How Real Estate Developers Think. Peter Hendee Brown
completed those funds are lost. So in order to preserve capital and minimize risk, developers are more inclined to adapt a product slightly rather than strike out into the unknown and try something significantly different. Equity investors and banks take a similarly conservative view—they want their money returned and so they are less inclined to try far-out things. For example, a developer may not think he needs to provide as much parking as a typical project because the site is near a transit line. He may have difficulty, however, obtaining a construction loan because the product does not provide the same basic features as its competitors, so the bank sees increased risk. On the other side, the market’s tastes evolve slowly too, so developers are careful not to get too far ahead of their buyers in terms of price, product, or location. There have been plenty of examples of development projects that were too exotic, in the wrong place, mispriced, or simply before their time, which is why, as one saying goes, “pioneering developers are the ones with arrows in their backs.”
When compared to the latest cell phone, real estate—housing, office, retail, and industrial—is a product type that evolves slowly, and yet it is always evolving. It takes a long time to get a real estate product to market—years and even decades can go by between the time a developer conceives of a project and the day the last unit is sold or the last lease is signed. During that time many things change, from market tastes and demographic trends to construction costs and the efforts of the competition. How, then, does a developer go about successfully conceiving, producing, and selling a real estate product? What are the steps and who are the actors?
The Five Stages of Development
Concept Stage
The real estate development process can be divided into five basic stages: concept, approvals, design, construction, and sales. First, during the concept development or “pursuit” phase, a developer must have an idea or a vision for a product that will serve a specific market, for which there will be adequate demand, and that can be built at a cost and sold at a price that will yield a minimum profit. This idea may start with a piece of land or a building in a good location, a product type for which there is demand, a real tenant or buyer, or an amount of investment capital under the developer’s control. The developer will take into account supply and demand for the product type and local, regional, and national business, technological, and population growth trends.
The developer will also begin assembling a skeletal team, starting with an architect whose job it will be to test what kind of project will fit on the property, including use, numbers of floors, and numbers and types of units. The developer may also ask a contractor to provide a simple cost estimate for the project, based on the architect’s preliminary sketches and an anticipated quality level. This cost estimate will serve as the basis for an economic model of the project or “pro forma” that summarizes project costs, financing, and potential profits based on anticipated prices. The developer will need access to capital to finance the project through to completion so she will begin to court potential investors, lenders, and other individuals and institutions that may be potential sources of funds. The developer rarely has a monopoly opportunity, so she must also scrutinize the marketplace and consider what her competitors are doing, what comparable products are already in the development pipeline, when they will hit the market, and the likely costs and prices of those products.
The developer must then consider the politics of obtaining approvals and whether or not she can generate the good will and support required from local elected officials and government staff, neighbors and members of the community, and other special interests. At the end of the concept phase the developer will have a team, a concept design, a pro forma, potential investors and lenders, a preliminary indication of support from the city and other relevant stakeholders, and a good idea of the market’s appetite for the product. The developer’s objective in this stage is to arrive at a politically and economically viable concept for the lowest possible cost. Next, the developer will advance the design to the level required to seek and obtain formal approvals from the city.
Approvals Stage
At this early stage of the project, from the viewpoint of the public, the developer is often a solitary individual attending neighborhood meetings with a staffperson or an architect in tow. Behind the scenes, however, the developer’s team is larger and will continue to grow. Developers are generalists and very knowledgeable but they lead as conductors and so, as Gerald Fogelson pointed out in Chapter 1, they must surround themselves with a wide array of specialists if they are to succeed. The design team will grow from that one architect to include landscape architects, land surveyors, geotechnical engineers, and structural, mechanical, electrical, and plumbing engineers. These different team members may be hired because they possess relevant expertise in the product type or because they have worked successfully with the developer in the past, or both.
As the design evolves, the developer will begin to consider which building systems—structural, heating and air conditioning, plumbing, and electrical—are most appropriate for the building and for the product type and how those systems will impact the economics of the project, including both costs and rents or sales prices. The marketing and sales team will help to improve elements of the design from the column bay spacing, window design, and ceiling heights for an office building to the unit plans, parking facilities, and common spaces for a residential building. Their combined efforts will be directed toward sharpening and differentiating the project’s image or brand to ensure a competitive edge in the marketplace. In the background, the developer’s real estate attorneys will assist with everything from executing real estate transactions—options, purchase agreements, and other contracts—to partnership agreements. Other attorneys will lobby local politicians and draft homeowners’ association documents or other covenants, conditions, restrictions, and easements that will be applied to the completed property.
Throughout all of this, the developer will continue to meet informally and formally with city staff, politicians, community groups, neighbors, investors, lenders, and many others. The developer will receive feedback on anything from the height, density, and massing of the building to the mix and sizes of units, design style, colors, materials, site layout, and parking arrangements. She will strive to integrate as much of this feedback as is reasonably possible into the design, with the goal of maximizing the attractiveness of the product to potential buyers. At the same time, the developer will seek the support of these various stakeholders and will strive to increase their commitment to the project. If successful, the developer will gradually broaden ownership of the project by ensuring that the issues of key constituencies are reflected in the developing design as much as is technically and economically feasible. The developer will incorporate this information into the design and will complete drawings to the level of detail required by the city to submit for approvals and to present at formal public planning and zoning commission meetings. If successful, this stage ends with the city granting the formal approvals or “entitlements” to the developer for the submitted design that are required for the project to be built.
Design Stage
With entitlements in hand, key team members in place, and the developer’s vision and project goals more clearly outlined, the team will begin to design the building in detail. More architects and engineers will join the team, along with a variety of other subconsultants specializing in everything from traffic engineering and parking structures to historic resources, lighting design, and interior design.
The contractor will use the approved concept design as the basis for a more detailed estimate of construction costs. These costs will include everything required to construct the building, from materials, labor, systems, and interior finishes to temporary heat, electricity, insurances, and fees to be paid to the city if a lane of the street must be closed or parking meters must be taken out of service. To this estimate the developer will add land costs, design fees, legal and other professional service fees, and all other “soft costs” to arrive at the “total project cost.” Next, the developer will add an amount or percentage for profit to determine final pricing for the product. Once all of this information has been assembled, the developer will begin to fine-tune the project, working back and forth to reduce costs, increase value, and simplify the design from a construction standpoint while maintaining a certain level of quality.