Cursed By Knowing The Numbers

Recently started construction on a project in Marin that proves the need for balancing cost and scope of work from the beginning.  A big part of a successful project is understanding what needs to be done, how much it costs, and having sufficient resources to get it done.  You need to know what your ratios between cost, quality, and time are, develop your design, and have the right development team onboard to get to an on-time, on-budget finish.

Brought in prior to final bidding, we realized that this project, in a normal market, was going to price out 60% over the resources committed to it.  Since we haven’t been in a normal market for over 2 years now, we stood by and waited for pricing—and unfortunately we were right.

Taking 10%, even 20% out of a project to get it to balance with available resources is not that hard, and routinely happens as  qualitative increases in one area creep into other areas, driving a contextual upgrade in quality [and cost].  Dialing back qualitative requirements to meet an overall level of quality can save ten percent without looking like the job got whacked.

What was unique here was the amount of the re-balancing needed.  Rebalancing a project that is 60% off requires real time costing, and a clear understanding of where we can, and can’t, pull from without compromising what this home wanted to be. 

How did we do it?

1. Pull in limits of demolition—defer landscaping and site work.
2. Cut square footage.
3. Focus quality where it is felt—balance finish with how the space will be used.
4. Recruit a builder partner right-sized for the project.

Now that the shovels are in the ground, the focus is on building pace and intensity on the project—getting it done in twelve months.  Slow jobs simply cost more.

Acting as development advisor to one of San Francisco’s most cherished civic institutions this past year has been a great opportunity to showcase our instant feasibility process.  Our development model generation tool has provided almost instantaneous project feasibility on several locations, allowing the building committee to make smarter, more informed choices as they search for a new headquarters.   Civic institutions have a responsibility to be effective stewards of the funds their donors provide—and for an institution evaluating whether to build a new headquarters for their next 100 years of service—our instant feasibility and development model generation tool can be invaluable.

The guiding document is a one page summary of salient facts, development costs, intended building program, and The Raise—the amount the institution needs to go out to their donors and raise.  This document, together with our 3D spatial demand overlay, provides a narrative to the action required to reach the end.

Balancing program with budgets via this tool reduces friction, dynamically evaluates options, and speeds time to generating truly compelling development alternatives. 

Decisions become easy when you have a compelling option—this instant feasibility process means you spend less time deciding and more time manipulating the model to arrive at a truly outstanding, and balanced, plan.

Feedback loops within the tool provide early warning signals.  In a recent case, the tool showed that the institution’s intended offer price for the site was markedly greater than the program’s land residual value, and close to the commercial property bubble pricing last seen in 2007.

We begin at the end—taking the end client’s perspective on its spatial demand needs, and then loop back to the beginning—the site context and the bones of the property currently being considered. Rinse and repeat on the program until costs, time, and existing conditions balance.

The institution's spatial demand was projected onto the existing bones of the building—in this case it included the original 1907 construction brick walls, 1996 seismic braced frames, stairs and vertical transport shafts—to understand how useful the bones are to this new program.

Rapid prototyping and conceptual costing is potentially the most valuable tool a board can have when searching for a new building or location.  The reduction of stress and upfront due diligence friction on boards, their architects, and most importantly, their lead donors makes me wonder why this powerful tool is not more widely used.

Development model generation is a prototyping tool providing a close enough “horseshoes and hand grenades”  level of costing, critical path implementation, and program definition.  I admit upfront that our forecasts…

“…are always wrong.  The real question is how wrong they are.”

This tool combines an architect’s creativity with our structured approach to development delivery—the best of both worlds—when you need it.  Now.

Most real estate development companies look for their project managers to have a graduate degree in architecture, real estate, an MBA, or a law degree.  I like the real estate development degree because it typically:

• has a mid-career student profile, designed so you can learn a lot from your fellow students,
• consists of small classes, and is only
• twelve months in duration, so you don't have to spend a lot of time offline reprogramming yourself.

Unless you are independently wealthy, or come from a prominent real estate family, one of the best moves you can make is to find a grad program that is a fit for you.

The one I went to was started by Hank Spaulding and Larry Bacow at MIT's Center for Real Estate.  The MIT Center for Real Estate is sponsoring an information session this Friday, 5NOV at 630P the headquarters of AMB Properties located on Pier One [Google Maps Link] on San Francisco’s waterfront.

If you are thinking about graduate school, and your passion is real estate and development, this may be worth a couple hours of your time to come in and listen to Tony Ciochetti, the Center’s director, pitch the program and talk with San Francisco alumni [you can start with me] of this twelve month intensive master’s program.

Register here.   Look forward to seeing you Friday!

Great article in today’s NYT Magazine. 

We understand the science, know how to limit carbon loading our atmosphere, we can manage the costs.  What we need now is to summon the political will.

…that make the difference in the long run.  Was reminded of this axiom this weekend when I looked back at MIT/CRE CREDL’s Transactions-Based Index. I was part of a team tracking and trying to close a Silicon Valley 400-unit apartment asset that was a solid C asset in an A- location—a classic value add play.   Our bid came up 16% short of the sale price [about a 6 cap on YE2008 NOI].  At the time I was really disappointed that we couldn’t close on this asset.

Now, with the benefit of hindsight, our pricing model was 10% HIGH—prices dropped another 10%  last year, and will probably bottom out at the end of this year,  as job growth returns to backstop occupancy in the Valley.

Thanks, Tom and Myles.  That lunch conversation over sphaghetti and meatballs saved my butt—nothing worse than being wrapped around the axle on a real estate project where you will never get out ahead of the preferred return.

We lives to die another day…

Commercial real estate’s epic fall from grace in 2009 is well documented in this markup of RREEF’s 2009 Real Estate Investment Outlook and Market Perspective.

I love this technique—the analyst actually went back and marked up their 2009 forecast at the end of the year with what actually happened. 

The downturn in San Francisco and Seattle, two traditionally downturn-resistant markets, was greater than forecast.

Pricing dropped 40% from its 2007 peak, and is forecast to drop another 10% in 2010.  NCREIF property returns were the worst in NCREIF’s 30+ year history.

The big conclusion of the markup?  2009 was the weakest year since the 1990’s—remember SURVIVE TIL ‘95?   I wonder what the new mantra is…

They are predicting a quicker return to zero or positive returns in 2010 than for the 1990s downturn—driven by cash on cash returns—with income getting re-established at sustainable levels.

Employment growth is expected to turn positive this year, with below long term GDP trend growth until 2011—performance tracking below previous recoveries.

The big thing they didn’t talk about?  What will the real estate banking market look like going forward?  The guys that threw the gasoline on the fire in 2005-2007—Lehman, Merrill, RBS, and Bear—are all gone.

The bottom line?  Commercial real estate, once viewed as a liquid, appreciating asset with the ability to carry a lot of debt as you rolled over the tenant mix, is now back to occupying its traditional role as a bond-like income producing investment with an inflation hedge.

Still puzzling through the IPD process.  Am a big fan of the bill of quantities [chartered surveyor] approach, have used it for years to bound in project costs. At its core, an owner is paying a contractor for pace, intensity, getting the right subs "on the bus", and quality [ no leaks, squeaks, or smells].  Architect is paid for putting the puzzle pieces together in a smarter & more valuable whole.  And the owner is responsible for maintaining vision and context--setting the course, and having the understanding when to nudge the tiller to keep on course.

I need to understand more about BIM, it seems like it is an essential tool in understanding how to chart/maintain a course.  Almost like a navigation system for building..."Left turn in one month...  Recalculating...  turn back now.  I REPEAT, TURN BACK NOW."

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?