Topic 5

Stage 1: Idea Conception

Idea conception is the most creative and least mechanical process for the developer

• Success is predicated on finding the right idea

• It is not uncommon for a developer to go through many ideas in the course of day or week

• Some developers are continuously brainstorming with their teams

• No magic formula exists for generating good development ideas

The developer is continuously scanning her environment for ideas and opportunities

Helping to guide the developer are

• His experience

• Her knowledge of the market

• His familiarity with changes in the industry

• Her network of consultants, lenders and investors

Some ideas are unsurprising and standard, but still profitable

Other ideas can be quite innovative in terms of

• Design

• Structure

• Location

Motivation Behind the Ideas

• Land

  • Supply: a site looking for a use.  The availability or discovery of land available for development or redevelopment

• Tenants

  • A use looking for a site.  Having knowledge about a prospective tenant’s unfulfilled needs

• Knowledge

  • A use looking for a site.  In depth knowledge of the local market and knowing where space is in short supply and which tenants are looking for space

Techniques for Generating Ideas

• There are many systematic techniques to foster creativity and generate or refine ideas

  • Brainstorming – a group or individual conduct an exercise to generate as many ideas as possible

  • Nominal group process – a group ranks and votes on generated ideas

  • Delphi method – Asks experts for their inputs

  • Focus groups – Ask the set of end-users to assemble and ask them prepared questions

  • Surveys – Polling the end-users

The Fit

• A key concern at this early stage is the fit

  • Does the idea fit the location?

  • Does the site fit the tenant and his needs

  • Does the concept fit with local politics and planning?

  • Does the site and project fit the available funding?

    • Still the biggest hurdle for the new developer

  • Does your idea fit with the experience of your team?

For example, the southwest corner of Bay & Dundas was vacant 10 years ago. Now it is a 29-storey, 463-unit apartment building (with unit sizes from studios to 2 bedroom plus den), LEED Gold. To come up with the idea the developer considered

• the location,

• the zoning

• the neighbouring buildings

• the competition

• the market for residential rental

• the size of the site

• the company’s resources and experience

• many other factors

Back-of-the-Envelope Pro-Forma

• The “Back-of-the-Envelope Pro-forma” attempts to do a quick financial feasibility test without investing money on a full analysis

  • A rough estimate of the rent and operating expenses per square foot are used to estimate a stabilized NOI

  • A value estimate can be derived by using the NOI and market cap rates

  • If the value generated is greater than the estimated cost of the project, the idea may survive to the next stage

  • If the value is less than costs, the project may be re-imagined or abandoned

  • Specialization in a product type or market can make these estimates easier to produce and more accurate

Risk Control Measures in Stage One

• Know your capabilities

• Know your team’s abilities, strengths and weaknesses

• Keep current

• Be willing to say “PASS”

Stage Two - Idea Refinement

Objectives

• The primary objectives and tasks in the stage are

  • Control the site

  • Identify the critical assumptions, modify them as appropriate, and prepare them for validation through the due diligence process

  • Make an initial determination of the project’s feasibility

    • This requires the involvement of the development team

  • The developer should feel reasonably confident at the end of stage two about the project’s feasibility

Selecting the Site

• For ideas that are not associated with a specific site, creating a plan for land acquisition is the first task of stage two

  • Analyzing areas/neighborhoods in the market

  • Analyzing competition

  • Discussing with elected and appointed official & city planners

  • Determining initial design requirements for the site

  • Negotiating site and structuring a contract to secure the site

  • Refine financial feasibility.

Selecting the Site - Sources of Information

• Urban growth models

  • Provide a theoretical framework for understanding a market’s current pattern of land use and potential directions of change.

• GISs (Geographic Information Systems)

  • Spatial interaction models

    • traffic flows

    • store patronage

    • store revenue

• Spatial diffusion models

  • predict population movements

  • growth/decay of neighborhoods

  • development of new neighborhoods)

Selecting the Site - Characteristics

• The Sites Physical Characteristics

  • Usable Area

  • Floor/area ratio: square feet of a parcel that can be constructed on

  • Situs: interaction of the project with surrounding sites & the impacts of those surrounding uses on the subject property

  • Geology

  • Soil condition (can lead to excavation & foundation work if not looked into)

  • Hazardous Material

  • Cultural considerations

  • Infrastructure

• Ideally the developer sets up contracts that allow her to back out of land purchase if significant environment contamination or geological problems are discovered

Controlling the Site

• To reduce the amount of money at risk during this period, the developer would rather not purchase the land but wants to control it

• A letter of intent (LOI) is often signed and is converted to purchase agreement following satisfactory due diligence

  • The price to be paid at closing

  • Deposits paid to the seller as an inducement to take the property off the market

  • Conditions of closing

  • Responsibility for brokerage commissions

  • Responsibilities of the buyer and seller

  • Due diligence rights, including entry, testing, interviews, and other acts

  • Right of assignment.

• An option is often used to control the site without an outright initial purchase

The Initial Feasibility

• In the initial feasibility the developer tests the concepts in the context of specific sites.

• Assumptions on every aspect of the project are validated

  • physical character of the site

  • entitlement environment

  • competitive environment

  • lending environment

• Ideas and initial design concepts are refined as more information becomes available

Participants

Contractors

• Business cycle affects the quality of available trades’ people. As business cycles peaks, construction costs may escalate and quality may suffer, as less experienced people only are the ones available.

• Contractors are consulted to ensure that the concept can be built on the proposed site or if adjustments need to be made

End Users

• developers begin discussions with a range of possible tenants to determine users’ specific requirements and to refine the general idea of market demand established during stage one.

Property Managers

• Valuable in helping developers avoid costly design mistakes and in planning design features that will make the building easier to manage and/or reduce operating costs

• Input from property managers is particularly important when a proposed project will involve extensive, ongoing services

  • Senior residences

Designers and architects

• Initial discussions on the feasibility of the concepts and designs may begin at this stage

• More important if this is a new concept

• These discussions may lead to changes in the initial design

Lenders

• Determining if the project can be financed is imperative

•Possible terms and conditions required by the lender are assessed

•Informal discussions and negotiations are started

Investors

• Early equity investors typically want a greater portion of the project’s cash flow because they assume more of the development risk.

• Early involvement of equity investors reduces the risk to permanent & construction lenders, thereby lowering the cost of debt financing

• Many projects endure a period in which none of the money will be returned to investors if the project doesn’t proceed

• Expensive to attract investors at this stage

• Often funded by the developer

The Public

• Government

• neighborhood associations

• advocacy groups

Financial Feasibility

• Analysis of financial feasibility gets refined in stage two

  • Development cash flows are estimated

    • Amounts and timing

• Estimates of NOI are refined

• Profitability re-assessed

Risk Control measures in Stage Two

• Control the site through an option or a low-down payment

• Ensure a site is acceptable to the community.

• Seek approvals and opinion in writing.

• More and better market research

• Be aware of and control the amount of time and money invested at this stage

Stage Three - The Feasibility Study

A definition of Feasibility

“A real estate project is ‘feasible’ when the real estate analyst determines that there is a reasonable likelihood of satisfying explicit objectives when a selected course of action is tested for fit to a context of specific constraints and limited resources.”

• Feasibility is not certainty

• Must satisfy the objectives of all the participants (developer, lender, user, public, investor)

• The fit includes timing: it must fit in the timeframe we are considering

• Constraints must be considered (legal, capital, resources)

Components of the Feasibility Study

• Executive summary

• Maps of the site and surrounding area

• Photographs of the site

• Renderings of the proposed project

• Market study, including analysis of market demand and competitive supply

• Revenue and operating cost projections

• Electronic valuation model derived from the market study

• Cost projections

• Estimate of value

• Development schedule

• Background on key players, including project consultants.

• A sensitivity analysis

• Information about the terms and sources of financing

• Government and entitlement considerations

• A review of risks in the optimal configuration

• Risk management measures

• Confirmation that the project is feasible for each participant.

Components of Feasibility Study

• Depending on the size, complexity and originality of the development, the study can vary significantly in length, scope and cost.

• Many specialized companies are available to perform feasibility studies or some components

  • Real estate advisory firms

  • Appraisal companies

  • Business consultants

The Market Study

The market study is the basis of the feasibility analysis. Analyzing long-term global, national, regional, and local trends.

• Examines national economic conditions (including international influences) and projected trends, in light of  the characteristics of the region, locality, neighborhood and site.

  • Global and national economy

    • GDP

    • Inflation

• Consumer confidence

• Employment levels and trends

• Population growth and density

• Age trends

• Changes in technology or manufacturing processes (productivity)

• Investigates local and competitive factors as well as comparable properties to determine the features, function and benefits of those properties that are important to the market. The focus is on projects that are most directly competitive with the proposed development.

  • Local supply and competing space

  • Competing projects currently under development

  • Education level and skills of local workforce

  • Local population growth and density

  • Income levels

  • Infrastructure (roads, services, etc.)

  • Transportation

  • Age trends

*Projects absorption for the market segments that are appropriate for the specific property.

• How many units at what price over what time period will likely be absorbed?*

Preliminary Drawing

• Part of this work was done in stage two, but the formal feasibility study requires drawings that are much closer to final design plans and more detailed so that cost estimates can be more exact.

• High-quality design is much more than aesthetics.  It incorporates

  • Functionality

  • Cost-effectiveness of operations

  • Marketability

Cost Estimates (don't need to memorize)

Typical estimates includes the following elements:

• Land cost

• Site and infrastructure costs (on-site and off-site)

• Design fees (architecture and engineering)

• Hard costs by category (labor and materials)

• Entitlement costs (consultants, public agency fees)

• Financing costs (loan commitment fees, interest)

• Marketing costs (promotion, advertising, leasing commissions, broker fees)

• Preopening operating costs

• Legal fees

• Accounting and audit costs

• Field supervision (inspection) costs

• Overhead

• Property taxes

• Contingencies

• Development fees

Standard industry cost guides can be used to compile in-house cost projections and to compare with local general contractors’ estimates

Risk Control Measures in Stages Three

• Use the best available information and perform a rigorous data analysis

• Have a  formal review of the architect’s design plan by operating, marketing, and construction professionals as well as by public officials

• Verify that utilities and other infrastructure are available