How Real Estate Developers Think. Peter Hendee Brown
You can have the best location but if it is overpriced then you have to hit the market just right or else you are out of luck. You always have to assume that it is going to go bad,” says Ruttenberg, “and so the question becomes, how do I differentiate myself for when that happens? Once again, ‘cautious risk taking.’ That is how we managed the risk on this project—by designing a product that we could complete and get to market faster and that would be a value even after the market turned down.” And when Ruttenberg talks about “we,” he is including his main partner on the project, Michael Supera. “Michael is the son of Louis Supera so 600 Lake Shore Drive was like a fifty-year reunion of the Ruttenbergs and Superas working together.”
Buzz Ruttenberg’s story illustrates how upbringing and background influence a developer’s career. His ideas about rule breaking and cautious risk taking offer one view of opportunity, risk, and how “psychological barriers” can cause people to value things differently—and create a good deal for the observant entrepreneur. And with 600 Lake Shore Drive, Ruttenberg explains how he was able to hedge against a downturn in the market by using a more efficient design to differentiate his project from that of his competition. Finally, despite the common misconception of entrepreneurs as crazy risk takers, throughout this story Ruttenberg explains how most developers really think about their business and the products they produce. For those who are successful over time, development is not about taking huge risks on bold, creative, but unproven ideas. Rather, it is about minimizing exposure to risk through a careful process of incremental improvement to traditional product types over time.
“The best Shakespeare plays are based on Greek mythology,” says Ruttenberg, “so the question becomes what adaptations can you make and how can you make it better, more interesting, and more current. It is the same for development: You don’t want to reinvent the wheel—once they cut the corners off, it rolls.” Still, to succeed, a developer must always be improving the product at the margins, so in the next chapter we will look more closely at real estate development as a product-development process and how product types evolve over time.
Chapter 3
The Real Estate Development Process
There is a reason for everything with each developer and each project is a big life story making its way into the building.
—John Carroll, Portland, Oregon, real estate developer1
Real Estate Development as Product Development
Real estate means different things to different people. To most of us it means the physical homes we live in and the office buildings where we go to work. To city planners, real estate development is a way to mesh the economic goals of private developers and their investors with a city’s larger economic and social goals, from business growth to job creation and housing production. Planners may influence the geographic direction of development, for example, by encouraging ground-floor retail in buildings that will be built on commercial corridors or by encouraging higher-density and mixed-use development around transit stations. For elected politicians, development is a way to encourage investment in the city—in ways that are in concert with policies, plans, and the desires of their constituents—and as a way to attract and retain businesses, house residents, and expand the city’s tax base. For architects, a real estate development project means the opportunity to design a building that will generate fees and can lead to repeat business, allow them to practice their craft, and explore their own aesthetic ideas. If their peers consider their work important, they may also win design awards and attract positive media attention. To wealthy investors, real estate development is a way to earn a higher rate of return on their money than they can earn through the stock market or other less risky investments. From the developer’s viewpoint, real estate is all of these things but first and foremost it is “product” and real estate development is “product development.”
In the same way that Apple Computer, Inc., developed the next generation of computers, phones, pods, pads, and other must-have gadgets, real estate developers constantly work to produce the next generation of office spaces, warehouses, retail centers, or housing units. Developers even use the same language as other product manufacturers. They “develop,” “design,” “produce,” “market,” and “sell,” and they talk about what is in “the pipeline,” whether or not they have enough “sales velocity,” and the problem of having too much “inventory” or “product on the shelf.” Products change over time, however, and if there is one constant to the product-development process—and the real estate development process—it is innovation.
The Role of Innovation in Real Estate Development
In The Innovator’s Dilemma: When New Technologies Cause Great Firms to Fail, Clayton Christensen differentiates between “sustaining” and “disruptive” innovation. Sustaining innovation is an innovation that does not affect existing markets and can either be “evolutionary” or “revolutionary.” An evolutionary innovation is an improvement to an existing product that consumers expect, such as fuel injection for automobile engines. A revolutionary innovation is one that is new and unexpected but that does not affect existing markets. The automobile itself, for example, did not affect the horse-drawn carriage business because it was so costly and out of reach for the average consumer.2
Disruptive innovation, however, creates a new market by “applying a different set of values,” and it ultimately and sometimes unexpectedly overtakes an existing market. The use of the assembly line to manufacture the Ford Model T at a significantly lower cost is an example of disruptive innovation because it overtook the entire existing automobile industry and made cars cheap for the masses. Products based on disruptive technologies are typically cheaper, simpler, smaller, and more convenient to use.3 Examples of disruptive innovations and the markets they overtook include over-the-road trucking and railroads, digital photography and chemical photography, and cloud computing and USB flash drives.4
Real estate usually falls in the category of sustaining innovation, with evolutionary innovations including incremental improvements to materials and building systems for all product types as in the increasing emphasis on sustainable design and construction. Revolutionary innovations in real estate often take the form of variations on existing product types and locations. Over the past century, revolutionary jumps in retail products, for example, have led from downtown department stores to suburban strip malls, regional shopping centers, mega-malls, entertainment centers, and lifestyle centers. Similarly, revolutionary jumps in residential products have led from dense single-family and multifamily housing in cities to single-family homes and townhomes in the suburbs and then back downtown to loft conversions, new townhomes, high-rise condominiums, senior housing, student housing, and luxury apartments.
Whether evolutionary or revolutionary, different types of products evolve at different rates. In his book about product design and development, Where Stuff Comes From, Harvey Molotch points out that the introduction of entirely new products is relatively rare, and most products are based on existing but constantly evolving “type forms.” Vacuum cleaners, toasters, and other household goods evolve over time but do not change in terms of their general look and function. Across the spectrum of goods, “quick-turn” type forms like mobile phones evolve rapidly while products such as household appliances, automobiles, and homes that are more costly and expected to last much longer are called “slow-turn” type forms. In product-development terms, real estate is a “slow-turn type form,” and there are a number of reasons for this.5
First, real estate development is very risky. Every time a developer initiates a project he or she is attempting something that has, in effect, never been done before. Each project represents a unique combination of price, product, location, and market timing. Second, real estate development is very costly. Unlike other entrepreneurial ventures that can be cash-flowed or “bootstrapped,” development requires the upfront investment of large amounts of capital. Developers use their own risk capital—cash—and that of their investors to obtain control over a piece of property, complete a conceptual design, seek and obtain key approvals, and test the market for their product. The expenditure of these funds, however,