projects have bad accounting!” This rule is based on a high correlation between good accounting and good performance, and vice versa. Every development should begin with an accounting package that includes a relevant chart of accounts, and every dollar must be accounted for. If there are accounting problems, then there are financial problems which are usually caused by operational problems. When identified through accurate and timely accounting reports, these problems can be worked out, worked around, or solved outright, but they can never be ignored. Good accounting is fundamental to identifying and solving real estate development problems in a timely manner. Before a project begins, the developers must determine who will do the following: • • • •

keep the books; disburse the funds (pay the bills); collect the rents; prepare and distribute the required reports.

These people need to be identified, vetted, hired, and monitored. It is imperative to have correct names, working phone numbers, e-mail addresses, USPS addresses, and physical addresses. Every budget and schedule needs to identify who does what, and when. Communication conventions and protocols need to be established up front to ensure timeliness and minimize misunderstandings. There are reports on marketing activity, development progress, and building operations, as well as revenues and expenses. Regular and accurate reports must be submitted to the following: • • • • • • • • •

U.S. Internal Revenue Service (annually). State Department of Taxation (annually). Local taxing districts and authorities (annually). Lenders (defined in the loan documents). Equity investors (defined in the partnership agreements, usually semi-annually). Asset managers (quarterly). Property managers (monthly). Certification groups. Professional organizations (if applicable).

Annualized budgets must be based on monthly or quarterly reports that compare actual performance to budgeted expectations as variances. The most accurate, but meaningless, budgets are those which are done at the end of the year for which they are made. Don’t do this. Budgeting is a continuous activity. If the initial budgets are inaccurate, they should be

226   Part III revised and duly noted as revised budgets. Budget reports help set expectations and improve performance. Financial management and reporting example Potomac Yard @REDM16 Potomac Yard is an example of how to allocate land and infrastructure costs for land development in the budget. A difficult problem for Land Developers is the allocation of land costs and infrastructure costs to the building-ready lots, land bays, or building pads. When the individual land bays are sold, the appropriate cost allocations will establish the profit or gain from the sales. The allocation methodology used for these costs for the Potomac Yard Land Development is shown on the website example (note 16). The 12-year financial projections show the expected income from sales and the corresponding infrastructure costs, and that it will generate a 15.3% Internal Rate of Return on Total Capital (IRR TC). The IRR TC was used as a discount rate to allocate the land costs by product type: office, retail, Arlington residential, and Alexandria residential. These allocations could be used for accounting reports for tax assessors, investors, and income tax authorities. Several methodologies for cost allocations were vigorously debated by the accounting department, and this particular methodology was ultimately not chosen. While there is not a simple “right way” for cost allocations, reporting consistency is imperative.

Summary The Financing Tasks require developers to project future capital needs, raise the required capital for the project, and to report on the status and progress of the Real Estate Development Process in a timely fashion. All of these responsibilities require professionals with specialized skills. Consequently, developers must view these Tasks as “people problems” and not just as “number problems.” Making future predictions of revenues and expenses is a thankless and unrewarding task. Like weather forecasters, developers are always wrong. However, these predictions must be made, and their accuracy must be reported. The honesty and integrity of the developer depends on this. Good developments have good accounting! It is also imperative that developers match the sources of funds to the uses of funds, so that the variability of the actual events in the real estate enterprise can be supported by the capital structure. The creation and maintenance of adequate capital reserves cannot be overemphasized. Negative cashflows must be addressed immediately throughout the Real Estate Development Process.

Notes   1 http://realestatedevelopmentmatrix.com/pages/skills.html   2 http://realestatedevelopmentmatrix.com/textbook/res/Belgate+Proforma+Consolidated+Belk+ Tract+02.20.07.xls   3 The “Gross Margin” is defined as the difference between the total sales and total costs divided by the total sales.   4 http://realestatedevelopmentmatrix.com/textbook/res/2002e_land_development_model_concept_ plan.xls   5 This old saying is appropriate for Land Developers, especially with large projects, “If you don’t know where you are going, any road will get you there.”

II. Financing   227   6 http://realestatedevelopmentmatrix.com/textbook/res/Piedmont+Example+2.xls   7 A monetary default of a loan, like missing a mortgage payment, can be cured by making the required payments and penalties. However, a status default of a loan, like exceeding a maximum loan-to-value ratio, is much more difficult to cure because the borrower must reduce the outstanding loan amount to comply with the loan-to-value ratio.   8 Interest Rate Caps are a loan provision in an adjustable rate mortgage that limits the increase in the rate of interest at each anniversary date of the rate change.   9 Interest Rate Floors are a loan provision in an adjustable rate mortgage that limits the decrease in the rate of interest at each anniversary date of the rate change. 10 Mezzanine Loans cover the gap between the first mortgage debt on the property and the equity investment. This is not a secured mortgage on the property, but is secured by the investors’ equity partnership ownership of the property. William Brueggeman and Jeffrey Fisher, Real Finance and Investments, McGraw Hill, 5th Edition, p. 424. 11 http://realestatedevelopmentmatrix.com/textbook/res/just_the_facts_mar_19_clarified.xls 12 http://realestatedevelopmentmatrix.com/textbook/res/ofc._1984_bent_tree.pdf 13 http://realestatedevelopmentmatrix.com/textbook/res/ret._1984_howell_mill_square.pdf 14 http://realestatedevelopmentmatrix.com/textbook/res/duke_industrial_portfolio.pdf 15 http://realestatedevelopmentmatrix.com/textbook/res/annapolis_waterfront_hotel.pdf 16 http://realestatedevelopmentmatrix.com/textbook/res/dbk_potomac_yard_land_valuation_ analysis_11-20-02.xls

16 III. Market Analysis and Marketing Strategies Tasks

INTRODUCTION The Market Analysis and Marketing Strategies Tasks are critically important and must be done in conjunction with the other Tasks by the marketing team (see Exhibit 16.1). As always, each Stage of development begins with Task Group I. (Acquisitions) and ends with Task Group VIII. (Disposition). The Task Groups II. through VII. are done simultaneously as they are all related to each other. The Acquisition Tasks included a market feasibility study, but now developers must determine what do to, when do to it, and who should do it. The Market Analysis and Marketing Strategies Tasks begin at the site level, expand to the broader real estate markets, then focus on the smaller submarkets, and finally narrow down to competitive properties. The overriding question is, “How do developers exploit or capture the perceived market opportunities?” The Market Analysis and Marketing Strategies Tasks are sometimes confusing because developers in a given Stage of development must sell the opportunity to developers in the next Stage of development. However, both sets of developers need to understand the needs of the end-users in the Building Operations Stage. Market Analysis and Marketing Strategies Tasks can be divided into five categories that include many subtasks.

Exhibit 16.1 Real Estate Development Matrix.

III. Market Analysis & Marketing Strategies   229 a

Conduct site-level strategies. • • •

b

Analyze current and future market conditions. • • •

c

Real estate cycles. Current market conditions. Future market conditions.

Analyze competitive properties. • • •

d e

Determine what land uses should be developed on the site. Determine when the land uses should be brought to market. Determine how and by whom the land uses should be brought to market.

Key characteristics. Ranking characteristics. Weighted-ranking characteristics.

Determine promotional and advertising programs. Market forecasting strategies.

James Graaskamp, in his ULI monograph, Fundamentals of Real Estate Development, refers to marketing as the “key to development.”1 This monograph is recommended to all developers and students of real estate development as essential reading. Graaskamp’s commentary and insights are as fresh and relevant today as they were 30 years ago.

a. Conduct site level strategies What is the highest and best use? The “highest and best use” of a site is an anachronistic concept that is carved in the history of site valuation analysis. The nineteenth century concept holds the use that produces the “highest profit” to the land owner is by definition the “best use” for society. This concept was refined in the last century to mean that the highest and best use of a site use must be physically possible, legally permissible, financial viable, and produce the highest profit from reasonable and probable alternative uses.2 Graaskamp suggested that the developer should determine the “most fitting and probable use” while “recognizing strong constraints imposed by current political factors, real estate technology, the personalities and talents responsible, the money market, and short-term solvency pressures on consumer, producer, and public infrastructure.”3 Clearly, developers must evaluate and determine the use, or set of uses, that can reasonably be developed considering the dynamic and uncertain decision-making environment. The most robust use(s) is that which can withstand the biggest and most dramatic changes in the environment and still be an economically viable real estate development that can complete each of the critical Tasks. When should the land use be brought to market? Developers must determine when the land use should be brought to the market and then evaluate the timeline of development. When developers begin their respective Stage of development and acquire the site, they must estimate two time periods: first, how long will it take to accomplish the tasks and create the economic value in this Stage; and second, how long will it take until the end-user will be ready to occupy and operate the property?

230   Part III For example, Land Developers must determine how long it will take to produce the building lots for the Building Developers, but they also must be cognizant of how long it will be until Building Developers can construct the improvements, so the Building Operators can have the end-users occupy the building. If the end-users (tenants or owner-occupants) are not ready to occupy the building for six years, then Land Developers have a realistic chance of selling the finished building sites to the Building Developers. However, if the end-users need to occupy the space immediately, Land Developers cannot expect this to be a real opportunity for the Building Developers. Therefore, all developers must look to the end-users’ occupancy timetable to determine the effective demand for their products. How, and by whom, should the land uses be brought to market? Developers must be prepared to market the property from the moment that they acquire the site, even if active sales and leasing activities are several months or years away. Developers must evaluate several options to determine who the best marketing teams are for the development: that is, who can best find buyers or tenants, negotiate contracts, and close contracts in a timely and cost-effective manner. There are several options to be analyzed. In-house marketing and sales teams Developers must determine if they are going to use in-house personnel, outside companies, or a combination of both to market the property. It takes time and effort to build an in-house marketing team, and the size of the project must support this team. Existing in-house teams may not be objective in their market analysis in order to keep their jobs; they may not have sufficient market knowledge or contacts to effectively market the property; and finally the in-house teams may not have marketed this type of product before. Outside marketing and sales teams Outside marketing and sales teams are usually real estate brokerage companies. These firms must be evaluated in terms of effectiveness, availability, and reliability, as well as the existence of possible conflicts of interest. Outside marketing firms usually have a broader market knowledge and more extensive market contacts than inside firms. They are usually more objective in their market analysis since they do not want to waste their time and energies on marginal products or weak markets. However, they may have other clients with timetables that conflict with the developer’s expectations. In-house and outside marketing combination teams Often, developers may have marketing people on their teams who are responsible for cultivating and maintaining good relationships with outside marketing firms. This combination of inside and outside teams can be based on informal understandings or very formal listing agreements. With combination teams, the compensation agreements must be fair to all parties without causing friction or creating conflicts of interest. These relationships require open communication without violating confidentiality agreements or creating misunderstandings among the teams. Inside and outside combination teams can be very productive, effectively providing developers with the best of both worlds, but they can be tricky to manage.

III. Market Analysis & Marketing Strategies   231 Examples of site level marketing strategies Potomac Yard: residential bidders @REDM4 This Arlington Residential Project is a good example of a Land Developer determining what to sell and when at Potomac Yard (see Exhibit 16.2). When the office market softened after the September 11 terrorists’ attacks in 2001, Crescent decided to change its development schedule and develop the residential land bays in the Arlington portion of Potomac Yard to the following maximum building densities: Land Bay D East: 428,368 ft2 Land Bay E East: 365,731 ft2 Land Bay F East and West: 500,000 ft2 Total residential: 1,294,099 ft2 The development plan was to construct all of the infrastructure for Arlington, so all of the land bays could be sold. In order to understand the land development needs of the new uses and the timetable associated with their building development, Crescent had to determine how to market four land bays to Building Developers who could build and market residential products that could be rental apartments or residential condominiums. In addition, the amount of space could not be sold or developed all at once without overwhelming the market. Finally, Crescent knew that the Building Developers would want Crescent

Exhibit 16.2 Arlington residential land bays.

232   Part III to restrict the marketing of other land bays until their projects were leased, occupied, and stabilized. Faced with these marketing decisions, Crescent prepared a due diligence package for the residential land bays and then solicited Letters of Intent from interested Building Developers. The market response was overwhelming: 68 Building Developers registered for the due diligence package and signed confidentiality agreements. The potential buyers were asked to submit a non-binding Letter of Intent (LOI) in 60 days that outlined which land bays they would like to buy and what type of product (condos or rentals) they intended to build. The potential Building Developers were asked to submit a price, closing schedule, and postclosing conditions. The top eight LOIs are summarized in the matrix presented in the referenced hyperlink. After reviewing and evaluating the LOIs, Crescent decided to select TCR as the Building Developer of choice. TCR offered to buy all three land bays over a four-year period at a competitive price. TCR would build all rental units. Dealing with one Building Developer, with whom the Land Developer had done several earlier deals, substantially reduced the administrative and coordination problems, as well as the “execution risk.”5 However, when Crescent and TCR began to negotiate a binding sales contract, the contemplated deal quickly fell apart. At this point, Crescent began negotiations with Camden for a rental apartment development on Land Bay D East and with Comstock for a residential condominium development on Land Bay F East and West. These negotiations resulted in binding contracts that closed on June 11, 2004, and December 25, 2015, respectively. Westfields Corporate Park: NGA Letter of Intent @REDM6 The Westfields Corporate Park project is an example of a Building Developer who proposed major site level strategies to one end-user for a real estate development project. When Crescent acquired the 101-acre site in the Westfields Corporate Park, the development plan was to build, lease, and sell a series of mid-rise office buildings. However, when the National Geospatial Intelligence Agency (NGA) disclosed its plans to consolidate its Northern Virginia operations into a single area, Crescent proposed a major development to the NGA through its broker, Millennium Realty Advisors. The proposal is presented on the companion website. The proposal outlined the following options: 1 2 3

Sell the 101-acre site to NGA with the right to develop the 1.2 million ft2 project for $44 million. Sell the 101-acre site to NGA without the right to develop the 1.2 million ft2 project for $55 million. Develop the 1.2 million ft2 project on a turnkey basis and lease it to NGA for 20 years at an annual net rental rate equal to 11% of total development costs.

The NGA responded that it was very interested in the third option and asked Crescent to prepare a site plan that met its space and security needs. Crescent prepared a site plan that satisfied the Level V security requirements, as well as its current and future office needs. See Exhibit 16.3, NGA site plan. After several meetings with NGA and incurring extensive design and architectural expense, Crescent was informed that the NGA had decided to stay where it was. Essentially, Crescent was used as a negotiating strawman by the NGA to negotiate a better deal at its current location.7

III. Market Analysis & Marketing Strategies   233

Exhibit 16.3 NGA site plan.

b. Analyze current and future market conditions Read and listen The best way to determine the current and future market conditions is for developers to read, read, and read everything they can, such as: • • •

national and regional publications (newspapers, magazines); local newsletters (online discussions of the regional and local economic conditions); online market surveys that are produced by national and regional brokerage firms, as well as market research firms.

However, it is also important for developers to network with local human beings such as: • • •

real estate agents; business and civic leaders; politicians and government officials.

Real estate market cycles @REDM8 Real estate markets follow a predictable cyclical pattern; however, it is very difficult to accurately predict the length and turning points in the cycle. To complicate matters, different cities and different product types within those cities may be at different points in the real estate development cycle.

234   Part III The best reports of the real estate development cycles are produced by Glenn Mueller and his firm, Dividend Capital. These reports are produced quarterly and are highly recommended. The graphical analysis in these reports demonstrates the pattern of the cycle and the characteristics of each part of the cycle. The reports present existing market conditions, as well as predicted future market conditions. The reports are non-technical and readily grasped by professionals. “The cycle forecast analyzes occupancy movements in five property types in more than 50 Metropolitan Statistical Areas (MSAs).”9 Market cycle analysis As shown in Exhibit 16.4, Mueller’s Market Cycle Forecast presents the cyclical nature of real estate in four quadrants: • • • •

Phase I – Recovery is characterized by declining vacancies, but no new construction. Phase II – Expansion is the period when vacancy continues to decline, but new construction is added to the supply. Phase III – Hypersupply occurs when the market becomes oversaturated with a product type due to a surplus of new construction, causing vacancies to increase. Phase IV – Recession represents a recession period brought on by more completions of the new construction products and a continuing increase of vacancies resulting from the Hypersupply in Phase III. If the graph were expanded horizontally, the line would continue back into the Phase I quadrant and the cycle would start again.

The large, open dot on the cycle graphs indicates when existing rents justify new construction. Existing market cycle analysis by city Exhibit 16.5 shows the existing market cycle conditions for all product types in the 50 largest cities in the United States.

Exhibit 16.4 Mueller’s Market Cycle Forecast.

III. Market Analysis & Marketing Strategies   235

Exhibit 16.5 Existing market cycle conditions.

Future market analysis Exhibit 16.6 demonstrates how the real estate market cycle varies by city and by product type. It is important for developers to appreciate these variances to understand the current and future market cycle. Like the law of gravity, the law of real estate market cycles cannot be denied or ignored. Regional economic analysis Generally, real estate markets are much more responsive to changes in regional economic conditions than to changes in the broader national and international markets. Clearly, the local employment rates are more important than the national unemployment rates in terms of demand for local housing or retail services. Regional economists and geographers perform economic base analysis to describe local economies and predict how they will perform in the future: “Tell me your industries, and I will tell you your future,” say the economic geographers. In economic base analysis, “location quotients” are calculated for each local industrial sector by comparing the percentage of the local labor market in the industry to the percentage of the national labor market in that industry. If the location quotient is greater than one (the local percentage is higher than the national percentage), then that industry is said to be an “export” industry, rather than a “service” industry. The future economic forecasts of the export industries are used to predict the future of the local economies. The theory holds that the export industries bring money into the local economy by selling goods and services outside the local economy (selling cars, for example), which is then spent locally by consuming goods and services produced by the service industries (grocery stores, for example). For instance, the future economy of Detroit is tied to the automobile industry, while

236   Part III

Exhibit 16.6 Future market analysis, industrial. Source: Mueller, 2017

the future economy of Las Vegas is tied to the entertainment and hospitality industry as Las Vegas sells entertainment to visitors from outside of Las Vegas. The industry forecasts are then converted to jobs, which are then converted to households, which are then converted to a demand for office space, retail stores, houses, and apartments. Clearly, these industry forecasts can be very wrong and overwhelmed by national and international events, as evidenced by the Great Recession and the collapse of the banking industry (nationally and internationally). Also, delineating local markets can also be tricky. For example, the Washington, DC, market is part of the greater Metropolitan Washington Market, which is part of the BaltimoreWashington Metropolitan Area, which is part of the Boston-Washington megalopolis. For product-type analysis, start big and work into smaller submarkets As shown in Exhibit 16.7, the market analysis should begin at the larger metropolitan level (Greater Washington, DC, metropolitan area) and then reduce to smaller submarket analysis (Northern Virginia). Sometimes, these submarkets need to be further reduced to even smaller sub-submarkets (Fairfax County). The product analysis should include key economic indicators for the past five years. It is important to know where the market has been, to determine where the market is going. (Remember the real estate cycles.) Key indicators include:

III. Market Analysis & Marketing Strategies   237 • • • • • • •

existing inventory; occupancy rates; occupied space; annual absorption; rental rates; sales prices; capitalization rates.

Exhibit 16.8 demonstrates the key economic indicators for industrial/flex space in Fairfax County, Virginia. However, even though information about what has been happening in the market is readily available, predicting future market conditions is still very difficult. Forecasting future job growth and corresponding household creation is important on the demand side of the analysis. On the supply side, the projects that are under construction are readily observable and called “the pipeline.” These projects (unless abandoned) will usually be put in service over the next three years. But the projects that are planned (and sometimes permitted) may or may not be started, and therefore they may or may not be future competition. Property type analysis: regional Location: Fairfax County, VA Market: Industrial/flex space Exhibit 16.9 demonstrates the projections for three and seven years in the future. Any future predication or forecast will be wrong, so developers must determine if they can live with deteriorating market conditions or improving market conditions—for example, an increasing job growth projection is very good for the construction and sale of industrial and flex buildings. However, this improving demand may be met with ruinous competition as several large multi-phase projects could start in the near future.

Exhibit 16.7 Start big and work into smaller submarkets.

238   Part III

Exhibit 16.8 Estimating market absorption and rental rates.

Exhibit 16.9 Market forecast.

c. Analyze competitive properties Once the submarket is determined, an analysis of competitive properties must be performed. To do this, choose three to five properties that match, or are very close to, the characteristics of the proposed property (i.e. product type, size, location, user, and year built). The more similar the competitive properties are to the proposed project, the more accurate the analysis should be. However, it is often difficult to find a large sample group without leaving the submarket boundaries. It is also important to note the age of the data for the competitive properties. For example, if a competitive property was last sold at a cap rate of 9%, but the sale was 15 years ago, that data may not be useful for the analysis.

III. Market Analysis & Marketing Strategies   239

Exhibit 16.10 Competitive property analysis.

Competitive characteristics The characteristics of the proposed project should be compared to its competitors based on the characteristics that the market participants use to evaluate the property in the future. The following matrix is an example of competitive property comparisons. Exhibit 16.10 is an example of a ranking system that uses seven characteristics and a scale of 1–5 so that a perfect score would be 35. The percentage of the individual property score (out of the most possible points) gives an idea of the market attractiveness, compared to the others, as well as the proposed property. Weighted-ranking competitive characteristics The analysis above shows a ranking based on all characteristics being of equal importance. However, the analysis can be performed with a weighted average based on the importance of each characteristic. For example, proximity to local transportation may be more important than window views or shared conference rooms. The weighted average and rank among characteristics should be based on current market trends of tenants and users, or individual preferences if finding a space for a specific tenant/use.

d. Determine promotional and advertising programs Determine to whom the development should be promoted and advertised Developers must determine who will ultimately buy the property, who will rent the property, and who will influence the buyers’ and renters’ decisions. These people are the target audience

240   Part III for the promotion and advertising efforts. They must be identified and have their needs evaluated. It is important that budgets must be estimated before the advertising and promotional firms are engaged. Advertising and promotional firms may offer more flexible fee structures or a-la-carte services to match budget constraints. While the lavish best-in-class marketing packages are tempting, a keen eye on these soft costs is needed to ensure the marketing objective is met without costly extras. In-house and outside marketing professionals usually have an acute sense of how to approach the target buyers, renters, and persons of influence. Often, they will have individual contacts and third-party referrals with references. Experienced developers will have their own contacts and referrals from past business deals. Another aspect of promotion and advertising that should not be overlooked are affinity groups. These affinity groups can be professional, social, political, or charitable. If their support is important, then the outreach should begin immediately, usually on a personal basis. The timing of the public promotional and advertising campaign should be carefully planned to coincide with project milestones, seasonal holidays, and other neighborhood developments (either complementary or adverse). Determine the sales pitch and who should make it The advertising and promotion of every real estate development project needs a consistent theme that focuses on the significant features of the project and why it is important to the audience. The message or pitch needs to be easily understood and presented. The timing of the completion of the real estate development should also be included in the pitch. The pitch should explain how the development will meet the prospects’ needs, as well as explaining what the prospect should do—the “next steps” so to speak. General property promotion to the community and neighborhood The general promotion to the community and neighborhood should explain how the real estate development will improve their lives and the lives of their neighbors. Some possible advantages of the development could be the creation of new jobs, better transportation systems or improvements, and public amenities such as parks, walking paths, or recreation areas. Specific property promotion to motivated and capable buyers/renters The specific advantages that the development will provide for the prospective buyers and renters must be emphasized, regardless of how obvious they are. For example, prospective companies can have expansion opportunities while their employees can enjoy improved working conditions, shorter commutes, and affordable and accessible childcare. Developers may want to emphasize how “green certified buildings” will provide healthy working environments and how new floor plans will increase work efficiency and foster better communication. Determine the appropriate marketing mix The appropriate “marketing mix”10 for the development should contain a combination of promotional events and materials, electronic advertising, as well as site visits and tours.

III. Market Analysis & Marketing Strategies   241 Promotional events Promotional events are fun and productive only if they are well planned and well executed. Hiring external event planners and caterers is a must. Examples of promotional events include: • • • •

ground breaking; ribbon cutting; award presentations; holiday celebrations.

Promotional materials @REDM11 Promotional materials must be tasteful, useful, and well identified with the project. Examples include: • • • •

brochures; space planning aids; give-aways; banners.

When Crescent acquired the 101-acre site in the Westfields Corporate Park, it prepared a three-page brochure to advertise and promote the first office building that it proposed to build. This brochure includes an architect’s rendering of Commonwealth Centre One, along with the basic building specifications. This advertising piece was used mostly as a “leave behind” after the developer or leasing agents visited a prospective tenant. Another example of promotional materials is to have the building tenant prepare a promotional brochure. The U.S. Environmental Protection Agency prepared a brochure that promoted its occupancy in a new green office building. The four-page brochure, “Sustainable Buildings and the EPA: One and Two Potomac Yard,” described 12 green building features and highlighted seven building achievements. The brochure also discussed the challenges of building a LEED-certified, speculative office building. The last paragraph emphasized that thanks to a team of eight LEED Accredited Professionals working together, “The building was able to attain the sustainable attributes (described) in this report while maintaining reasonable costs and schedules.” Of course, the brochure was printed on 100% post-consumer, processed chlorine-free recycled paper, with vegetable oil-based inks! All things considered, the best endorsement of a successful building development comes from satisfied and happy building users. Electronic advertising Electronic advertising can be incredibly efficient and informative, as well as ineffective and expensive. Electronic advertising must be specifically targeted to the project and the potential user, rather than as demonstrations of the programmers’ prowess. Electronic advertising examples include: • •

social media sites; websites;

242   Part III • • •

e-mail solicitations; blogs; videos.

Site visits and tours Site visits and tours are the best way to promote a project, if they are well planned, safe, and interesting. Also, these events must not be dependent on weather conditions because it will rain, snow, or sleet. Examples of site visits and tours include: • • •

hosting industry events; neighborhood open houses; historical or cultural tours.

e. Market forecasting strategies Estimating future market conditions, like financial projections and weather forecasts, is a thankless and unrewarding exercise because the market predictions are always wrong, one way or another. The old adage about market forecasts is, “If you are making predictions, make lots of them, and if you are ever right, never let them forget it!” Of course, there are “good mistakes” that lead to a more successful project and “bad mistakes” that lead to negative results. Examples of good mistakes are underestimating rents or sales prices, or overestimating acquisition costs, development costs, or sell-out or lease-up periods. On the other hand, examples of bad mistakes are overestimating rents or sales prices, or underestimating selling or leasing costs, acquisition costs, development costs, or sell-out or lease-up periods. However, it is important to note the following: • •

Making lots of “good mistakes” means that developers will systematically underestimate the profitability of the project and consequently will always be the low bidder for a new project. Making lots of “bad mistakes” will mean that developers will systematically overestimate the profitability of a project and will consequently pay too much for it and eventually go broke.

Therefore, developers need to make their “best guesses” of the future events and then evaluate the consequences of being wrong. This type of forecasting future market conditions is called “scenario analysis.” Scenario analysis requires developers to make pessimistic, as well as optimistic, assumptions about future market conditions. Optimistic scenarios will make developers smile, but they don’t cause worries. However, pessimistic scenarios should be taken very seriously as they will indicate the level of risk in the project. If market conditions deteriorate, developers need to determine what can be done to avoid disastrous loan defaults, negative cashflows, or bankruptcy.

Summary The Market Analysis and Marketing Strategies Tasks require skilled and knowledgeable market analysts. Developers need to reach out to professionals outside of their company to participate in the market analysis and strategy and to be part of the marketing team. The

III. Market Analysis & Marketing Strategies   243 overwhelming abundance of data in our electronic and connected marketplace forces developers to critically analyze relevant trends and emerging market changes. The Market Analysis and Marketing Strategies Tasks are performed continuously throughout the Real Estate Development Process. The results of these tasks affect every other set of development Tasks.

Notes   1 Graaskamp, James A. Fundamentals of Real Estate Development, Washington, DC: ULI–The Urban Land Institute, 1981. p. 23.   2 Boyce, Byrl, ed. Real Estate Terminology. Cambridge, MA: Ballinger Publishing Co., 1975.   3 Graaskamp, James A. Fundamentals of Real Estate Development, Washington, DC: ULI–The Urban Land Institute, 1981. p. 11.   4 http://realestatedevelopmentmatrix.com/textbook/res/arl._res_loi_sum_8_bidders.xls   5 The “execution risk” refers to the possibility that the Building Developers cannot accomplish the necessary tasks for a successful project. In other words, they can’t do what’s got to be done!   6 http://realestatedevelopmentmatrix.com/textbook/res/NGA+letter+of+Intent.pdf   7 Sometimes you get the bear; sometimes the bear gets you!   8 http://realestatedevelopmentmatrix.com/textbook/res/Mueller+-+Black+Creek+-+2nd+Quarter+ 2018+Market+Cycle+Forecast.pdf   9 http://realestatedevelopmentmatrix.com/textbook/res/Mueller+-+Black+Creek+-+2nd+Quarter+ 2017+Market+Cycle+Forecast.pdf 10 Marketing mix is a foundational concept in market theory and practice that emphasizes the appropriate combination of four to eight Ps: product, people, promotion, place, process, people, physical elements, and performance. 11 Westfields brochure: http://realestatedevelopmentmatrix.com/textbook/res/Westfields+Marketing+ Brochure.pdf and EPA brochure: http://realestatedevelopmentmatrix.com/textbook/res/20121105 161247660.pdf

17 IV. Environmental Issues

INTRODUCTION Environmental Issues is the fourth group of developmental Tasks in the Real Estate Development Matrix (see Exhibit 17.1). Remember, the Task order is arbitrary except that the Acquisition Tasks are done first and the Disposition Tasks are done last. Otherwise, the Tasks may be completed in any order. Environmental Issues may be addressed as a condition to close the purchase contract, before financing is approved, or as part of a marketing strategy. They may be done simultaneously, or in conjunction with the approval and permitting process. However, they are always addressed before the actual construction of the new physical improvements are begun on the site. Any discussion of environmental issues can quickly devolve into a political, moral, or religious discussion since there are so many environmental buzzwords that are poorly defined and generally misunderstood. Sixty percent of Americans like to think of themselves as “environmentalists,” as environmentalism is the most popular political affiliation. However, environmental discussions usually involve terms like “sustainability,” “green buildings,” “global warming” (aka climate change), “infrastructure” (both physical and social), and “public-private” partnerships. Often, these terms are reduced to articles of faith, e.g., “I don’t believe in that.”

Exhibit 17.1 Real Estate Development Matrix.

IV. Environmental Issues   245 For real estate developers, these terms and issues are part of their business landscape and economic reality. Developers ignore these issues at their peril—they should understand what these issues are and how to deal with them. Of course, each Stage of development presents these issues differently, but they cannot be ignored. This is also a set of Tasks that requires experienced professionals. Environmental laws are very confusing because most of the environmental restrictions for real estate are defined by administrative regulations, which have the same effect as laws.1 Today, developers can hire environmental engineers and environmental scientists who have specialized degrees in environmental issues. This field is growing rapidly, and the need for qualified and credentialed experts is tremendous. The simple definition of sustainability as “the ability to continue a defined behavior forever,” gets murky when it is modified to be “environmental sustainability.” John Elkington first defined the “triple bottom line” as a way to define environmental sustainability.2 He incorporated the three Ps of a holistic sustainability approach: People, Planet, and Profit. A real estate development project should satisfy each of these categories to be sustainable. First, an economic profit is necessary for any business decisions. Beyond the original bottom line, adding in the concern for people includes the benefits to the neighborhood and the surrounding community. Also, when people think about sustainability, they often think of environment in terms of the “Planet.” This takes into account environmental protection and conservation and analyzes the entire life cycle of a real estate development project from construction, materials, uses, and then redevelopment or destruction. This concept is shown in Exhibit 17.2 in the Venn diagram.

Exhibit 17.2 Triple bottom line.

246   Part III Many real estate development firms have embraced the sustainability movement, and Oaktree Development LLC3 has added a fourth “P,” for Partnership.4 Oaktree believes that this partnership is required between the developer, governing associations, and the community. Oaktree has also developed its “guiding principles for smart growth” in terms of the following criteria for prospective developments: • • • • • • • •

sense of place; walkability; community collaboration; transit-oriented; mixed-use; choice of housing; compact design; green design.

Whether or not Oaktree Development LLC is correct, it provides a leadership role in dealing with environmental issues. As noted above, the discussion of environmental issues is complicated and multifaceted. In this chapter, the discussion of environmental issues is divided into four categories of Tasks: 1 2 3 4

Phase I, II, and II environmental site assessments. Certifications. Atmospheric, surface, and subsurface conditions. Cultural and historical conditions.

a. Phase I, II, and III environmental site assessments Environmental site assessments are an important part of risk management for developers, and usually they are addressed in the Acquisition Tasks. Phase I reports should indicate if Phase II testing is required, and the results of the Phase II tests determine the necessary Phase III action (see Exhibit 17.3).

Exhibit 17.3 Environmental site assessments.

IV. Environmental Issues   247 Phase I environmental site assessment A Phase I environmental site assessment summarizes the environmental conditions found on the site by environmental professionals, who review the existing public records of the site and the adjacent land uses, visit the site, interview persons who have had past involvement with the site, and prepare a very complete report of their findings and conclusions.5 A Phase I environmental site assessment should be conducted before any property is acquired by the developers. This should be part of the due diligence review and a condition for closing. Public records review The public records review should determine if the current or past uses of the property could have caused environmental damage on the site. The public records for adjacent land uses are also reviewed in terms of possible environmental contamination. This review also involves historical aerial photos, as well as records by local fire and police departments, and water and sewer authorities. Site visits Physical, on-site inspections are critical to determine if the current buildings, improvements, and land conditions could have a negative environmental effect on the property. The site boundaries are usually verified and photos are taken to document the visit. Adjacent properties may also be inspected if deemed necessary. There is no testing or sampling during the Phase I site visit. Personal interviews The environmental inspectors attempt to interview anyone who may have information about the historical land uses on the site. These people may include present and past owners, property managers, and tenants. If possible, persons familiar with the adjacent land holders are also interviewed, along with various governmental regulators. The Environmental Site Assessment Report6 The Phase I Environmental Site Assessment Report is very formally prepared and written. The report includes a summary of the documentation review, the scope of services, the relevant findings and opinions, the critical data gaps (if any), and a conclusion of the recognized environmental conditions on the site.7 A sample of a Phase I environmental site assessment can be found on the companion website. Phase II environmental site assessment If the Phase I Environmental Site Assessment Report indicates the existence or high probability of pollution or contamination on the site, developers should commission a Phase II Environmental Site Assessment Report. “Contamination” and “pollution” are politically charged terms. In fact, all water and soils are contaminated or polluted with some kind of chemical constituents. The real issue is the level of contamination compared to specific thresholds or levels, which are deemed to be dangerous or hazardous. Initially, the Phase II

248   Part III issues are limited to verify the existence and extent of the environmental conditions. If the contamination exists above the predetermined thresholds, then a more complete study is undertaken, which usually involves hydrological or soil issues. Hydrological issues The hydrological issues are usually undertaken to determine ground water characteristics. The constituent chemicals are compared to various levels and thresholds to evaluate the need for remediation or additional monitoring. Soil issues Investigating soil issues attempts to determine the chemical makeup of the soil, to find out if there are significant amounts of contaminants that will require remediation or monitoring, or that might create land use limitations.8 Phase II environmental site assessments are commissioned by developers to evaluate the extent of the contaminated substances. Almost always, this type of analysis helps to reduce the risks of the site because the actual knowledge of what environmental conditions are present helps to add clarity and understanding to what can be a very delicate situation. Land Packagers will do Phase II studies so that the public discussion of approvals needed takes place in a more rational and less hysterical manner. Land Developers will carry out environmental studies to allay the fears and anxieties of community leaders, as well as potential Building Developers. Phase II issues are all somewhat unique, as they are determined by the type and extent of contamination or pollution. Usually, these issues will recommend a course of action for the developer. Phase III environmental site assessment 9 Phase III environmental site assessment determines what remediation is necessary, and what benchmarks will indicate when the actual remediation efforts are successful. At the end of the Phase III remediation program, developers apply for a “no further action” letter from the appropriate regulatory authority—usually the state Environmental Protection Agency. Once this letter is in hand, the environmental site assessment process is deemed complete, with certification that the hazard is no longer present, or in some cases, may be monitored and contained. On page eight of a “no further action letter” from the Ohio EPA, the magic words appear: On the basis of this information and my direct involvement throughout the voluntary action at the Property, I have determined that this Property meets the applicable standards under the Ohio Environmental Protection Agency’s VAP. Accordingly, there is no further action required at the Property.10 It should be noted that the above paragraph is surrounded by 21 pages of limiting conditions and caveats. Phase I, II, and III environmental site assessments focus on problem areas where environmental laws or regulations may have been, or may be, violated. Phase I issues are a

IV. Environmental Issues   249 necessary part of any real estate acquisition. However, Phase II and Phase III issues may be necessary and require technical expertise, political savvy, and objective problem-solving.

b. Certifications Environmental or sustainability building certifications are very popular among private building users (tenants), regulatory agencies, and governmental building users such as the General Services Administration (GSA) and the U.S. Department of Defense. However, many private developers have been skeptical about the validity of, or need for, these certifications—but the participants in the broad real estate market have generally embraced them. Environmental certifications have become the market standard for many types of property, especially new office buildings. Environment certification for buildings and land developments are becoming part of the Real Estate Development Process in the 21st century. Complying with these certifications can help developers find synergies and greater efficiencies within a development. The certifications force developers in one Stage of development to think about the eventual building users in other Stages of the development process. Land Developers must be keenly aware of the green building certification requirements of the Building Developer, and the Building Developer must fully appreciate the property management requirements in the Building Operations Stage. Generally, green certified buildings are developed in a more thoughtful manner than non-certified buildings. In some municipalities, specific green certifications are required, and sometimes the local codes have raised even higher standards than the third-party certifications. Many developers have complained that it is improper to have political lobbyist organizations like the United States Green Building Council (USGBC) provide required government certifications. This argument has led to some municipalities setting their own environmental ratings. This murky process is here to stay, so developers in every Stage need to become knowledgeable about the environmental certification game and learn how to participate in one way or another. Below are four groups that are actively promoting environmental certification programs for commercial building: • • • •

United States Green Building Council’s Leadership in Energy and Environmental Design (LEED)11 U.S. Department of Energy and the U.S. Environmental Protection Agency’s Energy Star Program12 Building Owners and Managers Association International’s BOMA 360 Performance Program13 Green Globe Certification Program14

It is important to keep up with the times and to stay current, as the designations and certification requirements are always changing. These organizations both compete with and are complementary to each other. The costs and benefits of environmental certification programs are always debated, and there have been many issues that have attempted to quantify the costs and benefits. The major costs of environmental certifications appear to be in planning and documentation. The discipline to plan ahead and to think through the environmental consequences of the building design and operation is sometimes painful, but almost always beneficial.

250   Part III Also, the certifying organizations require reports to be submitted to document the plans for, and construction of, the improvements. The biggest cost is doing the first set of submissions for a property because subsequent building submissions are very similar. The actual additional costs of designing, engineering, and building environmentally certified buildings have been reduced to almost zero because of the widespread acceptance of the green building technologies and products. Architects and engineers no longer charge a premium for green building designs, and building product companies now provide an extensive inventory of pre-approved building products. Several statistical issues have demonstrated the correlation between property values and green building certifications, but the specific increase in value due solely to the green building certification has been hard to tease out of the data—so far. In addition, there is widespread anecdotal evidence of increased productivity in green buildings. However, green building occupants are very reluctant to provide statistical evidence. Environmental certification example @REDM15 EPA lease requirements for LEED certification A good example of the complexities of the environmental certification process is Crescent’s lease with the General Services Administration (GSA) for the U.S. Environmental Protection Agency, which required the building to have a USGBC LEED-NC Silver rating or the gross rent would be reduced by 10%! Consequently, the development team dedicated itself to obtaining the Silver Rating. Their efforts to achieve the Silver Rating were documented on a point-by-point basis. To be sure that the Silver Rating was achieved (failure was not an option), the team attempted to get more than enough points for Silver, and in the end achieved a LEED Gold certification instead. This project became the largest LEED Gold speculative office building at the time. Furthermore, the USGBC commissioned the Center for Housing Innovation at the University of Oregon to prepare a case study of the project that examined the various perspectives and insights of the assorted team members. As the notoriety of One and Two Potomac Yard’s LEED-NC Gold rating spread in the Washington, DC, region, three LEED AP professionals prepared a presentation that explained the challenges and lessons learned in the leasing of a green building to the GSA. They represented the developer (Crescent Resources), the general contractor (Davis Construction), and the green building consultant (Sustainable Design) in their presentation. The LEED-NC rating required all tenant finishes to meet the LEED standards. Potential tenants had to be informed of this requirement, as well the lease language. These specifications were viewed as onerous by the leasing agents and prospective tenants. Consequently, the Building Operators (JP Morgan), who purchased the building before completion, decided to suspend all leasing efforts until after the LEED-NC certification was awarded. Because of this competitive disadvantage, or quirk, in the rating system, the USGBC added two new LEED designations: “core and shell,” and “commercial interiors.” These designations allowed the Building Developer to construct a LEED certified building shell, and then transfer the tenant improvement requirements to the Building Operators, who could provide green interior space as the lessees specified.

IV. Environmental Issues   251

c. Atmospheric, surface, and subsurface environmental conditions The Phase I, II, and III environmental studies, as well as the green certifications discussed earlier in this chapter, deal mostly with regulatory approvals and public opinion. However, the physical site conditions discussed below will determine what can be placed on a site and how it can be developed. Developers need awareness, knowledge, and appreciation of these conditions—the sooner the better. These environmental concerns are based on the site’s specific conditions, regional environmental conditions, and, of course, adjacent properties. The list below provides some examples for each of the three most common categories that are examined for possible contamination, pollution, and structural concerns. Atmospheric conditions Atmospheric examples can be thought of as “above-ground and non- surface” issues. •







Sunlight or heat issues are often looked at as a “heat island effect.” This occurs around large, paved parking lots and black tar roofs that absorb the heat from the sun, rather than reflect it back into the atmosphere. Some solutions to this include shaded parking areas, semi-permeable surfaces, white colored roofs, and vegetative green roofs. Of course, lots of sunlight can provide opportunities for on-site solar energy production. Wind issues occur in highly developed areas (i.e. New York City) where the wind cannot easily go around buildings and instead creates very windy pathways to direct the wind around the many buildings instead of pushing directly on the flat edges. Wind can become a real issue during construction. For example, the newly constructed World Trade Center in New York City encountered serious and dangerous issues when installing windows on the upper floors; the wind gusts had to be closely monitored, and work would stop if the wind was too strong for accurate installation. On the other hand, plenty of wind can provide opportunities for on-site wind turbines Air pollution is a concern in highly industrialized areas, or areas with dense populations and exceptional amounts of vehicular traffic. This results in high levels of toxic emissions and exhausts entering the atmosphere and creating poor air quality conditions. Los Angeles and Beijing are examples of cities with major air pollution problems. Of course, properties located downwind of older sanitary water treatment plants or paper mills can experience unpleasant odors every day. Hurricanes, tornadoes, and storms of dust, rain, or sand are generally predictable. The design and construction of buildings and infrastructure in affected areas must be able to accommodate their occurrence and minimize possible damage.

Surface conditions Surface environmental issues may include the following: •

Flood plains create unique circumstances for construction and site uses. Sometimes, water must be pumped out to excavate the foundation. One common use of flood plains is athletic fields: they require large, flat, grassy areas that are able to flood without major impacts on the use. Local governments vary widely on the appropriate use for land areas in flood plains. The delineation of flood plains is done by the U.S. Federal Emergency

252   Part III







Management Agency, but the allowable uses in flood plains are usually determined locally. Streams and wetlands usually require a level of preservation and conservation for the ecosystem in the area. Wetlands are heavily regulated, and each site must be evaluated by local and state governmental agencies to determine if it meets regulations established by state and federal authorities. The United States has a series of Clean Water Acts that started in 1972 and that have been expanded and clarified ever since. The federal legislation gave the authority to protect the “waters of the United States” to the U.S. Environmental Protection Agency, and this agency in turn has empowered the U.S Army Corps of Engineers and states’ Departments of Environmental Protection. The enforcement of these laws and regulations has been very controversial as the definition of the “waters of the United States” has been interpreted very broadly by these agencies. Federal court rulings have attempted to restrict the definition and actions of the agencies, but the revised regulations continue to expand the government authority. These federal and state agencies also determine setbacks from the stream banks for the construction of manmade improvements. Developers need to recognize the vagueness of these regulations and the aggressiveness of their enforcement to avoid prolonged and costly encounters with these federal and state agencies. Forestation may include both removal of trees or the selective timbering on the site. Usually, developers are required to plant new trees on-site or to plant additional trees off-site to compensate for the loss of trees during development. Many municipalities have enacted special shade tree ordinances to further restrict on-site tree removal. Ground cover, when removed from the site, may cause soil erosion, siltation, and/or downstream flooding. Erosion control fencing and storm water management ponds are critical in reducing the negative environmental consequences of removing ground cover. In addition, the installation of impermeable surfaces such as roofs, parking lots, or roads can help mitigate the water run-off conditions caused by the removal of ground cover.

Subsurface conditions Subsurface environmental issues may include: • •





Underground water levels, or the water table (in a similar way to flood plains), cause issues for the construction of foundations, basements, road bases, and storm water run-off that must be addressed prior to construction. Soil compaction conditionals including “uncontrolled fill,” or dumping, must be dealt with to avoid dangerous foundation and settling issues. Filled in areas for building sites, roads, or parking lots need to be systematically compacted to specified threshold levels to avoid future settling problems. Geological strata conditions may determine where buildings are placed and how foundations are constructed. The removal of various rock formations will need special treatment for safe and efficient excavation. In swampy areas, the developers will need to know the depth of a stable soil formation for pile excavation. Subsurface contamination from prior land uses, which are commonly caused by old or leaking underground storage tanks, usually must be removed. Also, adjacent land uses can cause underground soil contamination as the regulated constituents flow across property lines. These conditions usually require some government agency involvement.

IV. Environmental Issues   253 •

Earthquake prone locations must be dealt with carefully and conservatively as this environmental risk can be reduced through appropriate construction techniques. There are usually state or municipal requirements for new construction in earthquake prone areas.

Subsurface conditions example: soil contamination @REDM16 The land development of Potomac Yard is a good example of a project that faced subsurface environmental issues. Potomac Yard was severely affected by two types of subsurface conditions: a layer of cinder ballast that was used in old rail track beds, and sporadic contaminated soils that existed to some extent throughout the site. The cinder ballast problem was addressed by trying to find alternative uses for the cinder ballast that ranged from burying the material under the road, to hauling it off-site for daily cover at sanitary landfill operations. Several landfills in the Washington area were interested in the cinder ballast, and one eventually agreed to haul the 70,000 yd3 of material off-site at the same rate as “clean fill.” This is a good example of finding creative alternatives and uses for “bad dirt.” When the Land Developer sold Land Bay F in Arlington to Comstock, the Building Developers, Comstock had the soil tested prior to closing. Four out of ten drilling samples contained soil with constituent levels that exceeded government thresholds. Consequently, Comstock announced that 40% of the soil that needed to be excavated for parking and foundations was contaminated and it demanded a price adjustment. Crescent had additional soil samples drilled, and the results showed virtually no contamination. This a good example of the sampling variance and inconsistency in soil testing. Crescent analyzed the numerous contamination scenarios and the cost of dealing with various levels of soil contamination. Based on this analysis, Crescent proposed that, rather than a price adjustment, Crescent would take all of the excavated dirt from Land Bay F at a rate of $9.75 per yd3. Essentially, Comstock would treat all dirt as “clean,” and Crescent would deal with any and all soil contamination issues. Crescent’s Soil Management Plan provided for all excavated dirt to be dumped nearby, tested for contamination levels, and then to be treated accordingly. It turned out that less than 3% of the dirt was contaminated and hauled off-site, so 97% was hauled to the Alexandria portion of Potomac Yard to be used as clean fill.

d. Cultural and historical conditions Beyond the ecological environment, cultural and historical environments are important aspects for developers to consider when creating a development plan. No longer are cultural and historical importance determined in the eye of the beholder. Now every major city and state has an Office of Historical Preservation that must determine the significance of the site and the effect of the proposed use on the cultural and historical aspects of the communities. Sites may have been locations of historical events or hold cultural importance for communities. Cemeteries or old burial grounds are extremely problematic because of the lack of historical records and the dearth of living relatives for consultation. It is important to include a history of the site in a proposal for a new real estate development to maintain amicable neighborhood relations and ensure the approval of the development on that site. In some cases, however, cultural and historical events may prohibit any development on a site: these may include battlefields, archeological sites, or locations of historic events. Local resources including historians, anthropologists, and neighborhood activist groups can provide information on the site and the significance of previous uses, if any.

254   Part III

Summary Environmental Issues Tasks in the Real Estate Development Process must be dealt with head-on, rather than avoided or obscured. In our information society, the facts will always be revealed. Developers need to be leaders, rather than respondents, in identifying and addressing environmental concerns. The community, lenders, investors, and business associates should view developers as pragmatic and thoughtful leaders in protecting our natural, cultural, and historic environment. Because of the long-term consequences of developers’ decisions, they are the natural leaders in the preservation and conservation of our natural resources. Developers need to understand all sides of the environmental issues facing the proposed development and strive to find pragmatic solutions or compromises to the various stakeholder positions. This can be very difficult when some stakeholders resort to name-calling and personal attacks. Developers must remember to attack the problems and not the people. No one will win the arguments about environmental issues, so a workable compromise is the main goal. Environmental issues will not go away, even after a compromise solution is reached, so developers must be constantly vigilant for alternative solutions and new issues.

Notes   1 The best readable reference for environmental laws and regulation is: Roger W. Finley and David A. Forbes. Environmental Law in a Nutshell. Eighth Edition. Thompson West. St Paul. MN., 2010. ISBN Number: 978-0-314-17720-9. The ultimate reference for environmental laws and regulations is: James B. Witkin, Editor. Environmental Aspects of Real Estate and Commercial Transactions, Fourth Edition. ABA Publishing, Chicago, Illinois. 2011. ISBN: 978-1-61632-911-2.   2 Elkington, J., Cannibals with Forks: The Triple Bottom Line of 21st Century Business, Capstone, 1997.   3 www.oakdev.com   4 From a presentation given by Chryse Gibson at Smart Growth America’s Leadership Summit, Washington, DC., 2015.   5 http://ublog.naiglobal.com/blog/2011/03/29/what-is-a-phase-1-environmental-site-assessment/   6 www.heicorporation.com/Sample-Phase-I.php   7 A sample of a Phase I Environmental Site Assessment can be found at: www.heicorporation.com/ Sample-Phase-I.php   8 www.aaienvcorp.com/phaseii.html   9 www.gaea.ca/public/ASTM_Phase_II_Example.pdf 10 http://epa.ohio.gov/portals/30/sabr/docs/a_training/Master%20NFA%20Letter%20HANDOUT. pdf page 8 11 http://leed.usgbc.org/leed.html?gclid=CLzh-_zbpMoCFcGRHwodjY0Img 12 www.energystar.gov/ 13 www.boma.org/awards/360-program/Pages/default.aspx 14 www.thegbi.org/green-globes-certification/ 15 http://realestatedevelopmentmatrix.com/textbook/res/3._the_greening_of_one_and_two_potomac_ yard_v2.pdf.  http://realestatedevelopmentmatrix.com/textbook/res/case_study_one_and_two_ potomac_yard.pdf.  http://realestatedevelopmentmatrix.com/textbook/res/2._green_leasing_to_a_ government_tenant_-_potomac_yard.pdf http://realestatedevelopmentmatrix.com/textbook/res/PY++Green+TI-Section+C-draft2-010505.pdf 16 http://realestatedevelopmentmatrix.com/textbook/res/cinder_ballast_use_options.pdf http://realestate developmentmatrix.com/textbook/res/land_bay_f_dirt_analysis_.xls  http://realestatedevelopment matrix.com/textbook/res/land_bay_f_dirt_memo.pdf

18 V. Approvals and Permits Tasks

INTRODUCTION The Real Estate Development Matrix in Exhibit 18.1 highlights the Approval and Permits Tasks in the context of the other groups of Tasks. While each Stage of the Real Estate Development Process starts with the Acquisition Tasks and ends with the Disposition Tasks, the other tasks are done almost simultaneously because they are all related to each other. One could argue that Approvals and Permits should not be a separate group of Tasks because they are such an integral part of the other Tasks, and all the other Tasks require some approvals and permits in one way or another. However, obtaining the required approvals and permits in a timely and cost-efficient manner requires special talents and skills. Unfortunately, if the developer cannot obtain the necessary permits and approvals, the project cannot continue to the next Stage of development, and the anticipated increase in economic value never occurs.

What kind of approvals and permits? @REDM1 Real estate development is a highly regulated process that requires government, as well as private, approvals and permits. An excellent checklist of all of the permits and approvals

Exhibit 18.1 Real Estate Development Matrix.

256   Part III that are necessary to acquire, develop, operate, or sell a parcel of real estate in Boston, Massachusetts, was compiled by Charles Schilke, JD. This extensive, but not quite exhaustive, list dramatically illustrates the extent to which real estate is regulated at all levels of government: federal, state, and municipal. While specific for Boston, a list of similar approvals and permits can be compiled for everywhere else in the U.S. A brief look at the major categories of approvals makes the point:   1   2   3   4   5   6   7   8   9 10 11 12 13

Building Codes Subdivisions Water Supply Water Discharges Regulated Substances Air Discharges Site Work Wetlands Coastal Zone Management State Environmental Policies State Permits Municipal Laws & Regulations Federal Laws

Often, the Approvals and Permits Tasks are broken down into four categories. The first three Tasks are philosophical in nature, but they are necessary to achieve the fourth, which is to actually obtain the required permits and approvals. Successful developers are either very skilled at getting the necessary approvals and permits for their Stage of development, or they hire very skilled professionals to achieve these Tasks. a b c d

Respect the natural tension in the approvals and permits process. Communicate with understanding. Expect and prepare for the worst. Obtain the required approvals and permits.

a. Respect the natural tension in the approvals and permits process Developers must realize that there is a “natural tension” in the approval and permitting process that can be used positively or negatively by developers. Developers must not take it personally. The natural tension is necessary for the resolution of the permit and approval requests. There are several layers of natural tension: between public agencies and private businesses; between different layers of governments, e.g., federal, state, regional, and local; between departments within a government; and between private land owners and their neighbors. Between private and public ownership rights There seems to be a “public vs. private” mentality that pervades the entire approval process. Some people believe that the more the governmental agencies can get from the private sector, the better off the public sector is. This mindset creates a “zero sum game” where there must be winners and losers. Generally, it is not a very productive strategy for obtaining approvals or permits.

V. Approvals and Permits   257 Developers need to redefine this process in terms of a “win-win” strategy, so that both sides can get what they need. There may be ideological issues involved that developers must transcend. Rather than becoming “martyrs for the cause,” developers need a pragmatic view that focuses on obtaining the necessary approvals and permits. Between federal, state, regional, and local governments @REDM2 The private sector assumes that there is a hierarchy of power so that the federal government supersedes the state government, the state government supersedes the regional government, and so on. However, all levels of government have complex relationships that determine various roles and authority (real or perceived), so developers cannot get drawn into situations of defending one governmental jurisdiction over another. For example, the District of Columbia and the United States Government constantly contest who has authority to do what in this federal city. The DC/Federal Government Memorandum of Understanding (MOU) that was agreed upon for the Armed Forces Retirement Home (AFRH) was written “solely for the unique circumstances” of the AFRH. The MOU outlined a hybrid planning-zoning process between the National Capital Planning Commission and the District of Columbia Office of Planning. This process was not to be considered precedent setting, but it was a way to resolve these long-standing conflicts on a case-by-case basis. These governmental disputes and conflicts have been going on for a long time, and developers can become “fresh meat” to be fought over. However, there are laws and regulations that must be respected by all parties, at all levels. Developers need to keep the process professional, non-partisan, objective, and focused on the outcome. Between various departments and commissions within a government In local government, especially, the various departments and commissions can have different agendas and points of view when it comes to approving real estate development of any kind. The “classic battles” are between the planning department and the public works department. Planners look at how neighborhoods should behave, while the public works department looks at how the neighborhood will be maintained in real life. Consider the following examples: • • •

Planners like streets and alleys to be narrow for neighborhood cohesion while the public works departments want broad streets with wide turning radiuses, so the snow plows, street cleaners, and maintenance equipment can do their jobs. Aesthetically-minded planners prefer down-oriented and task-focused street lighting while the security-minded public works departments prefer street lights that brighten up the whole area (including the night skies). Planners abhor buildings that are set back from property lines while public works departments like buildings that have front yards and entrances for easy emergency access.

Well-intentioned projects from parks and recreation departments can also be opposed by the public works department because of the construction issues and ongoing maintenance responsibilities. These conflicts revolve around:

258   Part III • • •

maintaining the parking lots, paths, trails, restroom and pavilions; setting and enforcing the hours of operation; providing night lighting for the public’s safety.

At the risk of overgeneralizing, historical commissions and environmental commissions usually have conflicts with everyone. Economic development departments usually present themselves as friends of developers, and consequently they are also at odds with most other municipal departments. Be careful of their “help.” Between adjacent land users and neighbors Good neighborhood relations are important, but sometimes neighbors may object to, or find offensive, legal land uses that are permitted by the existing zoning laws. Some neighbors may object to parks or recreational areas; duplexes, fourplexes, or multi-family apartments; group homes for disabled persons; or gathering places for day workers. Sometimes, land use issues arise because of vagueness or undefined terms in the zoning code. For example, neighbors may object to on-street parking restrictions, or the lack of onstreet parking restrictions, the number of unrelated persons in a household, or the definition of a “family” in a single-family residence. Proposed zoning changes may be opposed by well-intentioned neighbors, as well as by no-growth advocates. Neighbors who support a development but “Not In My Back Yard” are well known as NIMBYs. Also, no-growth zealots who may join any land use protest are known as “Not On Planet Earth” or NOPEs. No-growth advocates will grasp any opportunity to stop new developments or changes in their environments, but developers must tread lightly and attempt to ferret out their real intentions. Finally, some neighborhood groups may oppose any development unless concessions or contributions are made to their favorite cause. For example, affordable housing or lowincome housing advocates routinely campaign for contributions from all new developments, even if the land use is non-residential. Real estate is a public good Every Stage of the Real Estate Development Process requires some kind of governmental, quasi-governmental, or private approvals and/or permits. Even the most passive real estate developers (Land Bankers and Property Redevelopers) face the need to have permits for land uses and approvals for any kind of operation. Real estate developers must remember that real estate is a public good. From a pragmatic point of view, James Graaskamp contended that the developers own property to the extent that they can defend their rights: that is, developers can improve their property to the extent that laws and regulations allow them to do so. Developers must realize that the community and the various governments believe that they control what happens to, and with, the developers’ properties. This is not a debatable issue for the individual developers. This is where industry groups like NAIOP,3 Urban Land Institute,4 or the National Association of Realtors5 are valuable as advocates for broad issues involving real estate development, operation, and ownership, e.g., defining the “Waters of the United States.”

V. Approvals and Permits   259 Conflicting government approvals example @REDM6 A great example of overlapping and conflicting government approvals is the real case study that was presented by a Building Developer to a Johns Hopkins graduate real estate class on June 15, 2016. The Building Developer had negotiated a 100% pre-lease on a to-be-built, 71,000 ft2 office building on land that the developer already owned. The building development was approved by the Township in 2000, and the approval was good for ten years. Because of the Great Recession, in July 2010 the state extended the expiration of any municipal permit or approval that would have expired at any time during the period from January 1, 2009 to July 2, 2013. A subsequent act by the state amended the date to July 2, 2016. The Building Developer thought that all he had to do was to pull a building permit at the Township offices. However, the State Department of Environmental Protection (DEP) informed the developer that his National Pollutant Discharge Elimination System (NPDES) approvals and permits had expired. While these approvals were given by the DEP, they were given on behalf of the Federal Government and, consequently, were not subject to the state’s Permit Extension Act. Any development on the property would need to comply with the state’s new storm water management regulations. This would cost the developer an additional $725,000 of site work. Unfortunately for the developer, the Township had recently made revisions to the road extension requirements that would cost him another $400,000 for off-site improvements. Finally, the Township had recently passed a “steep slope” ordinance that would affect all building permits issued after July 2, 2016. The new ordinance would reduce the allowed building size from 71,000 ft2 to 35,000 ft2. The Building Developer’s dilemma was clear: should he absorb the additional $1,125,000 in development costs and pull a permit to save the 71,000 ft2 building plan and try to re-negotiate a better pre-lease deal, or walk away from the deal? The Building Developer reported that he had received his building permit prior to the July 2 deadline and had re-negotiated a slightly better pre-lease. The risk of the lower expected return on costs was considered better than losing almost 50% of the value of the potential building development.

b. Communicate with understanding When an All-Pro NFL offensive lineman was once asked how he prepared for the game on Sunday, he replied, “I know that I am going to take a beating, and I can’t fight back, so from Thursday to Sunday I just think, ‘Passive’!” Developers don’t have to think like the offensive lineman, but they also don’t want to “fight back” in the approval and permitting process. Don’t fight; make friends No one is going away. It may be hard to remember, but people will continue to come to work every day and be part of our world, like it or not. If developers can’t be friendly and gracious, then they shouldn’t go for approvals or permits. In this case, they should have another person who is knowledgeable and skilled in the permitting process apply for and respond to this Task. Most people (both private and public employees) prefer a positive and gracious business environment, rather than an angry and confrontational one. Developers and their team members need to learn about the government employees as persons: their interests, their families, and their backgrounds. It is important to find areas of

260   Part III common interest. It is also important to learn people’s names and titles (get their business cards). Remember: never trash talk their co-workers. Finally, developers should not brag about their political connections. Political connections must be used discreetly and discerningly. Find areas of agreement It is important for developers to understand their needs, but it is more important to understand the needs of others in the permitting and approval process. The government employees are not there just to say “no.” Find out what they think their jobs are, and find a way to help them do their jobs better. Mary Kay, the legendary cosmetic mogul and entrepreneur, said that everyone has an invisible sign on their chest that says, “Make me feel important!” Finally, developers cannot carry a grudge. Every meeting must start fresh. Respect is a two-way street that must be practiced every day. Structure workable compromises Successful developers understand that win-win solutions are imperative to obtain their approvals and permits quickly and efficiently. Compromised solutions are good, while outright victories don’t last. There will always be another meeting to re-trade the deal. In a speech at the ULI annual meeting in Denver, Alan Simpson, the retired U.S. Senator from Wyoming, said that, “anyone who cannot compromise on issues without compromising his character should not be in politics, nor should he be married!” This goes for real estate developers, too. Find timely resolutions Developers should know that “time wounds all deals.” Albert Einstein once said, “The most powerful force in the world is compound interest.”7 A long-fought battle to get an approval or permission is probably a folly and a temporary victory at best. In reality, negotiations are never over, so find a solution that works and then work to amend it as the development progresses.

c. Expect and prepare for the worst Understand the approval process It is imperative that developers understand the approval process or hire someone who does. In this case, ignorance is not bliss; it is a curse. There are lawyers, engineers, planners, and consultants who know the territory and the terrain. They are invaluable. The “city hall” team must do their homework and find out the history of land use decisions in the desired area. They must determine who the developers are that have already been granted the approvals that are needed for the project, as well as who has been denied the desired approvals. Precedents are important and educational. Developers must know the people who are involved with the approval process as individuals. While not taking the approvals and permits process personally, developers must appreciate that real people are involved. They must accept who people are and not try to change them, or pass judgment on them.

V. Approvals and Permits   261 It is imperative to understand who actually makes the approval/permit decisions and who influences the decisions. Hiring lobbyists to influence the influencers in the approval process is tricky business; proceed at your own risk. Because goodwill can be quickly used up, don’t waste it. Most municipalities have a graphic example that demonstrates the required steps in the process for a land subdivision approval. Exhibit 18.2 illustrates a very simple subdivision approval process for a rural township. However, this simplicity is misleading because of the hidden approvals that are required at each step in the process. For example, the “preliminary subdivision approval” requires approval by the state Department of Environmental Protection of the sanitary sewer system specified for the site. The schematic diagram in Exhibit 18.3 depicts the complicated subdivision approval process for an urban county. Note, the authors superimposed the stars in the diagram, so the beginning and ending of the process could be more easily identified. This intimidating diagram is very helpful for developers trying to negotiate the approval process. This county actually has a good reputation for being “developer friendly.” Developers should remember that real people (with families, friends, and emotions), administer the above subdivision process. These people make decisions and usually want to do a good job. Developers who become impatient with, or irritated by, these processes should not participate. Rather, someone else on their team should lead the effort for this Task. Knowing when to “hold ’em,” and when to “fold ’em” is critical. A well-made argument will stand the test of time, so don’t give up too quickly. On the other hand, “beating a dead horse” indicates a lack of character and judgment; try not to do this. Expect prior agreements or understandings to be retracted or contested The private and public sectors have different ethical systems when it comes to making a deal. The private sector believes that a “deal’s a deal,” and that persons of integrity will stick by their deal. However, the public sector believes that a “deal’s a deal” only if it will stand up to public (and political) scrutiny. Consequently, when the public sector decides to change an agreement that the private sector thinks was already made and finalized, the public sector considers this good or responsible government, while the private sector considers this a breach of good faith and trust. Expect confidential information to be made public Private developers may be surprised that information that was given or disclosed in confidence at a “working meeting” with a municipal staff is readily disclosed as public information by the public sector. The public sector’s ability to keep information private is limited by Freedom of Information Laws or Open Meeting Laws. These different points of view can lead to misunderstandings, distrust, and suspicion. Smart developers will understand the phenomenon and act accordingly. Address social and community problems that the developer cannot solve Developers may be asked to address social issues such as affordable housing on a commercial tract of ground, or to address problems of poverty, education, and recreational facilities, even though the project is small in size and commercial in nature. Sometimes, developers may be asked to address community-wide environmental pollution, storm water management, or

Exhibit 18.2 Simple township subdivision process.

Exhibit 18.3 Complex county subdivision process.

264   Part III traffic congestion, even if the project has little connection to these problems. Developers must find a way to empathize with these problems and their effect on citizens, while keeping the discussion focused on the subject project and how it will improve the lives of everyone in the community. Well-meaning and well-intentioned citizens may express points of view that are heartfelt and sincere, but not economically or financial feasible. However, these citizens’ concerns cannot be cavalierly dismissed or rejected out-of-hand by developers. Sometimes, further discussions with citizens on a personal level outside of the public meeting can help to clarify issues or understand concerns. However, sometimes developers can inadvertently get caught up in political issues (or elections) that are not part of the Real Estate Development Process. Developers can become “collateral damage,” so to speak. Again, this is all tricky business. Appreciate the perceived realities of various stakeholders Developers need to recognize the co-existence of “multiple realities.” Even though developers may clearly and articulately describe their vision of the real estate project, other stakeholders may describe an entirely different vision of the proposed project. Which vision is true and real? They both are. Developers need to accept the existence of these multiple realities. Reject illegal, inappropriate, and questionable offers in the name of “finding a solution” Developers are recognized as business leaders who are asking their community for help. Unfortunately, some despicable characters may attempt to exploit this situation for personal gain, and sometimes at the edge of or outside of the law. Throughout the entire approval and permission process, developers must maintain their personal integrity and good citizenship. Developers need to be examples of the best of the community, regardless of personal or unfair attacks by others. Willard G. Rouse III is a great example of personal integrity and responsible citizenship. Bill Rouse was the developer of the huge Penn Landing waterfront project in downtown Philadelphia. In 1986, a local mobster attempted to extort $1 million from Rouse to guarantee the passage of two bills by the City Council that would provide funding for the project. Rouse immediately went to the U.S. Attorney’s office, and the FBI inserted an undercover agent into the discussions with the mobster. Three weeks later the mobsters were arrested, and eventually three city councilmen and two congressmen were convicted of bribery and corruption charges! Bill Rouse was a man of unquestionable character and integrity. He has set a high bar for other real estate developers. His company, Rouse and Associates, became Liberty Property Trust, one of the largest real estate investment trusts in the United States.

d. Obtain the required approvals and permits In every Stage, there are the required approvals and permits needed to construct, operate, improve, or modify the property during the development. Developers must not only determine what approvals and permits are necessary, but they must also acquire these approvals and permits in a timely and cost-effective manner. The approvals may be at the

V. Approvals and Permits   265 federal, state, or municipal level, and they also may be from regional authorities or private individuals or organizations. The list of governmental authorities and departments below demonstrates the extent of the approval and permitting process, as well as the overlap of jurisdictional authority at all levels of government. Each bulleted agency can be found in the Schilke’s checklist8 mentioned previously. However, every municipality, county, and state has its own set of specific approvals and permits. Developers must engage good legal, political, and technical professionals to decipher and then to obtain the required permits and approvals. Federal approvals • • • • • • • • • •

Interstate Highway Commission Environmental Protection Agency Department of Defense Department of Homeland Security Department of Interior United States Postal Service Department of Transportation Internal Revenue Service Fish and Game Commission Army Corps of Engineers

State approvals • • • • • • • • • •

Department of Environmental Protection Highway Department Fish and Game Commission Consumer Protection Agency State Department of Taxation State Real Estate Commission Department of Natural Resources Department of Health State Zoning Codes State Historical Association

Regional approvals • • • • •

Water Authorities Transportation Authorities Airport Authorities Sanitation Authorities Councils of Governments

Municipals approvals • • •

Zoning Boards Public Works Departments Fire Department

266   Part III • • • •

Code Enforcement Department Sanitation Departments Parks and Recreation Local Historical Association

Private approvals • • •

Deed restrictions in subdivision agreements Easements and rights-of-way Privately owned utilities: ○ Electric ○ Gas ○ Communications ○ Recycling and garbage

Examples of permitting and approval process @REDM9 The Potomac Yard Case Study mentioned in Part II is an excellent example of zoning ordinances that permit and regulate future development. The zoning ordinances that were negotiated by the Land Packager determined what the Land Developers, Building Developers, and Building Operators could do and the conditions under which they could do it. Both Alexandria and Arlington passed zoning ordinances that included allowable densities and Urban Design Guidelines. The Alexandria Coordinated Development District (CDD) ordinance specified an approved master plan and an alternative master plan. The alternative master plan could be chosen by the City if it approved and partially funded a new Monroe Avenue Bridge in the future. The CDD had 38 conditions that had to be met. Arlington’s Phased Development Site Plan (PDSP) ordinance had an approved master plan provided that 40 acres were given to the County and the densities on the transferred land were transferred to the remaining 44 acres. Otherwise the PDSP zoning would not be vested. The CDD and the PDSP required the developers to establish a Transportation Master Plan (TMP) and specified what these plans included and how they would be funded in the future as development progressed. Ironically, neither TMP was required to coordinate or cooperate with the other. Arlington’s PDSP required the Land Developer to create a Public Art Concept Plan10 that was approved by the Art and Planning Commissions, as well as the County Board before any land bays could be sold. Unlike many master plans that are revised constantly over time, both Alexandria’s CDD and Arlington’s PDSP have remained intact since they were passed in 1999 and 2000. Both municipalities credit this outcome to stable and committed political leadership. Storm Water Management at Piedmont Town Center @REDM11 A $125 million mixed-used development in Charlotte, North Carolina, Piedmont Town Center included 400,000 ft2 of office, a 2,000 space car parking structure, 100,000 ft2 of retail, and 180 residential units on 11 acres of land. While Crescent had pre-leased half of the office space, it had to re-zone the property to a MUDD (Mixed Use Development District) that allowed for more flexibility and density, but also gave the municipality more control over the design and infrastructure improvements. A signature roundabout at the front

V. Approvals and Permits   267 entrance was endorsed by the planning department, but was objected to by the fire department until a compromise solution was reached. Crescent was able to deal with neighborhood objections by preserving a grove of old oak trees as a green buffer, and incorporating wetlands and storm water management ponds into a neighborhood park. The pre-lease agreement required office occupancy in two years, so Crescent and its development team were under significant pressure to reach agreements, to obtain permits, and to construct the project in record time. The construction team included 20 managers, 1,000 workers, and 12 cranes! This project is discussed again in Chapter 21. Permit Purgatory @REDM12 “Permit Purgatory” is a non-technical article that discusses the problems associated with repairing older homes in Arlington County, Virginia. Homeowners are Building Operators in the Real Estate Development Process, and they must obtain all of the permits and approvals that professional Building Operators need. Several case studies focus on the need to obtain approvals from the Arlington Board of Zoning Approvals (BZA) before building permits can be obtained. As zoning laws are updated over time, existing properties can inadvertently become “non-conforming uses.” Half of the detached housing units in Arlington are estimated to be non-conforming. Minimum lot size requirements are especially problematic. Using minimum lot size regulations, municipalities effectively zone out modest or affordable housing which is torn down and replaced with McMansions on several consolidated lots. Ironically, most homeowners don’t understand that obtaining permits and approvals to repair or replace parts of their homes is a public process.

Summary The Approvals and Permits Tasks require developers to be politically astute, as well as to understand the requisite permitting and approval processes. Idealistic developers can become antagonistic towards the public-sector approvals and permits if they insist on making value judgments about the permits and approvals such as “right or wrong,” “fair or unfair,” or “good or bad.” Successful developers take a pragmatic approach to these processes, so that the necessary approvals and permits can be obtained in a timely manner. Recognizing that most of the population views real estate development as a regulated process, developers need to find ways to meet both the public’s desire for regulation and the private market’s need for expediency. Developers must embrace the “sweet art of compromise,” so that the Real Estate Development Process is cast as a win-win proposition, rather than a win-lose situation. The Approvals and Permits Tasks bring into sharp focus the problems caused by overlapping governmental authorities who often have competing political agendas. Well-meaning developers can easily get played as unwitting pawns in interjurisdictional squabbles between governmental agencies. Finally, developers must respect the interconnectedness of the myriad of approvals and permits required in all Stages of development. Federal legislation empowers federal agencies, who in turn empower state agencies, who in turn require local municipalities to enforce the federal regulations! Developers may believe it is more efficient to “ask for forgiveness than to beg for permission,” but they do so at their own peril. Ignorance or naiveté is not an effective defense for violating laws and regulations.

268   Part III Successful developers need to obtain the required approvals and permits in a cost effective and timely manner, and they must strive to remain on good terms with the regulators, with whom they must work. There will always be another project that requires additional permits and approvals. Developers need to embrace approvers and the regulators as important partners on the development team who will share in the glory of a successful project! “Please” and “thank-you” are the most important words to accomplish the Approvals and Permits Tasks.

Notes   1 http://realestatedevelopmentmatrix.com/textbook/res/master_real_estate_permitting_checklist.pdf   2 http://realestatedevelopmentmatrix.com/textbook/res/afrh_mou_dc_and_usa.pdf   3 NAIOP, A Commercial Real Estate Organization www.naiop.org/   4 Urban Land Institute: http://uli.org/   5 National Association of Realtors: www.nar.realtor/   6 http://realestatedevelopmentmatrix.com/textbook/res/Hopkins+Building+Case+Study-+ Additional+Information.pdf   7 There is no proof that Einstein ever really said this, since the quote became public several decades after his death. However, maybe he could have said it . . . if he were a real estate developer.   8 http://realestatedevelopmentmatrix.com/textbook/res/master_real_estate_permitting_checklist.pdf   9 http://realestatedevelopmentmatrix.com/textbook/res/master_real_estate_permitting_checklist.pdf 10 http://realestatedevelopmentmatrix.com/textbook/res/potomac_yard_public_art_concept_plan_. pdf 11 http://realestatedevelopmentmatrix.com/textbook/res/Piedmont+Town+Center+Article.pdf 12 http://realestatedevelopmentmatrix.com/textbook/res/Permit+Purgatory.pdf

19 VI. Physical Improvements Tasks

INTRODUCTION Exhibit 19.1 highlights the Physical Improvement Tasks in the context of the Real Estate Development Matrix. As noted earlier, these groups of Tasks are not accomplished in any particular order except that the Acquisition Tasks are done first and the Disposition Tasks are done last in each Stage of development. In fact, the Physical Improvement Tasks are done in conjunction and simultaneously with the other Task groups. In the Real Estate Development Matrix, physical improvements are defined as existing or planned improvements that can be seen, touched, heard, or smelled—both on or off the site. These improvements may be horizontal (roads, sewers, utilities) or vertical (buildings, towers, storage facilities), and they may be privately owned (building) or publicly owned (streets). Finally, they may be located within the site (buildings) or off-site (parks and recreation areas). To clarify, a change of the site’s zoning may be an improvement because it adds value to the site, but it is not a physical improvement for the purposes of this discussion. Zoning changes would be in the Approval and Permits Task Group. The Physical Improvements Tasks require developers to determine what improvements (public or private; horizontal or vertical) need to be planned, designed, engineered, and constructed. With that determination, developers must be able to plan, design, engineer

Exhibit 19.1 Real Estate Development Matrix.

270   Part III and/or construct these improvements in a timely, efficient, and cost-effective manner with the objective of adding value to the development. Once constructed, the existing physical improvements must be maintained, repaired, or renovated during their economic lives. The general public commonly perceives real estate development as the actual construction of buildings. However, the building construction is usually the easiest part of the real estate development process, especially if the design and engineering of the improvements are done correctly. The thesis of this Task group is that physical improvements must exist twice: first, they must exist in the minds of the developers; and second, they must exist physically— constructed to become part of our built environment.1 A brief review of the Stages of development and the Physical Improvement Tasks may be helpful. 1 2 3 4 5 6 7

Land Banking. Maintain the existing improvements and conceptualize possible future improvements. Land Packaging. Design a conceptual master plan for future improvements. Land Development. Design, engineer, and construct the horizontal and public area improvements. Building Development. Design, engineer, and construct the vertical improvements. Building Operations. Maintain and repair the existing improvements. Building Renovation. Design, engineer, and construct the repairs and replacements needed to renovate the property. Property Redevelopment. Maintain, demolish, repair, and replace existing improvements and provide for public safety during the redevelopment period.

The Physical Improvement Tasks closely follow the Stages of development and can be divided into four categories of subtasks: a

Planning and Design •

b

Engineering •

c

Can these improvements be built with existing materials and technologies?

Construction •

d

What physical improvements are needed and what do they look like?

Can these improvements be built in a timely and cost-effective manner?

Maintenance •

Once built, can these improvements be effectively maintained throughout their expected economic life?

a. Planning and design Physical improvements must exist first in the minds and imagination of the planners and architects. The conceptualization of projects that don’t yet exist is a special talent—a talent that some planners and architects can use more than others. Land planning and building design services are often provided by firms that specialize in these “big picture” and high level conceptual activities. When building designers are used, developers often hire another architectural firm to provide working drawings that show details behind the design. Usually

VI. Physical Improvements   271 referred to as “architects-of-record,” these firms prepare the bid and construction drawings, help developers obtain building permits,2 and administer the construction contracts. Consequently, developers’ design teams include design architects and architects-of-record, as well as land planners, landscape architects, and transportation planners. The team’s goal is to determine if the desired, permitted, or required improvements can be built on or in the space allocated for those improvements, i.e., can you put ten pounds of sugar in a five-pound bag? This is a critical exercise that architects and planners sometimes call Feasibility Studies. This exercise is often done in conjunction with developers’ engineering teams, as discussed in the next part of this chapter. This is also the time when the sustainability3 challenges and green building requirements should be considered and incorporated into the big picture. Innovation and technology are important factors in the planning and design phase. Along with the planning and innovative design features, developers must determine if the desired improvements will be acceptable in the marketplace, both now and in the future. It is amazing how every decade of new construction can be characterized by certain architectural clichés. Timeless design is rare, even though the structures commonly have a physical life of 100 years! Pictures of existing, but similar, improvements are helpful aids for developers, government officials, and end-users, to visualize the proposed improvements. Case studies of existing, similar improvements are also useful planning tools. But perhaps the most effective and most enjoyable way to evaluate proposed improvements, is to take field trips to see and experience actual projects that have been built and are currently in use. Ideally these are located in exotic locations or world-famous urban central business districts, but probably they are not. The last step in this subtask is to determine if the talents of the requisite planners and architects are available to the developers. Not all architects and planners are created equal, and architecture is a personal service business, like it or not. It is important that the architects and planners who will lead the design teams have the time availability to do so. Often, these projects will require several years of planning and administration to complete, and the best people will have the most commitments. Also, developers must be comfortable that the lead architects and the planners have adequate staff to do the work, meet the schedules, and produce the documents. A small firm with a capable, talented, and available staff can get the job done, but it can also quickly become overcommitted, sometimes inadvertently. Developers need to have a good working relationship with their architectural and planning teams so that expectations and deadlines are met. Examples of planning and design The design vision and standards for proposed mixed-use projects are often memorialized in the zoning ordinances by including Urban Design Guidelines.4 For example, the Potomac Yard project is a great example of Physical Improvements in the Land Packaging Stage. The project, located in two municipalities, was defined by two different zoning ordinances, which included two very different sets of Urban Design Guidelines. Both sets of guidelines were written by the same architecture firm, Cooper Robertson and Partners, and are presented in the same format. They are organized around six topics: • • •

Site analysis. Urban design principles. Development guidelines.

272   Part III • • •

Building guidelines. Landscape guidelines. Illustrative drawings.

The Urban Design Guidelines are extremely thoughtful and well written, and very detailed. While the purpose of the guidelines is to clarify what the language in the ordinance means, they are often interpreted very differently by various stakeholders when the Land Developers or Building Developers submit their plans for building permits. Thus, the public discussion begins all over again. Sometimes, the master plans in the zoning ordinance represent a ceasefire in the stakeholder battles, rather than a representation of the community’s consensus opinion. The newly hired director of planning at Alexandria informed the Potomac Yard Land Developers that Urban Design Guidelines represented the maximum development density, rather than the actual density, which she felt should be much less than the densities specified in the ordinance and guidelines. However, Urban Design Guidelines are usually very helpful to both the stakeholders and developers to visualize the future development of the project. These guidelines are instrumental in getting the architects and engineers on the same page as the developers, and permitting and approval authorities. But real estate, as a public good, is subject to changing political environments, and the interpretation of the guidelines can change over time.

b. Engineering The professional space occupied by architects and engineers can be confusing and overlapping. Differentiating between these two professions can be difficult. For the best results, the architects and engineers must work together closely and respect one another’s work. The real estate developer needs the engineers to determine if the planned or designed improvements can be built in an attractive, timely, and cost-effective manner: the most beautifully designed improvements may be virtually impossible to engineer and construct. For example, office buildings in Dubai or Kuwait City are excellent examples of beautifully designed structures that were a nightmare to engineer and construct. Clearly these beautiful (and mostly unoccupied) buildings support the old adage that, “anything can be built with enough money and enough time!” Developers must ensure that the designed and engineered improvements will be acceptable to government agencies, end-users, and lenders, as well as performing economically and efficiently. Developers must balance the perceived benefits of innovation and technology with the end-users’ ability to enjoy and maintain the space. Developers must also determine if the planned or designed improvements can be engineered to meet the current and future standards for sustainability and safety. Sustainable and green buildings must begin with the appropriate design and engineering considerations. Sustainability considerations usually involve tying the new building systems into existing public infrastructure systems, such as water and sewer systems, and power grids. This is also the most important step in the green building process. Architects and engineers must work together with the building contractors and operators to use appropriate technologies with human-friendly operation. For example, green roofs may look beautiful on paper, but they can become a nightmare to construct and maintain if they are designed or engineered incorrectly. Refitting sustainable and green systems is much less efficient than constructing these new systems from the beginning of the development process. Healthy building and life safety systems must also be engineered from the beginning. Again, refitting buildings to meet new health and safety standards is neither effective nor

VI. Physical Improvements   273 efficient. Public safety considerations have become much more complicated since the terrorists’ attacks on September 11, 2001. Relatively simple security features such as the ingress and egress of people and automobiles can be accommodated relatively easily when planned and engineered correctly. However, they are extremely difficult and costly to accommodate after the structures have been built. The accommodation of bicycles, electric cars, and autonomous vehicles are similarly easy to construct new, but expensive to retro-fit afterward.

c. Construction Developers must determine if the improvements can be built on time and on budget; this determination is made in conjunction with their general contractor. General contractors should have a track record of constructing the desired improvements, as well as a cadre of subcontractors with whom they have worked for many years. The positive relationship between the general contractor and the subcontractors is the reason why the developer hires a particular general contractor, rather than trying to coordinate and construct the improvements themselves. Subcontractors are the key to determining if the project can be built on time and on budget. While architects and engineers can be helpful in determining construction costs and schedules, the best source of this information comes from general contractors, who in turn rely on their subcontractors. Developers can engage general contractors to provide pre-construction services that are outside of the traditional bidding process. If the general contractor wins the eventual contract, the pre-construction services are usually included in the overall bid prices, but if another contractor wins the bid, then the developer usually pays or reimburses the unsuccessful contractor directly for these services. These pre-construction services are so critical to the developer that sometimes two or more general contractors are employed. Clark Construction, the largest privately owned general building contractor in the United States, offers cost estimation and scheduling services, as well as pre-construction services5: • • • • • • • • • • • • • • • • • • • •

BIM coordination and implementation. Cashflow projections. Constructability reviews. Contractors’ scope coordination. Cost estimating and budgeting. Early start package development. Feasibility studies. LEED evaluation, score sheet development budget pricing. Life cycle cost analysis. Long lead item identification and procurement. Option pricing. Planning and programming. Project specific safety planning. Schedule development. Site investigations/existing conditions’ analysis. Site logistics planning. Small/minority business outreach. Subcontractor procurement. Systems analysis and selection. Value engineering.

274   Part III Construction cost estimation @REDM6 Construction cost budgets are part of the overall development budget. Usually referred to as “hard costs,” or direct construction cost, these costs are incurred in a predictable manner over the construction period in the form of an S-curve, or cumulative probability distribution. The Educational S-Curve Calculator is a handy method for estimating monthly construction expenditures. International Plaza IV is a good example of a preliminary development budget used in a preliminary feasibility study, or the “Back of the Envelope” method. Before construction actually begins, the timing of the construction costs is estimated using an S-curve, and the estimates are the basis of the construction loan balance and accrued interest, as demonstrated in the International Plaza IV Building Development Model @REDM7. Developers need to understand that construction costs and time schedules cannot be overestimated. General contractors and subcontractors are the best sources of this information. With the assistance of the general and subcontractors, developers can usually produce a good construction budget. However, the overall development budget must also include indirect construction costs, or “soft costs,” which are much more difficult to estimate. Experienced developers have historical references to begin the soft cost estimates, but new and inexperienced developers must rely on their own research and help from experienced developers. Each Stage of the Real Estate Development Process has its own set of development costs that must be considered. One good example of this difference in budgets is the land development of Crown Farm, which is very different from the building development budget for Commonwealth Center. Development budgets are the basis for all financial reporting as the actual costs incurred are compared to the estimated amounts. For example, the One and Two Potomac Yard development budget shows the actual versus budgeted costs, as well as the remaining costs to be incurred. Regardless of the developer’s background, a keen understanding of development budgets and reporting are essential for survival. Finally, developers should beware of cutting-edge technologies like new curtain wall systems because sometimes these can be “bleeding edge” as the glitches are worked out. It’s better to take the second bite from the apple, so to speak, and wait until these technologies become more proven. Example of cutting edge technology: Potomac Yard trunk sewer @REDM8 Unfortunately, in the Potomac Yard land development example, the master plan zoning ordinance (CDD) required the Land Developers of the Alexandria Potomac Yard to use trenchless technology to construct the required two-mile trunk sewer under Old Town Alexandria. This micro-tunneling construction technique had never been used in an urban area before. (It was mainly used to tunnel under rivers, highways, or harbors.) While the Potomac Yard Trunk Sewer Project was successful, it had several exciting moments as the development team and Alexandria residents discovered the implications of using this new technology. These experiences are recorded on a video that was made to document this project (see note 8). General contractors and subcontractors Land, Building, and Renovation Developers must evaluate the overall capacity of the general contractor chosen to undertake the project by determining what other jobs the contractor has

VI. Physical Improvements   275 underway, or to what other jobs the contractor has been committed. The capacities of the general contractors are limited not only by the availability of their subcontractors, but also by the availability of their own crews (project managers, superintendents, and foremen). Superior general contractors are also superior team builders. They often take a leadership role in defining business relationships, reporting protocols, and outlining conflict resolution procedures. Developers can learn a lot by observing and working with the team-building skills that the general contractors can provide. Developers should also be concerned about the construction seasons (winter, spring, summer, or fall) and weather conditions. Construction can be an outdoor sport, and the weather patterns are predictable. Common sense is imperative. Developers must determine if the necessary materials are available and affordable. While local availability of materials is critical, general availability is determined by global resource markets. Developers should be keenly aware of global shortages and surpluses.9 Finally, the developer must evaluate the availability of building systems that are manufactured off-site, for example: • • • • •

pre-cast concrete structures; solar panels; roof systems; curtain wall systems; HVAC equipment.

Traditional or fast-track options: Design-Bid-Build vs. Design-Build Design-Bid-Build model This traditional Design-Bid-Build process (as seen in Exhibit 19.2) is very comfortable for developers who are uncertain about the final building outcome, or who the eventual users/occupants will be. Developers employ the architect to guide and assist them throughout the design and bid process for the contemplated improvements. The architect then acts on the developers’ behalf to prepare and distribute the bid packages to qualified general contractors, and helps to evaluate the bids and negotiate the eventual contract.

Exhibit 19.2 Traditional Design-Bid-Build model.

276   Part III Developers then execute a separate contract with the successful bidder to construct those improvements. The architect continues to represent the developers and administers the contract as construction occurs. The Design-Bid-Build option has several advantages, as well as disadvantages10: ADVANTAGES

• • • • • •

Competitive equity and fairness. High quality design. Reasonable price certainty based on market forces with reduced unknowns. Acceptable strategy in terms of public accountability and transparency. Well-known procedure and proven approach. Flexibility: changes are easy to arrange with limited effect on value.

DISADVANTAGES

• • • • •

This strategy is potentially open to abuse, resulting in less certainty. The overall construction time frame may be longer than the design-build option. There is no buildability or constructability input from contractor.11 The strategy can lead to adversarial relationships between the parties. This approach is not fully promoted by all stakeholders.

Design-Build model The Design-Build approach, illustrated in Exhibit 19.3, has become much more common over the last two decades as the developers have a better sense of the final building outcome, and the needs of the eventual building users have become more predictable. Essentially, developers employ a Design-Build team that consists of an architect and a general contractor: this is usually done with one contract. The developer, architect, and contractor work closely

Exhibit 19.3 Design-Build model.

VI. Physical Improvements   277 together to design and review the proposed project, even while the construction of the project is underway. The developers and their Design-Build team must have a clear understanding and common agreement on the final building outcomes. This relationship requires a high degree of trust among the parties. Of course, this process shortens the overall construction period since the bidding and re-bidding stages are eliminated. Many developers have suggested that the most effective Design-Build teams are led by the building contractor, rather than the architects, since the contractors are more experienced in completing the improvements in a timely manner. The Design-Build option also has several advantages and disadvantages:12 ADVANTAGES

• • • •

The developer deals with only one construction company and therefore inherent buildability is achieved. A higher level of price certainty is achieved before construction commences, provided the developer’s requirements are adequately specified and changes are not made. The total time of the project is reduced due to overlapping activities. There are fewer overall uncertainties in the process.

DISADVANTAGES

• • • • • • • •

There are only a limited number of firms offering design-build services, so there is limited competition. The developer has to commit to a building before a detailed design is completed. Design-Build firms can be a mixed bag of talents, composed of weak and strong elements. There is no design oversight unless separate consultants are appointed for that purpose by the developer. Preparing an adequate project description can be difficult. There are difficulties in comparing bids, as each design, program, and cost varies. Design liability is limited by the standard contract. Changes to the scope of the project can be expensive.

d. Maintenance Developers in all Stages should determine how the constructed improvements will be operated and maintained in good working order over the life cycle of the improvements. While the Building Operators actually execute the maintenance and repair programs, the Land Packagers, Land Developers, and Building Developers must be cognizant of the challenges of maintaining physical improvements and operating systems as they are being planned, designed, engineered, and constructed. The Building Operators and the Building Renovators must determine the most cost-effective program for adequately maintaining the improvements over their economic lives. This program is critical for the successful operation of the buildings and their ancillary surrounding structures and support systems. Publicly owned buildings are the best examples of “design, build, and forget.” It seems that the political systems like to build new facilities, but abhor the costs of properly maintaining them. Examples of 20-year-old courthouses, penitentiaries, and municipal office buildings

278   Part III that are functionally obsolete and physically deteriorating are all too common. Finger-pointing for blame is substituted for rational and well-funded maintenance programs. Privately owned buildings, as well, need a well-established and well-funded maintenance plan. Also, experienced and well-trained building engineers are critical since highly technical operating systems usually have excellent monitoring systems, but a person must be tasked to monitor those monitors. Green roof systems are another example of well-intentioned building systems that fail because of poor maintenance programs due to the lack of knowledge, lack of awareness, or lack of concern for the green roof. Developers must determine if the appropriate vendors are available to maintain and operate the improvements over their life cycles. Developers must be aware of and appreciate the following: • • •

Experienced and credible outside vendors are the key to well-maintained building systems. Maintenance schedules with outside vendors can ensure that regular servicing occurs (and gets paid for, too). Green building cleaning systems can be challenging and may require new people, with new training, using new technologies.

Building Operators must establish appropriate financial reserves for future repairs and/or replacements. Building systems have physical lives that must be respected, and economic lives that can be calculated. Cash reserves should be established for major systems, such as: • • • • •

roofs; parking lots; wall systems (exterior and interior); landscaping; sprinkler systems (fire prevention systems).

Also, a specified and funded monetary reserve for replacements can be used as collateral for working capital loans for specific projects, but these reserves should be established and funded periodically throughout the lives of the improvements. Warranties and guarantees that are part of the initial cost of the building systems should be saved, monitored, and kept in force. These will force the Building Operators to install appropriate and timely maintenance programs, often using outside vendors and inspectors. However, purchasing or renewing warranties and guarantees on existing building systems may be more problematic. A thoughtful and well-executed maintenance system may be much more cost effective than buying additional warranties or guarantees.

Summary Physical improvements that are seen, heard, smelled, or touched are different from regulatory or legal improvements that only exist on paper, even though they too can add value to the property. The Physical Improvements Tasks are based on the premise that in the Real Estate Development Process, the constructed physical improvements must exist twice: first in the minds of the developers, architects, and engineers; and secondly, they must exist in the

VI. Physical Improvements   279 physical world where they must be properly maintained and repaired throughout their economic lives. Developers must recognize that planners, architects and engineers have different specialties and expertise which are sometimes hard to describe or differentiate. Consequently, assembling a team of architects, planners, and engineers to provide the vision, imagination, and physics is difficult and challenging at best. These professional groups must work together in an iterative and collaborative fashion, so the physical improvements can exist in developers’ minds before they attempt to construct them. Working through a development project on paper is a necessary condition for a successfully constructed project. When contractors and subcontractors are brought into this complex team and actual construction begins, the time pressure makes for volatile and unstable situations. To handle these situations, developers may employ many different strategies to manage and define these relationships. While there is no right way to do this, inexperienced or passive developers can find an infinite variety of wrong ways! The constructed physical improvements must be properly maintained, repaired, and operated to provide the expected service and benefits throughout their economic lives. In a technological and digital world, trained and educated service providers are imperative. Also, the need for cash reserves to fund major repairs and replacements cannot be overemphasized. When a colleague recently changed careers from being a Land Developer to becoming a Building Developer, he observed, “Vertical construction is much easier than horizontal construction especially if the architects and engineers do their jobs right!” Clearly, the Physical Improvements Tasks require a well-balanced, capable, and experienced team of professionals from multiple disciplines.

Notes   1 In social science, the term “built environment” refers to the man-made surroundings that provide the setting for human activity, ranging in scale from buildings and parks or green space, to neighborhoods and cities, that can often include their supporting infrastructure, such as water supply or energy networks. Built environment: Wikipedia https://en.wikipedia.org/wiki/Built_ environment   2 The “architect-of-record” is officially defined as the architect whose name appears on the building permit.   3 Sustainable Development meets the needs of the present population without compromising the ability of the future generations to meet their needs.   4 http://realestatedevelopmentmatrix.com/textbook/res/PotomacYardDesignGuidelines+Arligton. pdf and http://realestatedevelopmentmatrix.com/textbook/res/PotomacYardUrbanDesignGuidelines Alexandria.pdf   5 https://www.clarkconstruction.com/our-work/expertise/preconstruction   6 http://realestatedevelopmentmatrix.com/textbook/res/construction_draws_24months_modified. xlsx http://realestatedevelopmentmatrix.com/textbook/res/Crown+Land+Development+Budget. xls http://realestatedevelopmentmatrix.com/textbook/res/Commonwealth+Center+One++Develop ment+budget.xls.  http://realestatedevelopmentmatrix.com/textbook/res/land_bay__a_budget_ reconcilliation_june_26_06.xls  7 http://realestatedevelopmentmatrix.com/textbook/res/bote_international_plaza_four.xls   8 https://www.youtube.com/watch?v=-7Y5Iy_T33Y&feature=youtu.be   9 A good review of the global material markets is presented in NAIOP’s Development Magazine, Summer 2015: “Construction Materials Price Trends” Ken Simonson, chief economist, Associated General Contractors of America www.naiop.org/en/Magazine/2015/Summer-2015/Business-Trends/ Construction-Materials-Price-Trends.aspx 10 Reed, Richard and Sims, Sally, Property Development, Sixth Edition. Routledge Taylor and Francis Group, New York, 2015. p. 193.

280   Part III 11 “Constructability or  buildability is a project management technique to review construction processes from start to finish during pre-construction phase. It is to identify obstacles before a project is actually built, to reduce or prevent errors, delays, and cost overruns.” Constructability: Wikipedia https://en.wikipedia.org/wiki/Constructability 12 Reed, Richard and Sims, Sally. Property Development, Sixth Edition. Routledge Taylor & Francis Group, New York, 2015. p. 196

20 VII. Transportation and Accessibility Tasks

INTRODUCTION Transportation and Accessibility Tasks, as shown in Exhibit 20.1, create and address a special category of improvements because they are moving and dynamic systems that feature human and physical interactions. These Tasks also require developers to consider on-site and off-site improvements that need special public approvals and permits. To successfully complete these Tasks, developers need the skills of specialized planners, specialized engineers, and specialized contractors, as well as sophisticated political skills. Today, it is popular to discuss major transit-oriented developments in urban areas, but it is important to understand that all developments (large and small) must focus on both transportation and accessibility systems to be successful. The Transportation and Accessibility Tasks require developers to determine not only what transportation systems (public and private) the space users (tenants, customers, suppliers) will use to get to the property, but also to determine how tenants, customers, visitors, and suppliers will get around the site once they have arrived. In some cases, the off-site transportation systems (and in all cases the on-site accessibility systems), must be designed, engineered, constructed, and maintained.

Exhibit 20.1 Real Estate Development Matrix.

282   Part III The nature of the Transportation and Accessibility Tasks vary in each Stage of development, as well as by product type. Also, Transportation and Accessibility Tasks are intricately related to the other development Task groups.

Location. Location. Location. The old saying is, “There are three determinants of real estate value: location, location, and location!” This clever ditty disguises the real nature of location in the determination of past, present, and future real estate values. “Location” is a relative term so that a property’s location is always changing.1 While longitude and latitude measures of a property indicate a property’s location relative to the earth’s equator or the Greenwich Prime Meridian, it means nothing in terms of the economic value of the property. More importantly, a property’s location is determined by its distance from key economic activities. These are called its linkages. The importance of these activities depends on the use of the site. For example, the important linkages for a residential lot would be the distance to schools, shopping, or employment centers. Similarly, important linkages for a retail center would be the distance to population centers or residential neighborhoods, or the distance to other competitive retail centers. These linkages beg the question, “How do you measure distance?” Of course, distance can be measured in many ways: mileage, time, or cost. The distance between two economic activities can be measured directly “as the crow flies,” or by the distance that a car would travel between the activities. Distance can be measured by travel time, and this time would be further qualified by the mode of travel (car, subway, or bike?) and the time of day (late night or rush hour). Finally, distance can be measured by the cost of traveling between the two activities. These costs can include direct costs, such as tolls or fares, or by an allowance for direct costs such as gasoline for cars and indirect costs such as vehicle depreciation or insurance. The Internal Revenue Service is famous for its mileage allowance for the cost of automotive travel. Since there are usually several employment centers, shopping districts, or residential areas in an urban area, linkages to these areas is often defined using an accessibility index, which can be used for various economic activities and is usually calculated by weighting the distance from the subject property to the activity, by the size of the activity relative to all other activities. This is getting a little too complicated, but it makes the point that location is a relative concept that is constantly changing. For the purpose of this discussion, transportation Tasks refer to the off-site issues of getting people, goods, and services to the site, while accessibility Tasks refer to the issues involved with moving people, goods, and services around the site and within the buildings once they have arrived. These tasks can be divided into four categories: a. Off-site transportation • •

Determine what transportation systems (public and private) that space users, tenants, customers, and suppliers will use to get to the property. Evaluate the possibilities of improving or modifying these systems to enhance the location of the property and thereby increase the value of the property and proposed improvements.

b. On-site accessibility • •

Determine how tenants, customers, and suppliers will get around on the site and within the buildings once they have reached it. Design, engineer, construct, and maintain these accessibility improvements.

VII. Transportation and Accessibility   283 c. On- and off-site construction •

Determine who has the responsibility to design, engineer, construct, and fund the required improvements: the private developer or a public authority.

d. On- and off-site maintenance •

Determine who is responsible for the maintenance and repair and eventual replacement of the required improvements: developer, public authority, or tenant.

a. Off-site transportation Evaluate the existing transportation systems available to bring people and goods to the property. Developers must evaluate all available and contemplated transportation systems to bring people, goods, and services to the property. The fact is, that customers, visitors, tenants, and vendors will use several modes of transportation rather than just one, so this Task can be quite complex. Here is an incomplete list of transportation systems that developers should evaluate: private or public. Streets Streets are the most common method for cars, trucks and buses to reach a site. However, the ownership and control of these streets can be confusing and overlapping. This is especially true if developers would like to (or must) improve these streets. Private streets are subject to control by public authorities and public streets may be municipality, county, state, and/or federally owned or regulated. Developers must understand the ownership and control of these streets in order to determine what can, and what should, be done to enhance the value of the site. For example, a thoroughfare may be a municipal street and also a state highway. Consequently, both governmental entities must be contacted for permission to make any improvements. Streets usually have some time type of pedestrian walkways, and some streets include bicycle lanes as well. The requirements for these sidewalks and lanes can be complicated, but they must be understood before making any improvements to the streets. Highways Highways are usually streets that allow for higher speeds and more liberal truck use. They may have limited access points or signaled intersections with restricted curb cuts or access points. County, state, or federal ownership may be involved. Usually, these authorities have protocols and procedures for controlling, regulating, or maintaining these highways. The federal Interstate Highway Commission, with its limited access interstate highways, trumps the other jurisdictions when it comes to controlling and regulating its rights-of-way, exits, and roadways. Bus routes Bus routes, especially in urban areas, can be a critical transportation system for employees and customers to get to the site. Bus routes are always being evaluated and modified, and many times there are different bus systems using the same stops or access points.

284   Part III Dedicated transit systems Dedicated transit systems such as subways, heavy rail, light rail, or rubber-tire transitvehicles are critical people movers in urban areas because they are very expensive to build and maintain. However, they are very efficient in terms of ride time and user fees for customers and employees. Unfortunately, they are usually multi-jurisdictional so that the financing, construction, operation, and maintenance of these systems are always topics of constant political debate. Most of the successful transit-oriented developments are built around dedicated transit systems, often including two or more modes of transportation. Industrial rail systems Industrial rail systems are very different to heavy rail people movers and require specialized access points (rail sidings) with specialized equipment. Existing rail systems are readily identifiable, but the restriction on the use of these systems can be complicated because of federal commissions and privately-owned rail cars. Seaports Seaports, like railroad yards and airports, are controlled and regulated by a myriad of government agencies who work closely with private companies. These are very technical operational facilities that are quite different from our romantic notions of seaports. Developers who rely on seaport-oriented transportation systems need to appreciate the technical and political complexities, as well as the international dimensions of these logistical systems. Air transportation Air transport systems usually revolve around airports and the other complementary transit systems like highways and railways. Passenger airlines and commercial air transport companies are critical for the success of these systems, since the designation of an airport as an operational hub for the company has significant impact on the use and economic viability of the airport. Gaining or losing a hub designation is critical for airports and all of the commercial activities associated with them. The post-9/11 security initiative taken by the Federal Government has further complicated the construction, financing, operation, and maintenance of air transportation systems. Intermodal hubs Intermodal hubs are the industrial/commercial equivalent of the residential/commercial transit-oriented developments. Successful intermodal hubs bring together highway, rail, sea, or air transportations in order to efficiently handle and distribute goods among these systems. This type of mixed-use development requires a special kind of public-private partnership to be viable. Trails and paths Trails and paths for pedestrians and bicycles are becoming very popular commuter transit ways, as well as recreational opportunities. Many times these paths and trails are not directly

VII. Transportation and Accessibility   285 associated with a specific highway or other transit systems, which can be problematic in terms of their maintenance and regulation. Parks and recreation authorities have historically controlled these systems, but as their use as commuter routes has increased, many problems have arisen. During and after a recent snow storm in the Washington, DC, area, the National Park Service decided not to plow the pedestrian and bike paths, but rather to focus on the streets and parking lots for automobiles. Literally thousands of bicycle commuters were stranded and could not get to work. The National Park Service is now re-evaluating this maintenance strategy. Determine what changes or improvements to those systems are required to improve bringing goods and people to the site. There are very traditional improvements that may be necessary for the development of a site; these would include curb cuts to highways or pipe culverts across drainage ditches. However, other desired improvements can be very expensive, time consuming, and politically charged. These improvements may include bridges across streams, access roads to limited access highways, or even new bus or transit stations. New rail sidings may be important to provide efficient access to airports via private streets. Developers must assess the potential added value of these improvements, compared to the time and money necessary to bring them into being. Road extensions may be more expensive than path or trail extensions, but the political complexities of extending paths or trails—or even gaining access to them—may be overwhelming. Consequently, road extensions that include sidewalks and bike paths may be the most efficient choice. Evaluate the impact of emerging disruptive technologies. Emerging technologies may have a very significant impact on future transportation systems. The post-9/11 security initiatives and the rapid development of online retail shopping are already affecting our transportation systems. However, there are several new and potentially disruptive technologies that must be at least considered because they impact how people, goods, and services get to and from the site. •

• •

Prototypes of driverless or autonomous vehicles have already been developed, and their safety and cost efficiency are being evaluated by private vendors and public regulators. Driverless vehicles would have a dramatic impact on the need for parking facilities, as well as highway safety. Trucking companies and taxi operators would need to redefine their need for human drivers. Airborne drones are rapidly improving, and their commercial use to move goods (and people, too) has been proposed. The impact of drones on shipping/receiving facilities would be enormous. The millennium generation has embraced ride sharing and is being credited for the rapid development of technologies that provide taxi services (Uber or Lyft), car sharing (Cars-To-Go) and bike sharing (Citi Bike)—for example, a new DC development is adding a ride share waiting room to its lobby. These may be attitudinal changes that are supported by technology. Also, these technologies may be critical in solving the last-mile issues that have plagued the traditional transit systems for years.

286   Part III Evaluate if the desired changes or improvements can be permitted, designed, and constructed in a timely and cost-effective manner. Transportation changes and physical improvements are expensive and require numerous political approvals. Proposed transit lines or even stations make take decades to be approved and funded. Even then, the actual construction time of the improvements may be another decade as rights-of-way are obtained, environmental impact studies are completed, contracts are let out for bid, and numerous lawsuits are resolved. The requisite public-private partnerships may fray or unravel as new political leaders redefine the needs of the community and their political constituencies. When physical construction actually begins, especially in urban areas, numerous scheduling accommodations are required so that normal life routines, such as rush hour traffic, can continue in the affected neighborhoods. Mother Nature will also dictate the construction schedule. Finally, the world-wide commodity markets will affect the price and availability of building materials. At some point, developers must reduce their expectations and ask themselves, “Are there small accommodations to the existing transportation systems that can help get goods, services, and people to the site?” Transportation systems require visionary planning, but private developers must deal with monthly expenses, contractual time constraints, and changing market conditions. Successful developers must be both visionary and pragmatic when it comes to changing or improving transportation systems.

b. On-site accessibility Determine how goods, services, and people will access their destination once they arrive on site. The accessibility dilemma may be summarized by the old saying, “A good location, but hard to get to.” The on-site accessibility issues are related to the mode of transportation that brought the goods, services, or people to the site in the first place. Trucks will need a place to stop or park; service providers will need a place to unload and do what they need to do; people will need a way to walk to the buildings from their cars, bus stops, or transit stations. These accessibility points or paths need to be appropriately designed and clearly visible. Unobstructed paths and informative signage systems are key to moving people and vehicles around a site to the appropriate building entrance locations. Entrance doors for people, loading docks for trucks, and convenient parking areas for service providers must be well marked and easy to approach. Once inside a building, another set of accessibility challenges comes into play. Entrance lobbies must have readable directories, and the location of escalators and elevators should be readily apparent. Security considerations are also important, and the various levels of security procedures must be customer-friendly, so to speak. Sign-in logs, bag checks, metal detectors, and card readers should be obvious and convenient to persons entering the building. If necessary, designated receptionists or uniformed security personnel may ease the screening procedures. Secure waiting areas in the lobbies may also be appropriate if visitors need to be escorted to their destinations. The American with Disabilities Act (ADA) dictated the requirements for the basic accessibility facilities and prohibited barriers for disabled people. These are a good start. The people using buildings should be comfortable moving about, regardless of their physical or

VII. Transportation and Accessibility   287 mental abilities. Developers must strike a balance between the ease of movement and the need for security. Here are some imaginative scenarios to help the developer evaluate the accessibility needs of the building tenants: • • • • • • •

Assume you are a new employee, how will you get to your workplace? Assume you are a FedEx driver, how will you deliver your packages? Assume you are an important client, how will you find your service provider? Assume you are a terrorist, how will you cause harm to the workers or property? Assume you are wheelchair-bound, how will you get to your job? Assume you don’t speak English, how will you find your way around? Assume you are elderly and can’t see very well, how will you find your parking spot?2

Determine if roads, trails, walkways, elevators, escalators, and storage areas are adequate to handle the expected traffic among and within buildings. Developers must plan for the expected movement of people and vehicles not only around a building, but also among buildings if this is a multi-building development. Parking lots or structures may provide convenient access to a particular building, but they may become an inadvertent pedestrian barrier to others. Dedicated pedestrian walkways (elevated or ongrade) are important for tenant satisfaction as well as safety. Retail developers are especially keen on the shopper’s experience—both from car to store, and between stores—and they usually set the best examples of accessibility on a site. Mixed-use projects can provide challenging on-site accessibility features as the timing and needs of the various users can be very different. Apartment users may be leaving the property when office users are entering the property, while retail users may have a different schedule altogether. Holidays, special events, and extreme weather conditions will stymie the best accessibility plans, so flexibility is imperative for workable accessibility systems. Determine the priorities of accessible activities. Developers and their teams must balance the daily needs of the building users with lifesafety issues. Everyone must get to work, use the restrooms, and take a break or two. Here are some daily needs that must be addressed. • • • • • • •

Vehicle parking. Building entrances. Trash removal. Mail and freight deliveries. Suite entrances. Emergency access ways. Life-safety facilities and systems.

• • • • • •

Restrooms and feeding areas. Child care facilities. Dining and lunch areas/facilities. Recreational facilities. Bike storage. Vehicle charging stations.

Determine if these accessibility improvements can be designed and constructed in a timely and cost-effective manner. Well-intentioned accessibility improvements may be extremely expensive, such as moving sidewalks or enclosed or underground passageways between buildings. Developers must

288   Part III balance the convenience with the cost to build these improvements. However, life-safety issues must come first. Rather than put people at risk of injury, the project should be delayed until cost-effective and safe accessibility improvements can be built and maintained. Airpark West infrastructure @REDM3 In 2001, Crescent acquired a 61-acre parcel which it intended to develop as a warehouse/ industrial park—AirPark West—adjacent to the Charlotte Douglas International Airport. This real estate development is a good illustration of some the Transportation and Accessibility Tasks just discussed. Phase I of the required infrastructure was installed when the first warehouse was constructed. When the second building was proposed, Charlotte insisted that all of the remaining infrastructure be constructed, rather than just an extension of the Airpark West Drive. Consequently, Crescent had to construct an additional 2,200 linear feet of roadway, as well as the wet and dry utilities, for an additional cost of $1,070,000. This is a good example of how the municipality’s concern for public safety and completed water and sewer lines trumped the Land Developer’s desire for efficiency. Effectively, the developer brought two additional building sites to the market ahead of schedule.

c. On- and off-site construction Most transportation improvements are constructed off-site, while most accessibility improvements are constructed on-site. The off-site construction of transportation improvements is much more complex, time-consuming, and expensive than on-site construction of accessibility improvements. However, even though their integration may take decades to occur, the off-site construction and the on-site construction must eventually be tied together. Determine required public approvals and permits. Off-site approvals and permits Approvals and permits for off-site improvement transportation improvements are the hardest to get. While the improvements must be constructed to meet “government specifications,” there can be numerous overlapping governmental jurisdictions, each with its own specifications and approval process. For example, road improvements may be governed by federal, state, or municipal authorities depending on the location or use of the new roads. Also, regional airport and transportation authorities have requirements that may overlay state and local authorities. The approval of federal and state environmental agencies will be necessary if an Environmental Impact Study is required for construction of the off-site improvements. Finally, off-site transportation improvements may impact existing recreational facilities, paths, or trails so that state and local parks and recreational authorities must also approve the improvements. On-site approvals and permits Many times, the on-site transportation improvements, such as roads and bridges, are constructed on privately owned land, but the expectation is that the developer will donate, gift, or deed over the improvements to the municipality or state so that the new public owners will maintain the improvements going forward. In this case, the improvements must be built

VII. Transportation and Accessibility   289 to government specifications, so the authorities will accept the improvements and the future maintenance liabilities. Even if the streets and roads are built on-site on privately owned land, private approvals may be necessary. Future users, such as prospective tenants, may have the right to confirm that the improvements are built to pre-approved specifications to handle the transportation needs of the tenants and their vendors and customers. Land Developers who construct roads that serve multiple building sites and users must be sensitive to existing development agreements or subdivision restrictions that limit or impair the accessibility to each site. Evaluate if transportation/accessibility improvements can be built on time and on budget. Building contractors who are capable of, and specialize in, constructing transportation and accessibility improvements have limited capacity and availability during the building season, which is constrained by weather conditions, as well as timing considerations such as rush hour traffic or other transportation vehicles like trains. Finally, government-specified transportation improvements can be very costly. Thus, the developer must solicit competitive bids from qualified contractors who can deliver the finished improvements on time and on budget. Determine if the necessary building materials are available and affordable. Transportation and accessibility improvements require huge amounts of materials that are traded on the world-wide commodity markets. Consequently, the developer must be aware of the availability of such materials as cement, steel, and asphalt (oil). During a world-wide recession, material availability is not a problem. However, a world-wide economic boom can cause devastating shortages of critical materials. Evaluate the availability of public funding sources to finance roads, terminals, walkways, or other transportation improvements. The construction of transportation improvements is often done in the form of public-private partnerships. The private sector (or developer) usually takes the construction risks while the public sector (the governmental authority) provides access to free or low-cost capital. The availability of the federal, state, or local grants usually require a public partner of some sort. For example, the public partner could be a municipality, redevelopment authority, or a utility company. Another source of low-cost capital may be low-interest loans through various federal, state, or local authorities. In some areas, the local government may authorize low-cost infrastructure loans or bonds for special purpose entities, and in other areas, tax incremental financing (TIF) schemes may be used to pay off infrastructure loans over time. Nonprofit corporations or charitable foundations may also provide grants or low-cost loans for specific recreational improvements, such as trails or paths. Belgate infrastructure construction @REDM4 Crescent Resources approached the City of Charlotte with a plan to extend City Boulevard from Exit 43 on Interstate 85 to U.S. route 29 (Tryon Street) in order develop a 186-acre site that Crescent had obtained in a land swap.

290   Part III As the Land Packager, Crescent had prepared a master plan for the entire site, and was negotiating a pre-sale of the corner lot to a major retailer. The master plan also included an internal road, Ikea Parkway, that would connect the extended City Boulevard to McCullough Drive. Crescent and Charlotte were able negotiate a public-private agreement that would combine a previously negotiated Utility Agreement and an Enhanced Infrastructure Agreement. The Agreement stipulated that the City would pay $3,678,000 of the expected total cost of $5,753,000 of the road and utility extension. However, this agreement was subject to Crescent obtaining its pending re-zoning application.

d. On- and off-site maintenance The efficient maintenance and operation of Transportation and Accessibility improvements should not be problematic, but it is—for the same reasons that the permitting and construction of these improvements is so difficult. Overlapping governmental authorities, outside weather conditions, and limited financial resources can make maintenance and operation very challenging. Determine how the constructed transportation and accessibility improvements will be maintained and operated in good working order over their life cycles. Developer-owned facilities like elevators, escalators, security systems, and parking control equipment are the easiest improvements to maintain with the use of outside vendors and established maintenance schedules. Of course, the failure to maintain these facilities will have dramatic results, such as unhappy tenants, higher operating costs, and dangerous safety issues. Tenant-owned facilities become more problematic since the maintenance responsibilities may not be clearly articulated in the lease agreements. Special security systems and unique tenant facilities, such as drive-up banking windows or trash disposal facilities, can cause problems for other tenants if they not working or maintained properly. Developers may be responsible for maintaining the parking lots, but the extra time and effort to maintain the tenants’ facilities will cause additional expenses that may not be properly assigned to the tenant or landlord. Government owned or leased facilities can be very challenging to maintain properly because of changing staffing, funding, and priorities. The maintenance costs of government owned or leased transportation and accessibility facilities can be very high because of unreasonable expectations or over-reaching lease specifications. Sidewalks, alleys, and loading areas that may be officially owned by the municipality must be maintained by the developer to stabilize the value of the privately-owned property. Example of the dedication of roads and utilities to the municipality @REDM5 Usually, when Land Developers construct roadways and utilities on private land, they expect to dedicate these roads and utilities to the municipality. At Arlington Potomac Yard, Crescent dedicated 8.4 acres of land to Arlington County for the roads and utilities that were constructed according to the County’s standards and inspected and accepted by the County engineers. At the same time that the land was conveyed to the county, Crescent terminated all of the temporary easements that were granted and used during construction. At the time of dedication,

VII. Transportation and Accessibility   291 the County assumed all responsibility for the continued maintenance of the roads and utilities. Of course, Crescent posted several performance bonds to guarantee that the improvements would function as planned! Identify the appropriate vendors available to maintain and operate the transportation and accessibility improvements. Building Operators must identify and contract with credible vendors to operate and maintain the transportation and accessibility improvements. For example, parking facility operators must not only keep the traffic control equippment running properly, they must also be able to deal with a late-night crisis or bad weather problems. Snow removal must be included or integrated with the parking operations. Invariably, big snow storms cause additional problems that complicate the timely removal of the snow. Elevator and escalator maintenance is another area for reliable and credible vendors who are skilled, knowledgeable, and responsive. This equipment must operate in a manner so that the users never have to worry about their safety. Security system personnel must deal with highly technical equipment, as well as highly sensitive humans who expect security systems to operate flawlessly. This can be particularly difficult if there are multiple security systems and agencies in the same facility. Of course, these security systems and protocols must be coordinated with the municipal first responders like police, firefighters, and emergency medical technicians. Establish appropriate reserves for future repairs and/or replacement. Transportation and accessibility improvements will eventually wear out and must be replaced or renovated. At that time, cash reserves should be available to fund the cost of these replacements. Unfortunately, these cash reserves are seldom established in a meaningful way. Parking lots, sidewalks, and pathways can be maintained for many years past their replacement time, but operating equipment usually needs to be replaced. If cash reserves are not established, then developers should have readily available lines of credit. As noted above, Land Developers provide fiduciary or surety bonds, as well as performance bonds, to the municipality that takes ownership of public roads and traffic equipment. However, these bonds are for a specified period of time, and claims against them can be delayed and frustrating. Clearly define and assign maintenance responsibilities. A well-operating property maintenance plan clearly assigns responsibility for the tasks to the vendors to perform the work in a timely manner. Property owners’ associations are usually responsible for assigning maintenance tasks in large developments with multiple owners. Building Operators are responsible for clearly defining who does what, especially in emergencies. Snow and ice must be removed from parking areas as well as the vehicular entrances to the site; it must also be removed from sidewalks and pedestrian and bicycle pathways to the site, and from the building entrances. The assigned vendors must be able to do all of the required work, not just the areas that their snowplows can reach. Maintenance and operational responsibilities must be assigned for security systems, fire prevention systems, and traffic control systems. These assigned tasks must address normal

292   Part III operations, as well as emergency operations. It is important to determine who will reset the systems after an emergency situation occurs and determine how and when the building operations will return to normal. Define and distribute emergency plans. Building and project emergency plans must be developed and integrated into municipal and regional emergency plans. These emergency plans must address the appropriate use of alarm systems, escape routes, assembly areas, and safe places. Safety equipment should be identified and human floor monitors should be recruited and trained. These emergency plans must deal with the common dilemmas that affect an area, like power outages or fire and smoke emergencies. Plans should also address: • • • • • •

earthquakes; floods; hurricanes; tornadoes; terrorist attacks; active shooters.

Not only should the emergency plans be developed, they need to be distributed and communicated to the building occupants, as well as police and fire departments and other first responders. Finally, the emergency plans should address how lives and businesses can return to normal once the crisis has been averted or handled.

Summary The Transportation and Accessibility Tasks are defined somewhat uniquely in the Real Estate Development Matrix. The Transportation Tasks refer to the analysis, construction, and maintenance of the systems that move people, goods and services to the site. The Accessibility Tasks refer to the analysis, construction and maintenance of the systems that enable people, goods and services to move around to their final destinations once they have arrived at the site. The mantra that the three determinants of real estate value are “location, location, and location” is simple and usually true. However, the rest of the story is that a property’s location is always relative to other economic activities, so as transportation and accessibility systems change, the property’s location changes as well. Also, the distance from the site to other points of interests can be measured in numerous ways, such as mileage, time, or cost. Every property that is developed must address Transportation and Accessibility Tasks, not just those in the popular transit-oriented developments. What makes these Tasks especially challenging is that they require a plethora of permits and approvals by numerous governmental authorities with overlapping jurisdictions. Off-site transportation and accessibility improvements present particularly knotty approval and permitting processes that can take years (or decades) to obtain. Also, the off-site improvements are usually not entirely financed with private funds. Governmental sponsored loans, bonds, or grants are often required, which usually involve some type of public-private partnership agreements. To complete these Tasks successfully, developers must also work with a set of planners, architects, engineers, and contractors who are different from the physical improvements

VII. Transportation and Accessibility   293 team. Finally, the Transportation and Accessibility Tasks must be constructed and maintained in the context of other schedules, such as rush hour traffic, train and bus schedules, and unpredictable weather conditions. The Transportations and Accessibility Tasks may be overwhelming, such as transit improvements in large mixed-use developments, or relatively small, such as curb cuts for a small retail project, but their completion is critical for the success of all real estate development projects.

Notes 1 This relative concept is reminiscent of the old Henny Youngman joke, “The guy says, ‘How’s your wife?’ I says, ‘Compared to what?’” 2 The real question should be, “Assume you are an elderly person and can’t see very well, should you be driving a car?” 3 http://realestatedevelopmentmatrix.com/textbook/res/apw_infrastructure_white_paper_and_ exhibits_1-4.pdf 4 http://realestatedevelopmentmatrix.com/textbook/res/City+Blvd+IBM+aerial.pdf  http://realestate developmentmatrix.com/textbook/res/City+Blvd+Land+Plan+6-12-07.pdf  http://realestate developmentmatrix.com/textbook/res/Belgate+City+Infrastructure+Dev+Agr+5-21-07.pdf 5 http://realestatedevelopmentmatrix.com/textbook/res/PY++North+Tract+Transfer+Potomac_ Deed_Dedication_Termination+-+Copy.pdf

21 VIII. Sales and Disposition Tasks

INTRODUCTION Each Stage of the Real Estate Development Process begins with the Acquisition Tasks and ends with the Sales and Disposition Tasks as illustrated in Exhibit 21.1. The six other groups of Tasks are basically accomplished simultaneously as developers attempt to create value in a particular Stage of development. Again, it is important to note that the order of the eight Task categories in the Matrix are arbitrary except that developers must always begin each stage with the Acquisition Tasks and end with the Sales and Disposition Tasks. Basically, the Acquisition Tasks and the Sales and Disposition Tasks are two sides of the same coin. It all depends upon one’s perspective. The Selling Developers must look at the opportunities that they have created through the eyes of the developer buying the property to better understand the value they have created. They must appreciate the challenges facing Buying Developers. Many developers say that they can undertake several Stages of development to create additional value when the property is eventually sold. However, it is good practice and discipline for developers to determine how much value has been created at the end of each Stage, and then to evaluate the Tasks that must be accomplished in the next Stage of development. Smart developers know that the skills required to accomplish the Tasks in one

Exhibit 21.1 Real Estate Development Matrix.

VIII. Sales & Disposition   295 Stage of development are different from the skills required to accomplish the Tasks in the next Stage of development. In summary, even if developers assume that they will continue on to the next Stage of development, they must seriously evaluate: • • •

What value has been created (or lost) in this particular Stage? What skills are required in the next Stage of development? What is the fiduciary responsibility to investors and team members by going forward to the next Stage?

The Sales and Disposition Tasks can be broken down into five subtasks that must be undertaken: a. b. c. d.

Complete the seller’s due diligence. Market the property for sale. Negotiate and execute a Sales Contract. Close the sales transaction.

Complete the seller’s due diligence Developers who are selling the property must first prepare a Seller’s Due Diligence Package, which will eventually be used as the Offering Memorandum that is presented to potential buyers. Developers start with the Due Diligence Review that their team completed when the property was initially acquired. This due diligence material must be expanded to clearly address four questions for Buying Developer: • • • •

What do we have? What is it worth? Who wants to buy it? How do we affect a sale?

What do we have? The property must be described physically, legally, and economically. The physical description of the property should include the size and shape of the land area, as well as all of the actual and planned physical improvements to the site. These materials should include surveys, photographs, environmental studies, geo-technical reports, as well as plans and specifications for existing improvements and designs for planned improvements. Of particular importance are the ingress and egress points to the site and the adjacent land uses. The legal description of the property should start with the title and survey showing boundaries, as well as all easements and rights-of-way affecting the property. The legal description should include the current zoning and any deed restrictions or subdivision regulations that may impact the use and future development of the property. Height restrictions and required building setbacks should also be mentioned if appropriate. The Selling Developer must disclose any and all obligations or liabilities that the Buying Developer must accept going forward, such as land leases, options, or first rights of refusal.

296   Part III A rent roll summarizing all existing leases on the property should be prepared, and the Selling Developer should be ready to provide copies of leases if the sale of the property proceeds to a binding contract with appropriate confidentiality provisions. The economic description will, of course, include the rent roll, economic measures such as the allowable Floor Area Ratio (FAR) of the site, as well as the net developable land area that is not impacted by environmental conditions (wetlands) or easements, and rights-ofway. Also, buildings should be described in terms of the net rentable area and the net useable area. The Selling Developer should also list any benefits such as royalties from oil and gas drilling, existing permits for current land uses, and legal licenses and permits that are being sold with the property. What is it worth? Selling Developers attempt to estimate the market value of the property while recognizing the usual conditions of the “market value” definition.1 Selling Developers must also appreciate that not all of these conditions will be met if and when the property is sold. In any event, the three approaches to value estimation used by appraisers should be employed to estimate the value of the property: the Sales Comparison Approach, the Cost Approach, and the Income Approach. The Sales Comparison Approach requires that the subject property be compared to other recent sales or comparable sales of real estate properties to estimate its market value. A Unit of Comparison is usually employed to simplify this process. Units of Comparison may include the price per acre, the price per ft2 of building, or the Gross Income Multiplier. This approach to value estimation is most appropriate in a very active market. The Cost Approach determines the market value by estimating the cost to build improvements new and then deducting the amount of accrued depreciation. This approach to value estimation is most appropriate when the improvements are new and there is very little, if any, accrued depreciation. This approach also assumes that land value can be estimated separately from the building improvements, and it is valued using the Sales Comparison approach. The Income Approach to estimate market value determines the present value of the future benefits accruing to the owner of the property. The projected annual and reversionary2 benefits are converted to a present value (or today’s market value) using either a direct capitalization model or a discounted cash flow model. While the accurate prediction of future benefits is critical in this process, the selection of the appropriate capitalization rates or the risk-adjusted rates of discount are the keys to accurate estimates. The above approaches are the classic methods to estimate the market value of the property that will be sold. The market value is an objective or normative value estimate that represents the consensus of the market participants under a hypothetical set of conditions. In reality, the Selling Developers must estimate the lowest sales price that they are willing to accept that meets their investment objectives (the seller’s investment value.) Similarly, the sellers will need to find a buyer whose investment value is greater than or equal to the seller’s investment value. Investment values are very subjective and reflect the price and unique terms and conditions that are associated with the transaction. Who wants to buy it? At the time that they acquired the property, Selling Developers should have been thinking about who the likely buyers of the improved property are. Possible buyers may include active

VIII. Sales & Disposition   297 investors in the capital markets who represent “capital in search of an opportunity.” Building Developers, Building Operators, and Building Renovators should identify possible “space users” who would like to occupy the property as owner-operators. They would represent “users in search of a site.” Finally, the most-likely buyers would be real estate developers who are ready to begin the next Stage of real estate development: • • • • • • •

For Land Bankers, the most likely buyers would be Land Packagers; For Land Packagers, the most likely buyers would be Land Developers; For Land Developers, the most likely buyers would be Building Developers; For Building Developers, the most likely buyers would be Building Operators; For Building Operators, the most likely buyers would be other Building Operators or Building Renovators; For Building Renovators, the most likely buyers would be Building Operators or Property Redevelopers; For Property Redevelopers, the most likely buyers would be Land Packagers.

How do we affect a sale? Selling Developers must determine what price and set of terms and conditions would be the most attractive to the expected buyers. In other words, sellers must put themselves in the mindset of the possible buyers to imagine what would motivate the potential buyers into action. The old adage is, “If one side sets the price, thes other side sets the terms. A deal can be made every time!” Usually, the seller begins with an asking price. This suggested purchase price is really the most money the seller can expect for the property. However, it cannot be so exorbitant that it appears the that seller is not in touch with the current market conditions and, therefore, not a reasonable market participant with whom to work. Sometimes, the seller may complete the Seller’s Due Diligence Package, and then use parts of it to solicit offers from potential buyers. However, it is important that the seller’s team has a reasonable expectation about what the price will be. Selling Developers should also consider the terms and conditions that can be offered along with the asking price. The terms and conditions may include various inducements that the seller could offer such as warranties, guarantees, seller financing arrangements, options on future sales opportunities (such as Phase II and Phase III), or restrictions on future competition (such as no additional sales for 36 months). The seller should also determine what post-closing obligations are appropriate to include in the sale agreements. These may include: the installation of landscaping when the weather permits if it cannot be completed before closing; the completion of the parking lot’s top surface until the tenant move-ins are completed; or the remediation of certain environmental conditions that will not be finished at the time of closing. Once the Selling Developer completes this Due Diligence Package, then the marketing strategy must be addressed.

Market the property for sale After completing the Seller Due Diligence Study, the developer is ready to address the second Task, which is to develop the appropriate marketing strategy for the property. The Selling Developer must address and answer the following questions:

298   Part III • • • • •

How should the property be presented to potential, qualified buyers? What is the appropriate pricing strategy? Are there seller-financing possibilities? What risks is the Selling Developer willing to retain? How will competitive buyers be treated?

How should the property be presented to potential, qualified buyers? Once potential and qualified buyers have been identified, there are a number of ways that Selling Developers can approach them and present the property. If the Selling Developer has identified a small number of possible buyers, then a targeted approach should be used. Each potential buyer should be evaluated in terms of personal relationships, past business experiences, or mutual friends or acquaintances. The presentation should be tailored to address specific motivating factors or specific property characteristics that would appeal to the buyer. On the other hand, if there are numerous possible buyers or the buyers haven’t been personally identified, then the Selling Developer should take a broader approach to marketing the property. Clearly, a market strategy should include printed and electronic brochures and advertisements, as well as a number of promotional events. The use of social media should be included as well. Selling Developers must address the need to use licensed brokers and to pay commissions. There are a host listing arrangements that can be employed, but probably the most difficult issue is how to treat third party or “outside” brokers fairly, especially if there are “inside” brokers (brokers who are directly employed by the Selling Developer). Many times, a Selling Developer will have marketing employees whose mission is to work closely with the outside brokerage community. Selling Developers must also set up a timeline or a schedule for the marketing process. When does the seller expect the potential buyers to respond to the seller’s offer, and when can the seller respond to the buyer’s offer? If there are several buyers, the timing expectations should be very clear so the buyers feel that they are being treated fairly and their offers are not being “shopped” to other competitors. Sellers may have a terms’ sheet or Letter of Intent that they expect the buyers to use as the format for their responses. In any event, sellers must be ready to promptly reply to offers, questions, and clarifications. Finally, sellers should evaluate their ability to consummate a sale. Many times, the seller has a board of directors or an Investment Committee that must approve the sale. If so, there are procedures and timing considerations that must be respected. What is an appropriate pricing strategy? Selling Developers should start the marketing process with an asking price or a solicitation of offers for the property. The asking price and the solicitation for offers should also include suggested or acceptable conditions of sale. While there will be plenty of negotiations after a buyer submits an offer, the suggested terms of the sale will ensure that that the buyer’s expectations match the seller’s expectations. Sellers should also suggest their timeline to reach an executed contract, as well as the timing expectations acceptable in the contract itself, such as the duration of the free-look period, or the length of time from the end of the due diligence period until the actual closing of the transaction. The initial offering memorandum from the seller should also address how much of the property is for sale. For example, the seller should clearly specify if the entire property is for

VIII. Sales & Disposition   299 sale or only a certain portion of the property. If the property is being sold in phases, the seller should clarify how the sale of future phases will be handled. The seller should state if the buyer can obtain an option to buy future portions of the property or at least a right of first offer when additional phases become available for sale. Are there seller-financing possibilities? Selling Developers should investigate the possibility of providing financing to the buyer as an inducement to purchase the property, especially at a higher price. First of all, the seller must evaluate existing financing options available for the purchase of the property. The existing financing options may limit what the Selling Developer can do because there may be pre-payment prohibitions or penalty provisions. In addition, there may be personal guarantees or personal performance provisions that must be dealt with. Finally, the existing financing may be transferable to the new buyer under certain conditions. Seller financing options may be necessary because the new buyer has limited credit capabilities or because the property may not be readily financed through the use of conventional lenders. In these situations, Selling Developers may consider providing financing, also known as a purchase money mortgage, as part of the sale. Other reasons for the seller to provide financing may include the following: • • • • •

A shorter time period to close the transaction, An attractive interest rate for the seller, Continued control of the property through mortgage provisions, Control of the buyer’s business future activities through promissory note provisions, A higher sales price.

Selling Developers should investigate possible provisions in a purchase money mortgage to prepare for the purchase discussions and negotiations. These provisions should include: • • • • • •

Maximum loan amount, Fixed or variable interest rate, Term of the loan, Amortization period, Subordination provisions, Personal guarantees or credit enhancements.

An alternative to a purchase money mortgage may be a land contract that provides for periodic payments to the seller during the contract period and then for the title to transfer to the buyers at the end of the contract period. The land contract is usually for a long period of time and may have other conditions for the title to transfer to the buyer. The land contract is similar to a purchase money mortgage except that the seller remains the owner of record, so the title does not have to be contested in the event of a buyer who defaults on the payments. There are no legal foreclosure procedures and requirements. If there are multiple phases in the development project, the seller may want to provide the buyer with options to buy the subsequent phases of the project. The option agreement must clearly state the terms of the option to buy, which must include the option price, the option period, the price of the option, and the extension provisions if any.

300   Part III What risks are the Selling Developers willing to retain? Prior to marketing the property, Selling Developers should evaluate what risks they are willing will to accept as part of the contemplated transaction and how those risks will be priced. The most common risks are obtaining governmental approvals or permits. The buyer may want the closing on the property to be delayed or contingent upon the attainment of a site plan approval or a building permit. The seller may also need to guarantee the completion of certain common area improvements that are required by the site plan or zoning approvals. In addition, there may be certain environmental tests, approved remediation plans, or actual remediation activities that need to be done prior to closing. Sometimes these risks can be transferred to the buyer with seller guarantees, price adjustments, or at-risk escrow deposits. How will competitive buyers be treated? When there are multiple buyers and Selling Developers expect to continue in business, Selling Developers should determine how the losing bidders will be treated. Selling Developers want to maintain good relations with non-winning buyers, so they will be potential buyers for the next real estate development project. However, successful buyers may want Selling Developers to put competitive restrictions on non-winning buyers until the actual buyer achieves a certain occupancy level or for a specific time period. These are delicate situations and should be considered carefully and sensitively.

Negotiate and execute a sales contract After Selling Developers have completed the due diligence package and marketed the property to potential buyers, the next Task is to negotiate and execute a Sales Contract. The Sales Contract has main three parts:3 1 2 3

Price and terms, Conditions to close (pre-closing conditions), Post-closing conditions.

Ironically, the hard work of negotiating a sales contract is done with a Letter of Intent that is non-binding and non-technical. Written in plain English, the Letter of Intent essentially “gets the deal on the table,” so the seller and buyer can discuss the areas of agreement, as well as the areas of natural tension that require further discussion. The Letter of Intent is given to the seller’s and buyer’s attorneys to reduce the agreement to a legally binding contract. Sometimes the most difficult part of the Letter of Intent is the accurate description of the property involved. Letter of Intent example: Westfield sale by Crescent @REDM4 In 2005 through a commercial real estate broker, Crescent received an offer to sell the 101-acre Westfield property for $38.9 million in the form of a 3-page Letter of Intent in 2005. (In Chapter 14, Crescent’s 2001 LOI to purchase the property for $26.5 million was reviewed.) Even though the offering price appeared low, Crescent was very interested in the offer because the timeline for closing the transaction was very aggressive: 3 days to a contract, then a 35-day due diligence period, and then closing 30 days later. The Buyers were

VIII. Sales & Disposition   301 creditable investors, so of course, a condition to close included the approval of the Buyer’s Executive Committee. There were no other unusual pre-conditions to close or post-closing conditions. Price and terms The price of the property can be defined as all cash at closing or a cash down payment and a purchase money mortgage if seller financing is involved. The price of the buyer’s option to purchase additional property is usually part of the required cash at closing. Also, the buyer’s right of first offer may also be included as part of the option agreement. As mentioned earlier in this chapter, the Disposition Tasks are very similar to the Acquisition Tasks except from a different point of view. For example, the sellers’ preference is to sell the property as-is without any representation or warranties given to the buyers. However, the buyers would like to purchase a fully represented property along with a grocery list of warranties and guaranties from the sellers. Representations and warranties can be divided into three broad categories: the status of the seller, the status of the property, and the operation of the property.5 Sellers are asked to represent and warrant that they have the legal authority to sell the property and that there are no other prohibitions on the sale. Sellers must also clarify if there are other consents needed for the sale and state that there are no bankruptcy proceedings pending. The status of the real property involves statements of the ownership of the property and that there are no liens or litigation cases involving the property. Probably the most difficult representation that the seller is asked to make is that there are no violations of any federal, state, or municipal environmental laws or regulations. Of course, it is not possible for the seller to make this statement with complete integrity, so the clause, “To the best of my knowledge” usually precedes this statement. The operating of the property is usually represented by the sellers agreeing to disclose the leases, operating agreements, books and records, and maintenance schedules. Conditions to close The sales contract addresses what conditions must be met prior to the closing of the transactions. Again, the different perspectives of the sellers and the buyers are all important. This is the section where sellers and buyers trade the risks of ownership and development. The conditions to close can be myriad, but this is a summary of the most common closing issues: Buyer’s due diligence period • •

The length of time that the Buyer has to complete its Due Diligence Review, The availability of any necessary or desired time extensions, Whether or not the good faith deposit is at risk during the Due Diligence Review period.

Buyer’s good faith deposit • • •

The amount of the cash deposit that the buyer puts in escrow, If and when the deposit is refundable, Additional cash deposits that may be required for extensions or various contract provisions.

302   Part III Document preparation and review • • •

Who prepares the initial draft contract, The review period to respond to contract changes, The required addendums and exhibits that must be reviewed.

Title and survey resolution • •

Buyer’s approval of ALTA Survey showing all easement and rights-of-way, Buyer’s satisfaction with the title insurance exception.

Public approvals • •

Public approvals or permits acquired prior to closing, The maximum time period allowed for obtaining these approvals or permits.

Third-party debt or additional equity capital • •

Time period for buyers to obtain commitments for the required debt capital, Time period for buyers to obtain commitments for the required equity capital.

1031 tax deferred exchange requirements • •

Time periods identify properties to be traded, Pledge of Cooperation by both parties.

Board, Executive or Investment Committee Approvals prior to closing Westfield Disposition Example: Building Developer Sale to Another Building Developer @REDM6 The Letter of Intent (LOI) for Westfields, discussed above, was quickly converted to a binding contract where the final sales price increased to $42.45 million. Crescent’s Investment Committee reviewed the disposition memo and approved the sale. This is a good example of a Building Developer selling a zoned and ready-to-developed property to another Building Developer who is more optimistic and has a more aggressive building schedule. Tyvola Crossing example: Land Packager sale to a Land (Re)Packager @REDM7 Tyvola Crossing was a 12.2 -acre site that Crescent bought over 25 years ago and then zoned it for a grocery-anchored shopping center. Unfortunately, the anticipated residential development in the area never materialized, so the demand for a shopping center never occurred. Finally, Crescent management decided to sell the property to Land (Re)Packager whose intention was to re-zone the property for a mixed-use development. This is a good example of an Investment Committee reviewing a “mistake” and agreeing with management to move and redeploy the release capital to a more profitable development, hopefully. Hidden River example: sale of excess land to a related party @REDM8 Crescent acquired the 250-acre Hidden River property located on the outskirts of Tampa, Florida, over 30 years ago. The project was sold as a successful office research/office park,

VIII. Sales & Disposition   303 but two land parcels remained: a 20-acre site with only 2 buildable acres and a 107-acre site that was all wetlands. The original developer and former Crescent employee wanted to buy the property for sentimental reasons and possibly building a “gathering place” for his friends and family. Related party transactions are very problematic and fraught with suspicion and conflicts of interest. This is a good example of an Investment Committee providing oversight and approvals so that the best interests of the company investors are protected. Also, sometimes the Investment Committee needs to encourage the management to clean-up its balance sheet and get rid of non-productive properties Crosstown Center example: Land Developer sale to an owner-user @REDM9 This Disposition Memo seeks the approval of the sale of a 10-acre site to an owner/user who constructed its headquarters building on the site. Crosstown Center was a land development that Crescent acquire over 30 years ago. Acting as a Land Developer, it has sold buildingready lots to several multi-family developers, as well as several hotel developers. Recently, it had received Investment Committee approval to become an office Building Developer and start a speculative office building. The Investment Committee had to evaluate how this sale to an owner/user fits into the long-term development strategy, which appeared to be changing. In this case, the sale was approved because the owner/user headquarters building would help to establish the new direction of the development as a prime office location. This is a good example of the Investment Committee providing a “big picture perspective” to balance very transaction-oriented project developers. Belgate Ikea land sale: a land sale with significant pre-closing conditions @REDM10 The 164-acre Belgate development in Charlotte, NC, is driven by a pre-sale of a 30-acre site to a major international retailer. The disposition memo outlines the terms of the sale and highlights the pre-closing conditions. After the receipt of various governmental approvals, Crescent had specified time periods to complete the following: site grading, roadway extensions, and utility extensions. Because of the retailers anticipated opening date, failure to meet these milestones carried a penalty to Crescent of $30,000 per day. The Belgate development team was able to convince the Investment Committee that it could meet these milestones and the risk of penalties was very small. In fact, the milestones were met, and everyone lived happily ever after. Post-closing conditions Sales contracts must address certain actions that are underway and will continue after closing, as well as actions that will start after the actual closing has occurred. Some guarantees will extend long after closing has occurred. The closing of a contract represents the passing of the title of the property from the seller to the buyer. However, the Real Estate Development Process (aka the creation of value) continues during the contract period and into the post-closing period. Examples of these activities include the construction of tenant improvements, the leasing of vacant space, the remediation of environmental conditions, and the completion of weather-related activities such as landscaping. Typically, sellers and buyers agree on a transaction price that would occur if all of these activities were complete, and then at closing, the buyer and seller agree

304   Part III to holdback or place part of the sales proceed in a third-party escrow account. The escrow agent will have specific instructions concerning when and how the escrowed funds are to be disbursed to the seller. For example, the sale of a newly constructed office building that is partially leased may have holdbacks at closing for unfinished tenant improvements or unpaid leasing commissions. The escrow agent would disburse the escrowed funds based on a pro-rata schedule as the tenant improvements are completed or the leasing commissions are paid. Similarly, there may be an economic earnouts that are paid to the seller as leases are placed in effect at certain rent levels. Finally, funds may be disbursed according to a budget when landscaping or paving projects are completed. Environmental remediation projects are not complete until a government approval or a “no further action” letter is received, so funds at closing may be placed in escrow until the receipt of the approval or letter. Land developers and building developers often negotiate sales contracts that close before the building-ready site is completed. In these situations, the parties enter into post-closing Development Agreements. These agreements could deal with the completion of dry and wet utilities, roadways, traffic control systems, or common area improvements such as parks or storm water retention facilities. To be effective, the Development Agreements must address the following questions: • • •

What must occur? The exact specifications of the to-be-built improvements must be carefully documented. When must they occur? The exact dates or conditions for the completion of the improvements must be carefully documented. What happens if the specifications or milestones are not met? If the seller fails to complete the specified improvements by the exact date, then the buyer can seek a remedy by looking to the seller’s personal guarantees and letters of credit, posted surety bonds, or other self-help remedies.

Development Agreements between the seller and multiple buyers present a unique predicament if the seller defaults on the Development Agreements. The seller and multiple buyers would enter into another agreement that would specify the order of priority during which the buyers can engage in self-help provisions. Guarantees against future legal actions or penalties are commonly made in sales contracts by both parties may provide restrictions on future competition. Sellers may agree not to sell any additional properties that may be competitive until the buyers have attained a certain lease level or occupied the property for a specified number of months. Buyers also may agree not to engage in other activities. For example, apartment developers will not sell their units as condos, or the condo developers will not lease their unsold units as apartments. Finally, Selling Developers may restrict their future sales activities so that they will offer any new products first to the Buying Developers before offering them for sale on the open market. Potomac Yard Land Sales: Post Closing Development Agreements @REDM11 As discussed earlier in Chapter 8, Crescent’s land bay sales at Potomac Yard had substantial post-closing obligations that were memorialized in Development Agreements that were

VIII. Sales & Disposition   305 executed at closing. To manage its myriad of obligations in five different Development Agreements, Crescent constructed the worksheet shown in the referenced hyperlink that defined the post-closing subtasks, the responsible party, the completion dates, the current status, and side notes. This is a good example of Land Developers monitoring their postclosing obligations. This is also how Land Developers maintain a good reputation for integrity and responsibility. One and Two Potomac Yard sale: a building sale with significant post-closing conditions @REDM12 As discussed earlier in the Chapter 9, Crescent’s pre-sale of One and Two Potomac Yard to Morgan Stanley for $213.5 million was based on a staged purchase price. That is, closing would occur at shell completion and Crescent was paid $100 million. The next payment was at GSA occupancy and lease commencement when crescent would be paid $95.5 million. The final staged payment occurred at the USGBC LEED Silver Certification, and Crescent would be paid $18 million. Again, the development team had to convince the Investment Committee that the purchase price is fair, but also that the team could meet all the postclosing commitments, so Crescent could receive the full payment of the contract. Again, the post-closing conditions were met, the fundings were made, and everyone lived happily ever after!

Close the sales transaction “Closing” is a euphemism for a crisis. All of the outstanding issues must be resolved for the closing to take place, so the closing event provides the natural tension that is required for issue resolution. Seasoned developers, whether sellers or buyers, appreciate the tension that occurs around the closing, and they remain calm and clear-eyed as issues are resolved, one by one. Sometimes, closings don’t occur, and the transaction needs to be unwound. There may be fees or penalties that need to be paid and documents, reports, and certain work products that need to be returned or transferred according to the contract provisions. Closings, whether successful or not, require professional behavior from all parties. No one should forget that real estate development is a process, and one transaction will not end a career. There is always another deal to be done and more friends to be made. The closing Tasks require the following questions to be addressed: • • • •

When and where does closing occur? When does title pass? When and how are funds transferred? Who is notified and when?

When and where does closing occur? An exact time and place for the closing must be specified and shared with all parties. Since the ancillary agreements need to be reviewed and accepted before the closing can occur, there should be a series of dates established prior to closing for the distribution and review or all documents. A trial closing, or a “dry-run” a week before the scheduled closing is recommended to keep the scheduled closing date on track. Typically, Mondays and Fridays are not good days for a scheduled closing.

306   Part III A specific location for the closing should be established for the efficient collection, organization, and execution of the required documents. The specified location will also be influenced by what persons actually need to be physically present at the closing table. Of course, no one wants to miss the closing party, but a closing party can scheduled-on a separate date and at a different location. With electronic signatures and execution pages by counterpart, few principals need to be physically present. However, the authority to execute documents needs to be established and verified prior to closing; the dry-run closing should ferret this out. When does the title pass? While the title to the property usually transfers at the completion and execution of the closing documents, there are numerous other allocations that need to be made as of a certain date. Sometimes allocations and transfers are made as of a specified date just in case the actual closing date slips a little. A specified as-of date will make the lawyers’ and accountants’ jobs much easier as they specify the following: • • • • •

When the rent becomes the property of the buyer, When the insurance policies take effect, When the buyer’s liability begins (and the seller’s liability ends), When the buyer’s loan obligations begin, When the seller’s loan obligations are extinguished.

When and how are funds transferred? At the end of the closing process, the funds are distributed to the appropriate parties. However, in this age of electronic funds transfer, these transfers can be done at the speed of light so that accurate distribution instructions, electronic addresses, and notifications are imperative. This is where cyber security is paramount. Important transfers include the following: • • • •

Buyer’s cash proceeds to the seller, Buyer’s borrowed capital proceeds to the seller, Seller’s funds proceed to its lenders, Seller’s funds proceed to its equity investors.

The above transfers may not occur simultaneously, especially the transfer of the seller’s funds to their equity investors. The distribution of funds to equity investors is usually dictated by partnership agreements that explicitly provide for the priority of cash proceeds. Who is notified and when? Many times, the sales transaction is conducted with confidentiality although many persons are notified but subject to confidentiality agreements. However, once closing has occurred, numerous persons must be notified for legal, business, and personal reasons. While “constructive notice” of the sale occurs when certain documents are recorded in the county courthouse, the information can be incomplete and misleading. As part of the closing process, sellers and buyers should agree on a press release that accurately states the parties involved, the location of the property, and the date of the closing. This official press release can be

VIII. Sales & Disposition   307 distributed to the numerous persons, governments, vendors, and tenants affected by the transaction. An incomplete list of these parties include: • • • • • • • • •

Tax authorities, Municipal authorities, Tenants, Vendors, Equity investors, Lenders, Neighborhood stakeholders, Police and Fire departments, Local politicians.

Prior to closing, the individual names and contact information should be researched and verified. Of course, both the seller and buyer can use phone calls, email, and letters to communicate the completion of the transactions and to thank the many persons that made the closing possible.

Alternative disposition strategies Sometimes Selling Developers cannot find any buyers and cannot afford to hold the project any longer. In these cases, developers may need to evaluate alternative disposition strategies. These alternative disposition strategies should initially be considered during the Acquisition Tasks when developers consider the “back-door” exit possibilities if the expected plans don’t work out or materialize. Reserves, lines of credit, and partnership loans Developers need to expect negative cash flows when the major capital expenditures that require additional capital exceed the annual cash flow from the property. For these expected major expenditures, developers must establish reserves, lines of credit, and partnership loans. However, unexpected capital expenditures may also be handled by tapping into these sources of capital. Nevertheless, there may be restrictions on these funds, and they may not be adequate to handle major unexpected capital requirements. Buy-sell agreements Buy-sell provisions are usually part of partnership agreements and provide a method for the partnership to resolve partnership disputes. If some partners want to sell and some partners want to hold or continue, then the buy-sell provisions may provide a way to bring new capital partners into the project. Buy-sell agreements may also be included in joint venture agreements, loan documents, or tenant leases. Partial parcel sales The famous sage, James Graaskamp said, “Always sell your losers first!” when discussing the Land Development Stage of the Real Estate Development Process. This is good advice,

308   Part III but sometimes Land Developers are stuck holding their best parcels when a financial crisis occurs. This may be the incentive for the Land Developers to sell their best parcels to adjacent land owners, competitors, government agencies, or opportunistic buyers. These partial parcel sales may provide the capital to hold on to a development until better market conditions occur. Unfortunately, sometimes the sales of these partial parcels of land just postpone the inevitable. Note and mortgage default Default and foreclosure When developers default on the notes that are collateralized by the project through the mortgage agreement by not making the required monetary payments to comply with other loan provisions, then lenders declare default and give the borrowing developers the agreed upon period to cure the default. When the defaults are not fixed during the cure period, the lender begins the foreclosure process that is carefully specified in state laws. Effectively the lender forecloses on the borrower’s Right of Equity Redemption and then forces a sale of the property to repay the loan If the property sale is insufficient to pay off the mortgage loan amount, then a deficiency judgement is levied against the borrower. Deed in lieu of foreclosure In some cases of mortgage loan default, especially in purchase money mortgages, the borrower and lender agree that the borrower will give and the lender will accept a deed to the property as full payment of the mortgage amount. This provision eliminates the borrowers risk of a deficiency judgement. Contract default When developers are controlling or acquiring a property by using a contract agreement, developers may elect or be forced to default on the contract by violating some contract provision. In most cases, there are notification and cure provisions in the contract, along with specified penalties. Private contracts usually are not governed by state and federal laws, so termination provisions are simpler than mortgage loan defaults and foreclosure13. Three contracts are most commonly used by developers: sales contracts, land contracts, and option contracts. Sales contracts When developers default on a sales contract and the default tis not cured, the remedies usually are based on the good faith deposit or other personal guarantees. Land contracts If the title has not passed from the seller to the buyer, there may not be continued liability on the buyer once the default has occurred, notice is given, and the cure period has expired. At this time, the land contract is null and void, and both parties move on.

VIII. Sales & Disposition   309 Option contracts Option contracts usually provide the buying developer, the optionee, the right to buy the property at some future time and at some future price. These contracts usually provide for some defined action by the optionee such as making periodic monetary payments. Default occurs when the monetary payments or other required actions are not made. Default is declared, cure periods expire, and the option agreement is declared null and void. Both the optionee and the optionor can then move on with no further obligations. Bankruptcy The declaration of bankruptcy by developers or property owners is usually a last resort. However recently in the United States, high profile developers have contended that they are just using the “laws of the land” to their advantage. Bankruptcy is serious business and should not be discussed or declared without a full understanding of the bankruptcy process. Bankruptcy proceedings involve special bankruptcy judges and bankruptcy attorneys. The most frequent bankruptcy declarations are governed by Chapter 7 or Chapter 11 of Title 11 of the United States Bankruptcy Code. Chapter 7 Chapter 7 bankruptcy is often called “straight bankruptcy.” It is used to give the creditors chance for a fresh start by selling all of the bankrupt entity’s assets to pay off the outstanding indebtedness. Its purpose is for an orderly distribution of the debtor’s (developer’s) assets. Chapter 11 Chapter 11 is often referred to as “debtor in possession.” This bankruptcy proceeding looks to the preservation of the debtor’s assets while a plan of reorganization and repayment is worked out with the creditors. The bankruptcy judge and a majority of the creditors must approve the reorganization plan.

Summary The Sales and Disposition Tasks must be completed at the end of each Stage of the Real Estate Development Process even if Selling Developers plan to continue onto the next stage. The Disposition Tasks help developers understand and measure the increased property value that has occurred during the Stage of development that has just been completed. It also forces Selling Developers to look forward to the next Stage of real estate development in order to understand the challenges that Buying Developers will face. The Disposition Tasks and Acquisition Tasks are two sides of the same coin, but they have very different perspectives. Selling Developers begin the Disposition Tasks by updating the due diligence review package that they prepared as part of the Acquisition Tasks. Selling Developers’ due diligence packages will then become the starting place for the Buying Developers’ due diligence reviews. By understanding the challenges in the next stage of development, Selling Developers will also better understand how to provide attractive terms and conditions to Buying Developers, so Buying Developers will promptly submit letters of consent, and then negotiate and sign binding contracts, and then close the transaction.

310   Part III Selling Developers must be cognizant of the fact that unsuccessful Buying Developers may be excellent prospects for the Selling Developers’ next projects. This is particularly true for land projects with multiple phases of development. Unsuccessful bidders should be treated fairly and honestly in the bidding process. Biased or rigged bidding processes will tarnish Selling Developers’ reputations and make future sales more difficult. Building Operators who manage a portfolio of properties should annually evaluate whether a property should be sold or held for another year. However, we will hold these portfolio management decisions as the topic for another book. Sales and Disposition Tasks are the last group of Tasks for each Stage of the Real Estate Development Process, and they should be the most economically rewarding to the developers as they recognize the increased property value caused by the successful accomplishment of the other Development Tasks.

Notes   1 One definition of Market Value is: “The most probable price (in terms of money) which a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller each acting prudently and knowledgeably, and assuming the price is not affected by undue stimulus. Implicit in this definition is the consummation of a sale as of a specified date and the passing of title from seller to buyer under conditions whereby: the buyer and seller are typically motivated; both parties are well informed or well advised, and acting in what they consider their best interests; a reasonable time is allowed for exposure in the open market; payment is made in terms of cash in United States dollars or in terms of financial arrangements comparable thereto; and the price represents the normal consideration for the property sold unaffected by special or creative financing  or sales concessions granted by anyone associated with the sale.” From the Federal Register Vol. 55, No. 163, August 22, 1990.   2 Reversion Value is also known as sale price based on a cap rate and growth rate of long-term cash flows (B&F)   3 This is a pedestrian (non-legal) summary of very complicated documents that may have numerous major parts. Both Selling and Buying Developers need to engage experienced and competent transaction attorneys.   4 http://realestatedevelopmentmatrix.com/textbook/res/Westfields+Letter+of+Intent.pdf   5 Representation and Warranties are described in more detail in Chapter 14.   6 http://realestatedevelopmentmatrix.com/textbook/res/Westfields+Sale+white+paper.pdf  7 http://realestatedevelopmentmatrix.com/textbook/res/Tyvola+Crossing+Sale+white+paper.pdf   8 http://realestatedevelopmentmatrix.com/textbook/res/Hidden+River+Land+Sale.pdf   9 http://realestatedevelopmentmatrix.com/textbook/res/Crosstown+Center+Land+Sale.pdf 10 http://realestatedevelopmentmatrix.com/textbook/res/Belgate+White+Paper.pdf 11 http://realestatedevelopmentmatrix.com/textbook/res/development_agreement_summary1rev 9-1-05.xls 12 http://realestatedevelopmentmatrix.com/textbook/res/potomac_one__two_sale_v2.pdf 13 Of course, these contracts must be “legal.” That is, they must meet the conditions of a binding contract and not contain illegal provisions or intend to commit illegal acts.

22 Summary

The purpose of this book is to explain the Real Estate Development Process, using consistent terminology, to introduce a seven-Stage, holistic model that includes the entire lifecycle of a project, from the Land Banking Stage to the Property Redevelopment Stage. This model is presented visually by creating a matrix that combines the Stages of Development and the Development Tasks: The Real Estate Development Matrix. Part I of the book, Chapters 1–4, discusses the Real Estate Development Process using four graphics and then presents the Real Estate Development Matrix, a two-dimensional model which combines the Development Tasks and Stages. Part II of the book, Chapters 5–12, discusses each of the seven Stages of Development in terms of key players, critical tasks, controllable costs, and major risks. This discussion is expanded by the inclusion of real-world case studies to illustrate the Stages. Part III of the book, Chapters 13–21, discusses each group of the eight Development Tasks and their respective subtasks that are explained and amplified by real-world examples. Throughout the book, the companion website, http://realestatedevelopmentmatrix.com/, is used to complement the written material with links to case studies, examples, and special skills. READER TAKEAWAYS What is real estate development? Hopefully, readers will now be able to answer this question with the following insights gleaned from this book. Real Estate Development is: • • • • • •

a multidisciplinary endeavor; intrinsically simple, but incredibly complex; intellectually stimulating and incredibly interesting; a local activity, except when it is not; a public process; very humbling.

Readers should also be able to answer these additional questions: • • •

Where are we now? Where are we going? How do we get there?

312   Summary Finally, readers should recognize the three commandments of real estate development: • • •

Know Thy Markets. Know Thy Costs. Know Thy Self.

When asked to characterize what they learned at a CCIM live workshop, one person said, “Now I can go home and tell my wife and kids what I do for a living.” Immediately, another student said, “Now I can go back to my company and tell them what we do for a living!” One final caveat: the Real Estate Development Process provides developers with the opportunity to experience the full range of human emotions in a 24-hour period, from despair to euphoria. We wish you the best of luck!

Afterword

Future discussions of the Real Estate Development Process must be expanded and additional dimensions of the Process must be explored. These discussions should include recognizing globalization, understanding technological innovations, and enhancing communication skills.

Recognize globalization Real estate development is synonymous with economic development in most of the world, since economic development is usually associated with an improved built environment. In the United States, sustainability is relegated to a subtopic of environmental issues. However, in many parts of the world, especially in Western Europe, sustainability is a major criterion for evaluating economic expansion and real estate development. Also, green building construction techniques and conventions are rapidly advancing outside of the United States. Therefore, future discussions of real estate development should be less U.S.-centric and should include case studies and examples that are outside of the United States. Also, infrastructure discussions need to be enlarged to encompass a global perspective, so they expand beyond individual physical projects, like bridges or toll roads, and include international health, security, and trade systems. Improving infrastructure systems will directly increase real estate values throughout the world.

Understand technological innovations The technological revolution is changing people’s daily lives, and real estate developments as well. Real estate developments typically have an economic life of 20–30 years and a physical life of over 50 years. By contrast, rapid technological changes have an economic life of five to ten years, and directly impact the value of real estate developments. The ways in which energy is generated, transmitted, stored, and used changes almost monthly. In addition, building materials and construction technologies change every year and leave state and building codes constantly out of date. Technological advances in human health and safety systems are changing the way real estate projects deal with security, lifesafety, and interior environments. One of the most disruptive technologies is the rapid development of driverless vehicles. Driverless cars (and trucks) will change the way people connect to their jobs, and transitoriented developments will need to be re-conceptualized. Finally, the use of social media to promote, advertise, and finance real estate development is just starting to be appreciated. Households looking to buy or rent a home are keenly aware

314   Afterword of the importance of electronic advertising and marketing. The commercial market is just beginning to appreciate and adapt to these changes in the marketplace.

Enhance communication skills It’s ironic that the growth of the communication revolution seems to be correlated with the polarization of public discourse and debate. Recognizing that real estate is a public good, developers must engage in public discussions and debates about the governance of our existing built-environment, as well as future land use activities. Social media has become a vehicle to facilitate these discussions along with live, town-hall meetings. Developers must appreciate the power and the nuances of social media, as well as the need for personalized community outreach activities. Virtual reality technologies will help stakeholders of all kinds experience the developers’ dreams of landscapes, buildings, skylines, and viewsheds. Educators have coined the phrase “high tech, high touch” as a way to characterize the students’ interactions with digital technologies and personal interactions with faculty. Perhaps “high tech, high touch” will become the communication mantra of real estate developers.

Index

accessibility index 282, see also Transportation and Accessibility accounting 156, 213–14, 225–6 Acquisition 14, 56, 84, 111, 130, 192, 195–211; closing 209; contract negotiations 205–8; due diligence 208–9; feasibility studies 196–201; Financing and 213, 217; Land Banking 36, 38; Property Redevelopment 171, 174, 176; Sales/Disposition and 294, 301; underwriting requirements 201–5 activists 53, 82, 139, 173, 253; Building Renovation 154, 156 adjacent land owners 53, 55, 81–2, 133–4 advertising 57, 239–42, 298, 313–14 Advisory Council on Historic Preservation (ACHP) 66 Advisory Neighborhood Commissions (ANC) 66 affinity groups 240 air pollution 251 air transportation 284 AirPark West 288 airports 52, 288 Alberta 180 Alexandria (VA) 118, 185, 226, 266; Land Development 91–3, 95, 98, 100; Land Packaging 68–70, 73–4; Physical Improvements 272, 274 ALTA Surveys 57 American with Disabilities Act (ADA) 286 amortization 132–3, 218–19, 299 Annapolis (MA) 224 annexations 53, 59–60 Approvals and Permits 10, 14, 138, 192, 255–68, 272; Building Development 109, 112–13, 122; Building Renovation 154, 156; communicating with understanding 259–60; Land Development 81, 83, 85–6, 93, 95; Land Packaging 55–6, 58, 60; natural tension in process 256–9; obtaining 264–7; preparing for worst 260–4; Sales/Disposition 296, 300, 302; Transportation/Accessibility 288, 292 archeology 87

architects 107–8, 112–13, 250, 270–2, 275–9; landscape 82, 108, 271; of record 108, 271 Arlington County (VA) 139, 185, 199, 226, 231, 290; Approvals/Permits 266–7; Building Development 118, 120; Land Development 91–3, 95–6, 98–100; Land Packaging 68, 71–4 Armed Forces Retirement Home (AFRH) 42–4, 179, 257; Land Packaging 62–8, 74 Army Corps of Engineers 51, 66, 81, 83, 98, 252 Art and Planning Commissions 266 Arthur, C. 42 asking price 297–8 assemblage 37, 213 asset managers 132–3, 136 Atlanta (GA) 223 atmospheric conditions 251 attorneys 35, 53–4, 173, 300, 309 back door 37, 39, 307 “Back of the Envelope” (BOTE) 198–203, 274 Bank of America 59–60, 87 bankruptcy 60, 309 Base Relocation and Closure (BRAC) 169 Beijing 251 Belgate 100–1, 215–16, 289–90, 303 Bent Tree Tower 222–3 bicycles 283–5, 291 Blatchford (AB) 181 Board of Zoning Approvals (BZA) 267 bonds 82–3, 218, 291 Boston (MA) 256 box diagrams: Building Development 104–5; Building Operations 129; Building Renovation 148–9; Land Banking 32; Land Development 77–8; Land Packaging 48–9; Property Redevelopment 169; Stages 25, 27 Bozzuto 89, 114, 117 bribery 264 brochures 241 brokers 35, 230, 298 Brookfield Properties 162, 165 Brueggeman, W. 18

316   Index Buchanan, J. 42 budget 110, 155–6, 240, 274; Financing Tasks 214, 225–6; Land Development 83–4, 86, see also costs Builders’ Justified Land Price 111 Building Development 13, 15–16, 24, 103–26; Approvals/Permits 259, 266; Building Operations and 129, 132, 143, 145; case studies 114–25; costs 111–13; Environmental Issues 248–50, 253; Financing 217–18, 220, 222–3; key players 107–9; key Tasks 109–11; Land Development and 76–85, 87, 89–90, 96, 99, 101; Land Packaging and 58, 61; Marketing 230–2; Physical Improvements 270, 272, 274, 277, 279; Property Redevelopment and 187; risks 113–14; Sales/Disposition 297, 302–3 building improvement districts 134, see also neighborhood associations Building Operations 13, 25, 27, 127–46; Approvals/Permits 266–7; Building Development and 104–7, 109, 111, 117, 122, 124; Building Renovation and 148–52, 165; case studies 139–45; costs 136–7; Environmental Issues 249–50; Financing 215, 218, 220, 223–4; key players 132–4; key Tasks 135–6; Land Packaging and 58; Marketing 228, 230; Physical Improvements 270, 277–8; risks 138–9; Sales/Disposition 297, 310; Transportation/Accessibility 291 Building Owners and Managers Association (BOMA) 249 building ready 51, 78 Building Renovation 13, 16, 25, 27, 147–66; Building Operations and 129–30; case studies 157–65; costs 155–6; Financing 215, 218, 224; key players 151–4; key Tasks 154–5; Physical Improvements 270, 274, 277; Property Redevelopment and 169, 171, 174; risks 156–7; Sales/Disposition 297 building systems: improvements 275, 278; operations 133, 135, 143, 145; renovation 153, 156 Bureau of Indian Affairs 52 burial sites 87, 173, 253 buy-sell provisions 307 Cabin Mountain Land 74 Camden Property Trust 99, 232 Canada 180 capital 5, 37, 58, 82, 151, 212–27, 289; Acquisition Tasks 201, 204–5, 209; Building Development 107, 110; Building Operations 132–3, 136–7; financial projections 213–17; formation/accumulation 217–24; management/reporting 225–6; Sales/ Disposition Tasks 302, 307

capitalization 107, 117, 130, 132, 222; Overall Rate (OCR) 197, 199–201 Capitol Challenge 198 carrying costs 36, 38, 174 Cars-To-Go 285 case studies: Acquisition 198–201, 204–5, 207; Approvals/Permits 259, 266–7; Building Development 114–25; Building Operations 139–45; Building Renovation 157–65; Financing 215–17, 222–4, 226; Land Banking 39–46; Land Development 87–101; Land Packaging 59–74; Marketing 231–2; Physical Improvements 271–2, 274; Sales/Disposition 300–5; Transportation/Accessibility 288–91 cash-on-cash returns 197–8, 204 cashflows 213–15, 223 cemeteries 87, 173, 253 Center for Housing Innovation 250 Centex Homes 41, 59–60, 95 change orders 112–13 Charlotte (NC) 100, 215, 217, 266, 289, 303 Charlotte Douglas International Airport 288 checklists 209 Chesapeake (VA) 207 circle diagrams 27–8; Building Development 106; Building Operations 130–1; Building Renovation 150; Land Banking 32–3; Land Development 79; Land Packaging 50–1; Property Redevelopment 170–1 Citi Bike 285 civil engineers 35, 82 Clark Construction 273 Clean Water Acts 51, 252 Clearco 45 closing 209, 301, 304–7 Co-star 141 commencement 220 Commission of Fine Arts (CFA) 62 Commonwealth Atlantic Properties (CAP) 68, 73, 91, 185 Commonwealth Center One 241, 274 communicating 259–60, 314 community 10, 100–1, 240, 261, 264; outreach 93, 95, 314 Comparison, Units of 296 competitive properties analysis 238–9 Comstock Homes 99, 232, 253 confidentiality 261, 306 Congress 42–3, 51, 66 construction see Building Development; Land Development construction loans 132, 201, 217–20, 223; Building Development 107, 109–10, 112–13, 124; Building Renovation 151–2; Land Development 82, 85 consulting 36, 54, 134, 174, 176 contamination 70, 79, 97–8, 247–8, 252–3

Index   317 contingency 85, 156 contractors 82–6, 142–3, 173, 289; Building Development 108–9, 111–12; Building Renovation 153, 155; Physical Improvements 273–7, 279 contracts: acquisition 205–8; default 308–9; land 221, 299, 308; sales 84, 111, 174, 300–4; vendor 135 Cooke, J.K. 185 Cooper Robertson and Partners 271 Coordinated Development District (CDD) 68–9, 92–3, 266, 274 corruption 264 Cost Approach 296 cost-benefit analysis 153 costs 6, 56–7, 242; Building Development 111–13, 123–4; Building Operations 135–7; Building Renovation 155–6; hard/soft 213, 217, 240, 274; Land Banking 37–8; Land Development 80, 84–5; Land Packaging 56–7; over-runs 86, 113, 156; Property Redevelopment 171, 174, 176; of travel 282 county governments 52, 120, 169 cranes 120–1 Crescent Resources 43–4, 140, 250, 267; Acquisition 199, 204–5, 207, 209; Building Development 118–20, 122, 124; Land Development 91, 93, 95, 97–8, 100; Land Packaging 62, 66, 73; Marketing 231–2, 241; Sales/Disposition 300, 302–5; Transportation/ Accessibility 288–91 Crosstown Center 303 Crown Farm 39–41; Building Development 114–18, 125; Land Development 87–91, 101; Land Packaging 59–61, 74; Physical Improvements 274 CSX Transportation 120, 122, 183–7 culture 253 cumulative preferred returns 37 cycles, market 233–6 Dallas (TX) 222–3 Davis Bacon Act 52 Davis, J. 42 DC 62, 66–8, 177–80, 257 DC Department of Transportation (DDOT) 66–7 DC Office of Planning (DCOP) 66–8 deadlines 208 debt 5, 34, 215, 217; Acquisition Tasks 201, 204; Sales/Disposition Tasks 302, 308–9 default 175, 214, 308–9 deficiency judgment 308 defining real estate development 8–11 delays 83, 85–6, 113, 138, 156 demand and supply 5, 237 demolition contractors 173

Department of Defense (DOD) 52, 66, 169, 249 Department of Energy 136, 140–1, 249 Department of Environmental Protection (DEP) 52, 259, 261 Department of Highways 52 Department of Homeland Security 52 Department of Interior 51–2 Department of Natural Resources 52 Department of Transportation: federal 51; state 81 deposits, good faith 208, 301 depreciation 150 descriptions 295–6 design 181, 270–2 Design-Bid-Build model 275–6 Design-Build model 276–7 Detroit 235 developers 17, 25–6; behavior 14–15; defining 9–10; self-descriptions 10–11 developing: definition 8, see also Building Development; Land Development Development Agreements 84, 304–5 disabilities 286–7 disposition see Sales and Disposition distance 282 District of Columbia see DC Dividend Capital 234 documentation 135–6, 209, 249–50 Downtown Crown 114, 125 draw requests 214 driverless vehicles 285, 313 drones 285 Dubai 272 due diligence 177, 232, 247; Acquisition 196, 208–9; Sales/Disposition 295–8, 301, 309 Duke Energy 44, 207 Duke Industrial Project 224 dumping 252 Eakin Youngentob Associates 94 earthquakes 253 easements 55, 173, 290, 295–6 economic analysis see Market Analysis and Marketing Strategies Edmonton City Center Airport (ECCA) 180–3, 187 Einstein, A. 260 electricity 133, 137, 143, see also utilities elevators 133–4, 143, 286–7, 290–1 Elkington, J. 245 Elm Street Development 94 emergencies 134, 136, 292 Emery, C. 10–11 employment 179, 235, 282 empowerment 181 energy 137 Energy Star 134, 136, 140, 249

318   Index engineering 133, 172, 250; Building Development 108, 112–13; Building Renovation 153, 155; Land Packaging 54, 57; Physical Improvements 272–3, 278–9 Entitlement Documents Package 55 entrepreneurs 6, 9 Environmental Issues 14, 35, 54, 192, 240, 244–54, 258, 271, 304; atmospheric & (sub) surface 251–3; Building Development 108–9, 111–12, 119–22, 125; Building Operations 134, 136, 139, 141–3; Building Renovation 153, 157; certifications 249–50; cultural & historical 253; Impact Study 52, 154, 288; Land Development 81, 87; Property Redevelopment 173, 177; site assessments 246–9 Environmental Protection Agency (EPA) 51, 66, 119, 140, 154, 199, 222, 241, 248–50, 252; Land Development 81, 83 equity 5, 37, 56, 151; Acquisition Tasks 204–5; Building Development 107, 110, 124; Building Operations 132–3, 136; Financing Tasks 214–15, 217–18, 220–2; Land Development 80, 82; Sales/Disposition Tasks 302, 306 escalators 286–7, 290–1 escrow 111, 300–1, 304 factors of production 6, 9 Fairfax County (VA) 157–60, 237 feasibility studies 93, 196–203, 205, 208; Land Packaging 55, 57, 74; Physical Improvements 271, 274 Feasible Set 193 federal agencies 51–2, 66, 119, 222, 252 Federal Aviation Administration (FAA) 120 Federal Emergency Management Agency (FEMA) 66, 251–2 federal government 62, 66–8, 178–9, 257, 265, 288–9 Federal Highway Administration (FHA) 66 Federal Protection Services 119 Financing 14, 151, 175, 192, 209, 212–27; Building Development 110, 112, 124–5; Building Operations 127, 137; capital formation/accumulation 217–24; Land Banking 34, 36, 39; Land Development 82, 85; Land Packaging 56, 58; management/ reporting 225–6; projections 213–17; Sales/ Disposition 299, 301 Finley, R.W. 11, 198–9 fire fighters 134, 136 first right of refusal 83, 107 Fish and Game Commission 52 Fisher, J. 18 flex buildings 237 flood plains 251–2

Floor Area Ratio (FAR) 296 Florida 122, 207 force majeure 39 forecasting 10, 36, 235–7, 242 forestation 252 free look period 196, 208, 298 Freedom of Information Laws 261 Fundamentals of Real Estate Development 8, 229 funds transfers 209, 306 future see forecasting Galleria Mall 157 gap mortgage 132, 220 General Services Administration (GSA) 119, 122, 222, 249–50, 305 geology 93, 252 Georgetown (DC) 160–2, 166 Georgetown University 143 geotechnical studies 54, 86, 96, 99, 295 globalization 6, 313 Golden Triangle 141, 162 good faith deposits 208, 301 government 109, 251, 257–61, 265; Land Banking 42–4; Land Packaging 51, 62, 66–8; Property Redevelopment 169–70, 174, 178–9; Transportation/Accessibility 288–92, see also Approvals and Permits; regulation Graaskamp, J.A. 8–9, 12, 229, 258, 307–8 graves 87, 173, 253 Great Recession 60, 114, 214, 236, 259 Green Building Guidelines 140 green buildings see Environmental Issues; sustainability Green Globe Certification Program 249 Greenbrier Tower 207 Greensboro Grove 198 Gross Margin 197–8, 216 ground cover 252 Guaranteed Maximum Price (GMP) 111, 113, 155 guarantees 82, 220, 278, 301, 303–4 Hampton Courts 145 hard costs 213, 217, 274 Hayes, R.B. 42 hazardous materials 139, 153, 177 health and safety 136, 272–3 heat island effect 251 Hidden River 302–3 “highest and best use” 229 highways 51–2, 60, 283, 285 Hilton Waterfront Hotel 224 historical conditions 153–4, 156, 173, 253, 258 hold-over tenants 130, 149–50, 152–3, 155, 169 holdbacks 220, 223–4, 304 holding costs 85, 171, 213, 216

Index   319 horizontal development see Land Development hospitals 177–8 hotels 19, 224 House of Representatives 66 Howell Mill Square 223–4 Hyatt Hotel 120 hydrology see water hypersupply 234 IKEA 216, 290, 303 improvements see Physical Improvements Income Approach 296 industrial buildings 19, 237 infrastructure 61, 226, 272, 289; Land Development 76, 79, 81, 95–6, 99–100; Physical Improvements 266–7; Property Redevelopment 172, 177 innovation 179, 181–2, 271, 313–14 inspectors 109, 134 insurance 53–4, 140, 173; Financing Tasks 213, 224; Land Banking 35, 37, 39 interest 37, 80, 112, 224, 260 interest rates 58, 82, 152, 201, 217–19 interim users 70, 150, 213; Land Banking 36, 38–9; Property Redevelopment 169, 172, 174–5 interior architects 107 intermodal hubs 284 internal rates of return (IRR) 198, 204, 216–17, 222, 226 Internal Revenue Service (IRS) 52, 80, 225, 282 International Plaza 122–3, 201–2, 207, 274; Building Development 122–5 interviews 247 investible future 30 Investment Committees 207, 223, 298, 302–3, 305 Investment Reports 207 investment values 56, 296 investors 204, 306; Building Operations 127, 132, 136, 140–1; Financing Tasks 218, 222 Jamestown Properties 162 janitorial services 137, 143 JBGR 89, 114, 117 Johns Hopkins University 11, 259 joint venture 124, 204, 222–3, see also partnerships JP Morgan 122, 140–1, 250 K Street (DC) 141–3, 145 K-Corp 45–6 Kay, M. 260 KB Homes 41, 59–60, 89, 114 Kiwanis Trail 45 Kroger Grocery 223 Kuwait City 272

Land Banking 13, 15, 24, 30–46; Building Development and 115; case studies 39–46; costs 37–8; key players 34–6; key Tasks 36–7, 221–2; Land Development and 81; Land Packaging and 47–50, 74; Physical Improvements 270; Property Redevelopment and 152, 167, 170, 176, 187; risks 38–9; Sales/Disposition 297 land contracts 221, 299, 308 Land Development 13, 24, 76–102; Approvals/ Permits 266; Building Development and 103–7, 114; case studies 87–101; costs 84–5; Environmental Issues 248–9, 253; key players 80–3; key Tasks 83–4, 215–18, 226; Land Packaging and 48–51, 57–8, 61, 73–4; marketing 230; Physical Improvements 270, 272, 274, 277, 279; Property Redevelopment and 187; risks 85–7; Sales/Dispositions 297, 303–5, 307–8; Transportation/Accessibility 288–91 land lease 36, 62, 209, 221 land owners, adjacent 53, 55, 81–2, 133–4 Land Packaging 13, 24–5, 27, 47–75; Approvals/ Permits 266; Building Development and 114–15, 118; case studies 59–74; costs 56–7; Environmental Issues 248; key players 51–4; key Tasks 54–6, 221; Land Banking and 31–4, 36, 41–2, 44, 46; Land Development and 79, 81; Physical Improvements 270–1, 277; Property Redevelopment and 168–70, 172–6, 183, 187; risks 57–9; Sales/Disposition 297, 302; Transportation/Accessibility 290 land parcels 175–6 land planners 54–5, 57, 82 landscape architects 82, 108, 271 landscaping 137 Las Vegas 236 lawsuits 72 Lazard Freres 68, 185 Leadership in Environmental and Energy Design (LEED) 62, 241, 249–50, 305; Building Development 119–20, 122, 125; Building Operations 136, 140, 142–3 Leadership Legacies 8 leasing 36, 62, 176, 209, 296; Building Development 106–8, 110–11; Building Operations 130, 133, 135–6, 140–5; Building Renovation 153, 155; Financing Tasks 217–18, 221 legal description 208, 295–6 legal expenses 36, 174 Letter of Intent (LOI) 74, 196, 205, 232, 298, 300, 302 leverage 217 liability 37, 173, 175, 213, 222 Liberty Property Trust 264 lien 152

320   Index limiting assumptions 208 limiting conditions 192 Lincoln, A. 42 linkages 282 loans 37, 45, 80–2, 85, 217–18, 289, 307–8, see also capital lobbyists 261 local authorities 35, 109, 134, 251; Approvals/ Permits 257, 261, 265–6; Building Renovation 154, 156; Land Development 85, 100; Land Packaging 51, 53, 68–73; Property Redevelopment 168, 171, 174, 177–8; Transportation/Accessibility 288–91 local historians 153, 173 location 235, 282, 292 Los Angeles 251 Lyft 285 M Street (DC) 160–6 maintenance 133, 277–8, 290–2 management 132–3, 136, 152, 156, 225–6 marginal value see spread Market Analysis and Marketing Strategies 6, 14, 228–43; Acquisition and 197, 208; Building Development 110, 113–14; Building Operations 138, 143; Building Renovation 154–7; competitive properties analysis 238–9; Financing and 216, 223; forecasting 10, 36, 235–7, 242; Land Banking 35, 38; Land Development 85–8; Land Packaging 56–61, 73; market conditions analysis 233–8; promotions/advertising 239–42; Property Redevelopment 167–8, 176; real estate market characteristics 4–5; Sales/Disposition and 297–300; site level strategies 229–32; Transportation/Accessibility and 286, 289 Market Capitalization Rate 107 market cycles 233–6 market value 296 Massachusetts Avenue (DC) 143–5 mathematical programming 192 Mathews Company 45 Memorandum of Understanding (MOU) 66, 68, 257 merchant builders 103, 107, see also Building Development Meridian Development 99 Mexico City 42 mezzanine loans 220 M.I. Homes 89, 114 milestones 207–8 Millennium Realty Advisors 232 mini-perm loan 110, 220 mistakes 242 mixed use 19, 60, 90, 177, 223, 266 mold 139, 153, 157 Montgomery County (MD) 41, 59–60

mortgage 214, 217–24; Acquisition 201, 209; Building Development 104, 112; Building Operations 132–3, 136; Building Renovation 151–2; Land Development 80–1; Property Redevelopment 174–5; Sales/Disposition 299, 301, 308 motivated sellers 34–5 Mueller, G. 234 municipalities see local authorities Murphy’s Law 56 NAIOP 198, 258 National Association of Realtors 258 National Capital Planning Commission (NCPC) 66–8, 257 National Environmental Policy Act (NEPA) 52, 66, 72, 154 National Geospatial Intelligence Agency (NGA) 232 National Historic Preservation Act (NHPA) 52, 66, 154 National Park Service (NPS) 52, 62, 285 National Pollutant Discharge Elimination System (NPDES) 259 National Register of Historic Places 52 National Trust for Historic Places (NTHP) 66 Native Americans 52 negotiations 83–4, 232, 300–4 neighborhood 240; activists 53, 82, 154, 156, 173, 253; associations 118, 134, 139; deterioration/social issues 138, 177; groups 100, 174–5 neighbors 53–5, 81–2, 120, 133–4, 172–5, 258 Nestle 145 Net Operating Income (NOI) 123–4, 199 net present value 198 “no further action” letter 248 North Carolina 44, 215, 217 North Moore Street 145 “Not In My Back Yard” (NIMBY) 258 “Not On Planet Earth” (NOPE) 53, 258 Oaktree Development 246 off-site transportation 283–6 Offering Memorandum 295 Office of Historical Preservation 253 offices 18, 118–19, 141, 160, 162–5 Ohio 248 Oklahoma 11 on-site accessibility 286–8 Open Meeting Laws 261 options 37, 56, 74, 174; Acquisition Tasks 209, 221; Sales/Disposition Tasks 299, 301, 309 outreach 93, 95, 240, 314 over-runs 86, 113, 156 Overall Capitalization Rate (OCR) 197, 199–201 Overall Return 197–8

Index   321 paper enhancements 79 paper infrastructure 48, 54 parking 67, 120, 160, 198, 258, 290–1 parks and recreation departments 257, 285 partial parcel sales 307–8 partnerships 124, 133, 159, 204, 246; Financing Tasks 220, 222–3; Land Banking 39, 41; Land Packaging 56, 59–60; public-private 170, 187, 286, 289–90; Sales/Disposition Tasks 306–7 paths 284–5, 289, 291 patient money 222 Peabody College 44–5 pedestrians 283–5, 287, 291 Penn Landing 264 pension funds 140, 223 perched water 98–9 performance bonds 83, 291 Perkins and Will 182–3 permanent loans 133, 152, 218–20, 223–4 Permit Extension Act 259 Permit Purgatory 267 permits see Approvals and Permits Phased Development Site Plan (PDSP) 68, 92, 118–19, 266 phasing 87, 89, 299 Philadelphia 264 Phipps Tower 124–5, 201, 203–5, 207 Physical Improvements 14, 113, 269–80; Building Operations 138, 142–3; Building Renovation 156–7; construction 273–7; engineering 272–3; Land Development 86, 90; maintenance 277–8; planning/design 270–2; Sales/Disposition 303–4; Transportation/Accessibility 285–6, 289 Piedmont Town Center 217, 266–7 planning 82, 172, 249, 257; Land Packaging 52, 54–5, 57; Physical Improvements 270–2, 278–9 police officers 134, 136 politics 35, 53, 173, 175, 260, 264, 286 pollution 247–8, 251 portfolio 130, 132, 140, 224, 310 post-closing conditions 208–9, 303–5 Potomac Yard: Acquisition 199–201, 207; Approvals/Permits 266; Building Development 118–22, 125; Building Operations 139–41, 145; Environmental Issues 250, 253; Financing 222, 226; Land Development 91–101; Land Packaging 68–74; marketing 231–2, 241; Physical Improvements 271–2, 274; Property Redevelopment 183–7; Sales/Disposition 304–5; Tasks 216–17; Transportation/ Accessibility 290–1 pre-closing conditions 207 pre-construction services 103, 273 pre-sale 132, 152, 290, 303, 305

predicting see forecasting press release 306–7 price: acquisition 56, 74, 174; asking 297–8; guaranteed maximum 111, 113, 155; materials/labor 86; sales 87, 114, 171, 301–3 private sector 256, 261, 267 product types 17–20 production: factors of 6, 9; functions 5 professionals 15–16 proffers 112 profitability 216–17; feasibility studies 197–9, see also spread Program of Requirements (POR) 119 programming 192 project managers 152, 155–6 projections: financial 213–17, see also forecasts promotions 239–42 property managers 132–3, 136, 152, 156, 225 Property Redevelopment 25, 167–87, 198; Building Renovation and 148, 150, 152, 165; case studies 177–87; costs/risks 176–7; key players 172–4; key Tasks 174–5; Land Banking and 32–3; Land Packaging and 47–50, 53; Physical Improvements 270; Sales/Disposition 297 Public Art Concept Plan 266 public records review 247 public sector 256, 261, 267 public works departments 257 public-private partnerships 170, 187, 286, 289–90 Pulte Homes 89, 95, 114 purchase money mortgage 151, 174, 209, 221, 299, 301, 308 purchase and sale agreement 221 quality 86, 113, 138, 156–7 railways 120, 122, 177, 183–4, 284–5 reading 233 real estate: defining development 8–11; general themes 5–6; market characteristics 4–5; three commandments 6–7 Real Estate Development Cube 18 Real Estate Development Matrix (@REDM) 3–4, 12–16 Real Estate Development Process 8–9, 11, 303, 311–12 Real Estate Investment Grade Value Index 141 recession 234, see also Great Recession recovery 234 recycling 135, 137, 143 Redbrick LMD 180 redevelopment authorities 172, see also Property Redevelopment regional analysis 235–8 regional authorities 35, 52, 257, 265, 288

322   Index regulation 44, 58, 62, 81, 252, 267 REITs 162, 165 renovation see Building Renovation rent 132–3, 135, 147, 152–3, 213 repairs and replacements 278, 291 reports 136, 214, 225–6, 234, 247 representations 205–6 Request for Information (RFI) 181–2 Request for Proposals (RFP) 62, 119; Property Redevelopment 177, 179, 182, 187 Request for Qualifications (RFQ) 62 reserves 85, 137–8, 278, 291, 307 residential 18, 68, 89, 95, 114, 143, 145, 232 restaurants 142 retail 18–19, 302; Building Development 117, 122–3; Building Renovation 149–51, 154, 157–62, 166; Financing 223–4; Transportation/Accessibility 282, 287 returns 124, 197–201, 204, 217; Land Banking 34, 37; on total costs 107, 199–201, 222 review boards 206–7, see also Investment Committees Richmond Fredericksburg and Potomac Railroad (RF&P) 183, 185, see also Potomac Yard rights: -of-way 55, 60, 295–6; bundle of 4, 205 RIPA 117 risks 9, 217–18, 300; Building Development 113–14, 120, 124; Building Operations 130, 138–9; Building Renovation 152, 156–7; Land Banking 38–9; Land Development 80, 85–7; Land Packaging 57–9, 74; Property Redevelopment 176–7 roads 38, 60, 283, 285, 287–91; Land Development 78, 80–1, 96–7 Rouse, W.G. III 264 Rumsfeld, D. 17 Ryland 89, 114 S-Curve 274 safety 136, 155; Physical Improvements 272–3; Property Redevelopment 171–2, 174; Transportation/Accessibility 287–8, 292 St. Elizabeth’s 177–80, 187 Sales Comparison Approach 296 Sales and Disposition 14–15, 132, 151, 176, 192, 196, 294–310; alternative strategies 307–9; Building Development 108, 110; closing 305–7; contracts 84, 111, 174, 300–4, 308; due diligence 295–7; marketing 230, 240, 297–300; price 87, 114, 171 “satisficing” 192 scenario analysis 242 scheduling 83, 86, 225, 273, 305 schematic diagrams: Building Development 104; Building Operations 128–9; Building Renovation 147–8; Land Banking 31;

Land Development 76–7; Land Packaging 47–8; Property Redevelopment 167–9; Stages 25–6 Schilke, C. 256, 265 scope creep 112, 155 Scott, W. 42 seaports 284 security 119–20, 134, 137, 273, 284–7, 290–1 seller-financing 151, 175, 209, 210, 221, 299, 301 Senate 66 sewers 52, 70, 118, 177, 261, 274; Land Development 83, 92–4, 96, 100 Shakespeare, W. 7, 24 shopping centers see retail shovel ready 51, 78 sidewalks 283, 287, 290–1 Silo Bend Industrial Park 207 Simpson, A. 260 site level strategies 229–32 site visits and assessments 242, 246–9 Smith, A. 6 Smith (Charles E.) Company 72–3, 118 social media 176, 241, 298, 313–14 soft costs 213, 217, 240, 274 soil 86, 96–9, 247–8, 252–3 Soil Management Plan (SMP) 97–8, 253 solicitation for offers 298 Sources and Uses of Funds Statement 213 South Carolina 44 sovereign wealth funds 140 Special Skills 4, 215 spread 34, 51, 80, 132, 151, 171–2, 216–17; Acquisition 196–7, 199–201; Building Development 107, 123–4 Stages 5, 12–18, 23–9, 118 stakeholders 66–8, 73, 76, 82, 95, 254, 264, 272 state authorities 52, 81, 248, 257, 265, 288–9 State Historic Preservation Offices (SHPOs) 52, 154 storm water 58, 60, 83, 252, 259, 266–7 streams 252 streets see roads structural issues 157, 172 subcontractors 108, 153, 155, 273–5, 279 subdivision approval 261–3 submarkets 236–8 subsurface conditions 252–3 Sunbrook Partners 60, 87–90, 114–15 sunlight 251 supply and demand 5, 237 surety bonds 83, 291 surface conditions 251–2 survey 35, 54–5, 57, 82, 173, 295 sustainability 5, 125, 181–3, 241, 244–6, 271–2, 313; Building Operations 134, 136; Land Packaging 54, 58, see also Environmental Issues

Index   323 takeaways 311–12 Tampa (FL) 122, 207, 302 Tasks 14–18, 25, 191–4; Building Development 109–11, 120; Building Operations 135–6; Building Renovation 154–5; Land Banking 36–7; Land Development 83–4; Land Packaging 54–6; Property Redevelopment 174–5 tax 38–9, 52, 85, 134, 136, 213, 225–6 tax incremental financing (TIF) 289 TCR 232 technology 5, 274, 285, 313–14 tenants 169, 230; Building Development 108, 111–12; Building Operations 130, 133–8, 142–3; Building Renovation 149–55; Transportation/Accessibility 287, 289–90 Texas 222–3 third dimension 17–20 three commandments 6–7, 199, 210, 312 title 35, 53–5, 57, 111, 173, 295, 303, 306 Total Development Costs 199 trails 284–5, 287, 289 Transportation and Accessibility 14, 52, 120, 157, 281–93; construction 288–90; maintenance 290–2; off-site transportation 283–6; on-site accessibility 286–8; Property Redevelopment 177, 192, 198 Transportation Master Plan (TMP) 266 trees 252 tri-party agreements 220, 223 triple bottom line 245 Tucker County (VA) 74 Tysons Corner Shopping Center 157–60, 166 Tyvola Crossing 302 Uber 285 underwriting 153, 196, 201–5 Units of Comparison 296 University of Oregon 250 Urban Design Guidelines 55, 68, 70, 72, 92, 266, 271–2 Urban Land Institute (ULI) 8, 229, 258, 260 US Green Building Council (USGBC) 62, 249–50, 305; Building Development 119, 122, 125; Building Operations 136, 140–3 USAA 140–1 USF&G Insurance 207 utilities 55, 78, 137, 266, 290–1; Land Development 78, 80–1, 89, 94, 96 valuation 134, 229, 296 value creation 5, 13–16, 25–6, 145, 195–6, 224, 294; Building Operations 127, 129–30

Vanderbilt University 44–5 vendors 135, 137, 278, 291 Venn diagrams: Building Development 105–6; Building Operations 129–30; Building Renovation 149–50; Environmental Issues 245; Land Banking 32–3; Land Development 78–9; Land Packaging 49–50; Property Redevelopment 169–70; Stages 26–7 vertical development 103, 279, see also Building Development Vienna (VA) 198 Virginia 68, 96–8, 159, 184–5, 198, 207, 237, 266–7; Northern 154, 217, 232 Virginia Rail Express 122 Vornado 162 wages 52 walkways 283–5, 287, 291 warranties 206, 278, 301 Washington (DC) 222, 236, 250, 285; Building Operations 141, 143; Building Renovation 157–65; Land Banking 40, 42; Land Packaging 59, 62, 73; Property Redevelopment 178–9 Washington Area Airport Authority 122 Washington Metropolitan Area Transit Authority (WMATA) 157 Washington Redskins 185 waste 96, 135, 137, 143, 182 wasting parts 137 water 177; Environmental Issues 248, 251–2; Land Development 81, 83, 97, 100–1; Land Packaging 51–2, 58, see also storm water weather 85–6, 136, 251, 285, 291 website 4, 19 weighted average 239 West Virginia 205 Westfields Corporate Park 205, 232, 241, 300–2 wetlands 81, 252 White Paper 207 Wilder, L.D. 185 wildlife 52 wind issues 251 World Trade Center 251 Wormald Homes 90, 114 yield curve 218 zoning 71, 78, 114, 295; Approvals/Permits 258, 266–7; Building Renovation 169–70, 172; Physical Improvements 271–2, 277