Development and
management
Real Estate Principles: A Value Approach
Ling and Archer
Outline


Process of development
Operation: ongoing management
Occasions for development

A use in search of a site:



A site in search of a use:



New locations for expanding franchise.
Need for a new school.
Raw land in path of urban growth.
Land adjacent to new freeway intersection.
Resources in search of an opportunity:


Pension fund with money to invest.
Private investor looking for high-yield
investment.
Process of development
1.
2.
3.
4.
5.
6.
7.
8.
Establishing site control
Feasibility analysis, refinement, and testing
Obtaining permits
Design: Architect and other professionals
Financing
Construction
Marketing and leasing
Operation
The time line
1. Establishing site control



Wide differences in access to land.
Land already owned.
 Dream case.
Land assembled for specific purpose.
 Difficulty of land assembly often justifies
government involvement in urban
renewal.
 Assembly of land for Walt Disney
World—devised elaborate blind entities to
acquire all of the pieces of land to
eliminate a “hostage/holdout” situation.
A holdout in China
The builders have since excavated a 10-metre pit around Yang's
house, so he is holed up there without water or electricity,
threatening to use his martial arts skills against anyone who tries
to dislodge him.
Source: CBC News; AP
Another holdout
Source: AP
WSJ, June 15, 2007



“The Clise family began buying prime real estate
here (Seattle) in 1889…Now, after patiently
accumulating 13 contiguous acres downtown…the
family is putting the land on the market.”
“The area…has the potential for 13 million SF of
development—which would rival the size of…the
entire World Trade Center complex in New York.
“My father talked to me about this…you do not
want to sell this off piecemeal…the value is in the
assemblage as a whole.”
Tools for site control

Options: right (but not obligation) to
purchase land in future before a certain
date, at a predetermined price.


This gives time to developer for conducting
feasibility analysis, run construction and
environment evaluation, to obtain necessary
zoning, etc.
Joint venture: landowner puts land into
development in return for share of profits.

May do joint venture with future tenants as well.
2. Feasibility analysis,
refinement, and testing

Financial feasibility question: does the
value, when built, exceed the cost?


An application of NPV analysis.
Tests and surveys that may be necessary:





Soil tests.
Environmental tests.
Critical habitats (Endangered Species Act).
Seismic tests (earthquake vulnerability).
Archaeological (prehistoric ruins).
3. Obtaining permits

Multiple layers of permits may be needed.




Site plan review.
Regional and environmental impact review.
Zoning change.
Site plan review: an inevitable hurdle.





Complex set of issues.
Rules and criteria involve interpretation by authorities.
Neighbors usually resist change.
Negotiation is critical skill: important to building support of
authorities and citizens in advance.
Negative decision can kill a project in one meeting.
Hurdles



NIMBY: not in my back yard.
BANANA: build absolutely nothing
anywhere near anything.
“Every successful developer is a good
negotiator …. Through a thicket of
obstructions and objections.”
4. Design




Architect: represent developer in hearings
for permits; provide pre-design schematics
of user functions and resulting spatial
interactions; provide complete design; serve
as project manager.
Land planner: creates development layout
or “map.”
Landscape architect: Shapes topography,
soils, vegetation, and other objects around a
structure to harmonize with and enhance it.
Engineers: soil, mechanical, electrical, civil,
etc.
Greener buildings, greener bottom
line


Toyota Motor Sales USA likes green the way Henry
Ford liked black…the division's new Torrance,
California, headquarters is one of the largest
environmentally friendly building complexes in the
U.S… All good intentions aside, Toyota went green
more for the payback than the praise. At a
minimum…the Leadership in Energy and
Environmental Design (LEED)-guided design for the
complex had to surpass a 10 % return on
investment. "The project focused on long-term
operational savings to increase the rate of return."
Source: CFO.com.
5. Financing

Development has a sequence of
financing needs:




Land acquisition and
preconstruction.
Construction.
Gap or “mezzanine” financing.
Postconstruction.
Land acquisition and
preconstruction financing




Land acquisition cost: cost of the land.
Preconstruction costs (“soft costs”): title
examination; feasibility analysis, market
research and testing, permitting process (legal
and architectural fees).
Typical dilemma: developer faces capital
constraint, but banks and other institutions are
reluctant to lend on asset with no cash flow.
Solutions: use of option, joint venture, and equity
partners.
Construction financing




Covers soft costs and hard costs (for
direct costs of materials, labor, etc.).
Typically from a bank.
Floating rate is popular (over prime rate
or LIBOR).
This type of financing is less risky than
land acquisition financing: No title,
environmental or ecological risks; permits
all in hand.
Mezzanine debt




Banks usually lend only 70 – 80% of
construction costs.
In place of equity to fill gap, developer may
seek high-interest-rate mezzanine debt.
Often secured by pledge of ownership
shares, but not of property.
More expensive than first mortgage
construction debt, but often cheaper than
equity financing.
Postconstruction financing




Construction financing usually lasts less than 2-3
years.
Most construction financing providers (e.g., banks)
expect to harvest their loans shortly after issuance
of a certificate of occupancy.
Postconstruction financing can be a take-out
permanent loan that kicks in when the certificate of
occupancy is issued.
 This financing may be come in stages; at the
beginning, the financing size can be small,
called “floor loan.”
Another financing approach is to have a “miniperm
loan.” A miniperm loan is a construction and
postconstruction loan. The typical loan term is 5
years.
6. Construction



Construction is a complex
organizational problem with dozens of
subcontractors and hundreds of steps.
General contractor: oversees and
controls project.
Construction manager: liaison and
representative of developer during
construction.
7. Marketing and leasing

Marketing normally is carried out by an
“outside” broker.
8. Operation


Chapters 21 and 22.
Effective management is important to
maintain and increase value.
Home construction steps, I



1. Layout; homesite is cleared and
staked out.
2. Excavation: grading with proper
drainage.
3. Footing: foundation’s foundation, a
concrete base below the frostline,
upon which the foundation sits.
Home construction steps, II




4. Foundation
5. Framing: floor, wall, and roof
framing forms the "skeleton" of the
home.
6. Mechanicals: heating, cooling,
plumbing, electrical systems.
7. Insulation
Home construction steps, III






8. Drywall
9. Flooring
10. Trim: a carpenter installs doors,
cabinets, and molding.
11. Paint
12: Final trades: light fixtures, faucets,
commodes, and appliances.
13: Carpet/wood flooring and final
cleaning.
Operation: ongoing management




Commercial RE is extremely management
intensive; it is not like putting $ in stocks or
bonds.
The value of commercial RE is largely created
by holding the property for a long period of time,
say 10 years.
Transaction costs are too high to buy and sell
property frequently.
Thus for a long horizon, effective ongoing
management is particularly important.
2 layers’ RE management

Asset management: asset manager deals with
physical, financing, or ownership structure of the
property.





Managing the principal’s RE portfolios
Refinancing
Expansion
Making recommendations for buying and selling properties
Property management: property manager is
responsible for day-to-day operations of the
property.



Marketing
Selecting tenants
Collecting rents
RE management
Asset manager


Asset manager (who has RE
expertise) usually work for institutional
investors (who do not have RE
expertise).
Usually requires an advanced degree.
Asset management functions, I

Before property is acquired:





Finds specific assets in which owner/client can
invest.
Researches/arranges the financing.
Negotiates acquisition price.
Oversee due diligence and closing process.
Compare to asset managers of stock or
bond portfolios.
Asset management functions, II

After property is acquired:

Monitor and control operating performance.





Site visits, property tax assessments, etc.
Report value-enhancing opportunities for
rehabilitation, historic preservation,
modernization, and conversion.
Suggest strategies for lowering owner’s cost of
capital.
Be aware of opportunities to restructure equity
ownership.
Continually reassess sell vs. hold decision.
An asset manager’s required
knowledge set








Portfolio theory
Asset pricing
Capital market (financing)
Urban economics (location)
Investment value analysis
Appraisal
Property management
Get an MBA, MSRE, or MSRED.
An asset management firm: PREI


Prudential Real Estate Investors (PREI) is the real estate
investment management business of Prudential Financial.
PREI, comprised of fund management centers in the US in
Parsippany, New Jersey and Atlanta, Georgia; and globally in
Munich, London, Singapore and Mexico City; is supported by
a network of local offices throughout the world. PREI’s
specialized operating units offer a broad range of investment
opportunities and investment management services in the
United States, Europe, Asia and Latin America. As of
December 31, 2006, PREI managed $36.9 billion of gross
assets ($26.2 billion net) on behalf of more than 400 clients
and is ranked among the largest real estate investment
managers.
www.prudential.com/prei
Property manager


Often needs to report to an asset
manager.
Detail-oriented.
Property management functions


Marketing the property
 Leases are perishable assets.
 Independent brokers are usually paid on a
commission basis.
Selecting tenants
 Credit tenants.

Tenant mix.
Signing leases
Collecting rent
Repairing and maintaining property
Communicating with owners
Maintaining tenant relations






Vast majority of potential tenants are not credit tenants.
Property management education


University education rarely focuses on this
profession; the closest one may be hotel
management.
A number of professional and trade
organizations (education providers) exist:



Institute of Real Estate Management (IREM)
Building Owners and Managers Association
International (BOMA)
Human skills.