Cursed By Knowing The Numbers

Sat in on a SF ULI Panel yesterday morning on gaining traction in the NorCal residential development sector.   This industry sector is still trying to sell into an ever dropping value market--absolutely the reverse of 2005.  Economics and sales tactics are now more akin to the used car business than the real estate business.  VELOCITY is the key principle.

Housing price declines appear to have stopped accelerating--stabilizing at a rate of decline of 20% per year.  The good news is that it looks like we are approaching a trough.  Bad news is that peak to trough is expected to be about ~40%.  Yowza.

Pulling the levers to achieve a 40% reduction in housing costs means that residual land value is negative.  Brother, can you spare some dirt?

Most interesting points made were about what is working today. 

The panelists had kicked the print advertising addiction--their two best friends were now signage and social networking.  They are starting to leverage the value of social networking--but at what price do your friends consider you smart when buying that condo?   And those broker open houses with the free trips to Hawaii?  Fuhgeddaboudit.

Is it time to start buying hard assets?

Yowza.  From banks in the tank to property values falling off a table last fall.  We need to deleverage about $5T out of the economy, and real estate values are highly correlated with leverage.  The New Normal is about 40% equity and debt costs of ~6%.  Net Collected Rent and Net Operating Income on properties I am looking at have not started to deteriorate yet, but rising cap rates have given most assets about a 20% haircut on value.

Here is MIT's Center for Real Estate Transaction Based Index--although there are so few transactions you don't really know what the mark to market price is--and no transactions for the retail sector as an extreme example.  The results are showing a record price drop.

We are in the market right now buying apartments, so I am probing for a bottom every day--don't see one yet.  When will this end?  Repricing on compelled sales is happening now--question is getting commitment from our investors for what used to be good returns of low to mid teens on operations without construction and lease-up risk.

Not the type of curve that makes you want to jump back in the water, but demand may recover fairly quickly--unemployment is not THAT bad, no inflation, and the cost of debt is not unreasonable.

MIT's Supply and Demand index is another take on current market conditions--sell side is easily six months behind the buy side on pricing, and demand side pricing is off 30% from its high in 2Q07.  Demand spiked back up in early 07--don't believe we will see a repeat of that bounce.  Frankly, I don't know what is going to pick this market back up. 

Free Fallin'...

RREEF went back and looked at their 2008 Real Estate Investment Outlook with the benefit of 2008 behind us.  Interesting commentary, indeed.  Their apartment commentary is dead-on.

Demand, wherefore art thou?

Our jobs are typically very private, so I don't often get a chance to brag on them, or the team responsible for breathing life into them.  So I'm grateful when we get great press.

Our Palo Alto project received another award.  Custom Home Magazine awarded our project its Grand Award for a Custom Home more than 5,000SF.  This Palo Alto infill project struck me as one of the last great houses of the 20th Century, and probably the best built example of Architects Steven Ehrlich, Takashi Yanai and Alec Whitten.

Ryan Associates was our general contractor and raised the bar on cast in place architectural concrete.

Engineered Environments was our AV design/builder and I recommend them highly.

Depp Glass fabricated the glass for the main stair--they did the Apple stores--and were real pros to work with.

Pacific Pools was the pool contractor and, well they stuck with it until they got the job done. 

Great team, exacting job, glad to see it get some press.

Louis Sullivan's principle  "Form follows function" has been the battle cry for many of my architect friends and a way of understanding what needs to be done to our built environment.  Over dinner the other week, we were getting comfortable with a new paradigm--one that is becoming more and more apparent every day--Form follows Energy.

California is the 12th largest emitter of greenhouse gases in the world--the second largest user of transportation fuels--and the largest user if you look at it on a per capita basis.  If you are looking at the problem through a greenhouse gas lens, our problems are sprawl development, and a very high percentage of car use.

My focus here is whether building form is influenced, or follows, energy demand--I'm going to leave the car problem to the smarter folks.

My basic thesis is that we will not conserve our way out of the problem--we need to develop for a world where energy is expensive.  This will get the numbers working in the right direction, and then focus on delivering clean, cheap power as part of the solution.  Why isn't conservation the answer?  This is what happens when energy is cheap:

Every new home we add, every new apartment we build, every new office building developed--increases the demand for energy.  If we are generating electricity from carbon based fuels, it increases the carbon loading of the atmosphere.

The average Californian requires about 7,500 kWh per year:

This is a little more than half of the national average, but we add 400,000 people per year in population.  Part of the reason why our usage is so low is that we are blessed with a wonderful Mediterranean climate in our coastal regions.  The problem is that the majority of these new arrivals will live in the interior of the state, where the summer heat is intense, and AC loads drive a "peaky" electrical demand curve.  And no one wants a new power plant next to them.

Every new office building requires about 13 kWh per square foot per year to operate when fully occupied.

New data centers are being designed at 400 watts per square foot or 1600 kWh/SF/yr, more than 100 times your typical commercial office building.  And data center demands are increasing, not decreasing as Google, Netflix, and Amazon becoming a more familiar part of our lives.

The value of the asset we create is diminished by the energy costs necessary to operate it, and augmented by its value to its occupants.

Our demand for power is becoming increasingly "peak-y" due to building more in the Central Valley--peak demand is very sensitive to temperature variations:

The rising cost of petroleum and natural gas as a feedstock increases awareness of how much, and what type, of energy is used, in our daily activities.  Understanding energy flows can, and should, inform the design of our built environment. 

How do I practice Form follows Energy development?

The most basic form of energy is the sun--so Form flows with the Sun--

Start by understanding the energy flows of the site.   reflected in what is needed to be captured, deflected, or redirected.  Think daylighting, cross ventilation, night flushing, pre-chilling, and thermal cycling.

Intervening--reflecting, redirecting, and catching the energy flows.  Think shades, reflective roofs, and occupancy patterns.

Harvesting--solar electric--photovoltaics, and solar thermal--solar hot water and adsorptive chillers for air conditioning.  Harvesting on an inefficient building is a dumb idea--like trying to row a leaky boat.  Do you row faster, or fix the leak?

Methinks the answer is:

• more compact development patterns--ULI is already looking at this,
• net zero energy buildings--CPUC wants all new residential at net zero by 2020 and commercial by 2030,
• a revolution in how we fuel transportation,
• distributed electricity generation--think smart grid, solar, and wind, and
• a fuel tax/carbon tax/credit process to motivate us to do the right thing.

Creating incentives, building awareness, putting a cost to using energy unnecessarily.  This is a "wetware" problem--the people, economics, and politics--putting the skills to work.  We have won the hearts and minds, now we need to execute. 

Form following energy, indeed.

is the claim Al Masdar makes.  This is a new US$22B development I visited last week when I was in the United Arab Emirates on a project for my solar power business.

Along with Dongtan City in China, this new zero-carbon community designed by Sir Norman Foster is setting the bar for triple bottom line development.

This new city is seeded by a US$15B investment from the Abu Dhabi Emirate, and is located 10km from the center of the city.

Scheduled to be complete by 2016, this new 640 hectare [ 1,700 acre] home for alternative energy industries and research will be home to 50,000 people, create 70,000 jobs, and 1500 companies.  Passive solar design and energy efficient design will result in a community that

• uses 80% less energy,
• 50% less water--a big deal when all your water is produced by desalinization, and
• 1% of the waste going to landfill

than current community needs.

Green design principles will enable this community to save over $2B in oil consumption over the next 25 years, and add an estimated 2% to the GDP of Abu Dhabi.  A streamlined regulatory environment and a unique enabling environment, and a location in the trendsetting UAE completes the feasibility picture.

A Chicago architecture firm recently won the commission for the headquarters--using a positive energy, mixed use program.

A great example of developing like you give a Damn.

Tucked inside the 301 page CPUC Energy Policy Report [4MB]--their first policy guideline post-AB32--is this zinger:

The California Public Utilities Commission, through its “Big Bold Energy Efficiency Strategies,” has adopted three programs designed to move all new residential and commercial construction to a zero net energy standard. The goal of this program is to reach zero net energy in residential construction by 2020 and in commercial construction by 2030.

Another interesting point was the mandatory solar--so that it could be included in the T24 calc.

Mandatory solar isn't the way to go.  Shading, tilt and azimuth is a major issue in greater than 50% of residential sites, so we would end up with systems that don't pay for themselves quickly enough.  The report did admit that feed-in tariffs--the way they do it in Germany and Spain--are the way to go.  And this would promote higher performance design.

Price grid power high enough vs self generation--we think the curves have already crossed in PG&E territory and on the Big Island of Hawaii--add a feed in tariff, and the market will take care of the rest.  Or do what Marin did, and cap residential energy use at the equivalent of a 3,500SF home, and the owner or builder needs to compensate for any additional usage through greater efficiency, or the use of pv to self generate the difference.

Sometimes it helps to take a step back and get the bigger picture...

The CPUC came out last Friday recommending that all new residential buildings developed after 2020 be net zero energy.

Time to get to work...

is the quality of the interaction between

• you and the water, the light, the air
• you and quality of what you can touch
• you and other people
• you and what you need--food, solving a problem, finding a solution--and
• you and the architecture.

Leveraging how you choose to live a life.

In my pantheon of real estate pros, Sam Zell occupies a prominent place.  I first became aware of him and his grave dancer moniker when I was a grad student--he is a master of the real estate cycle.  In the past year, "he has achieved guru-like status in the business world." 

His sale of EOP at what looks like now as the top of the office cycle is recent proof that he hasn't lost his touch.

I recommend you take the time to read this article.  My takeaways:

he is constantly trying to "shut out the noise of conventional wisdom.  While it may not be wrong, it is rarely profitable."

"Look, business is easy.  If you've got a low downside and big upside, you go do it.  If you've got a big downside and low upside, you run away.  The only time you have any work to do is when you have a big downside and a big upside."

"...when you invest in emerging markets, you are trading growth for the rule of law, so it is critical to find the right local partner and build a strong personal relationship.  You're making a marriage."

Now to go do it...