Mike E. Miles is a portfolio manager for Guggenheim Real Estate and is a former professor of real estate and the dean of the business school at University of North Carolina–Chapel Hill. Laurence M. Netherton is a 40 year veteran of real estate investment and development. He is a former professor of land planning at the University of California–Irvine. Adrienne Schmitz is the former senior director of publications at the Urban Land Institute.

Real Estate Development

Principles and Process

By Mike E. Miles, Gayle Berens, Mark J. Eppli, Marc A. Weiss

Urban Land Institute

Copyright © 2007 ULI–the Urban Land Institute
All rights reserved.
ISBN: 9780-87420-343-1

Contents

PART I. INTRODUCTION,
Chapter 1. The Real Estate Development Process,
Chapter 2. The Raw Material: Land and Demographics in the United States,
Chapter 3. Developers and Their Partners,
PART II. THE HISTORY OF REAL ESTATE DEVELOPMENT IN THE UNITED STATES,
Chapter 4. The Colonial Period to the Late 1800s,
Chapter 5. The Late 1800s to World War II,
Chapter 6. Post–World War II to the Present,
PART III. FINANCE,
Chapter 7. Real Estate Finance: Background,
Chapter 8. Real Estate Finance: The Logic behind Real Estate Financing Decisions,
Chapter 9. Discounted Cash Flow: The Equity Perspective in More Detail,
PART IV. IDEAS,
Chapter 10. Stage One: Inception of an Idea,
Chapter 11. Market Research: A Tool for Generating Ideas,
Chapter 12. Stage Two: Refinement of the Idea,
PART V. PLANNING AND ANALYSIS: THE PUBLIC ROLES,
Chapter 13. The Roles of the Public Sector,
Chapter 14. Meshing Public and Private Roles in the Development Process,
Chapter 15. Affordable Housing,
PART VI. PLANNING AND ANALYSIS: THE MARKET PERSPECTIVE,
Chapter 16. Stage Three: The Feasibility Study,
Chapter 17. Market Analysis: Collecting, Validating, and Understanding Market Data,
Chapter 18. Data Sources Supporting Market Studies,
PART VII. MAKING IT HAPPEN,
Chapter 19. Stages Four and Five: Contract Negotiation and Formal Commitment,
Chapter 20. Stages Six and Seven: Construction, Completion, and Formal Opening,
PART VIII. MAKING IT WORK,
Chapter 21. Stage Eight: Property, Asset, and Portfolio Management,
Chapter 22. The Challenge of Marketing and Sales,
Chapter 23. Some Closing Thoughts and a Note about the Future,
Appendix A. Europa Center Case Study,
Appendix B. Gateway Business Center Offering Memorandum,
Appendix C. The Real Estate Game: Level One and Level Two,
Appendix D. Glossary,
Bibliography,
Index,

CHAPTER 1

The Real Estate Development Process

Real estate development is the continual reconfiguration of the built environment to meet society's needs. Roads, sewer systems, housing, office buildings, and lifestyle centers do not just happen. Someone must initiate and manage the creation, maintenance, and eventual re-creation of the spaces in which we live, work, and play.

The need for development is constant, because population, technology, and taste never stop changing. New generations, new lifestyle choices, and revolving immigrant groups, coupled with the evolution of technology, drive economic changes in consumer tastes and individual preferences.

Whether current consumer, new citizen, or real estate professional, all of us inhabit the built environment. Further, through the legislative/political process, we collectively continue to alter the rules of the development process. Therefore, we should all understand the development process. The development process creates the houses we live in, the mixed-use development down the street, the 25-story office tower downtown, the warehouse that stored the paper this book was printed on, and the convenient (but to some tastes terribly unattractive) fast-food restaurant on the commercial strip.

Both public and private participants in real estate development share compelling reasons for understanding the development process. The goals of private sector participants are to minimize risk while maximizing personal and/or institutional objectives — usually profit (wealth maximization) but often nonmonetary objectives as well. Few business ventures are as heavily leveraged as traditional real estate development projects, magnifying the risk of ruin but also increasing the potential for high returns to equity. Large fortunes have been and continue to be made and lost in real estate development.

The public sector's goal is to promote sound and smart development, ensuring that construction is attractive and safe and that new developments are located and designed to enhance the community, provide needed space, and boost the economy. Sound development means balancing the public's need for both constructed space and economic growth against the public responsibility to provide services and improve the quality of life without harming the environment.

The public and private sectors are involved as partners in every real estate development project. A key tenet of this book is that all participants enjoy a higher probability of achieving their goals and objectives if they understand how the development process works, who the other players are, how their objectives are interwoven, and the need to achieve consensus.

This book was written for people who need to understand real estate development from the perspectives of both the public and private sectors. Its aim is to be useful to present and future developers, city planners, legislators, regulators, corporate real estate officers, land planners, lawyers specializing in real estate or municipal law, architects, engineers, building contractors, lenders, market analysts, and leasing agents/brokers. Readers are assumed to have already acquired the fundamentals of real estate and/or city planning. This book summarizes but does not repeat in great detail basic information about real estate law and finance, urban economics, and land planning and design. Although the focus of our book is the individual entrepreneurial developer, it is important to note that developers can also be financial institutions, corporations, universities, medical centers, private investors, cities, municipalities, and others. The process laid out in this book remains essentially the same — no matter who the developer is. Market decisions still have to be made, pro form as still need integrity, designers have to be consulted, and so on. The process might be layered by various institutional procedures and committees and boards of trustees, but the product is achieved by going through the same steps. In fact, many institutions and cities are hiring entrepreneurial developers on a fee basis to manage a project's development within the larger organizational framework.

Throughout, the book includes profiles of developers and the diverse set of professionals who work with developers. Their career paths are always interesting and often surprising. Their perspectives on development are especially valuable because these individuals have lived the process we are describing. Development decision making has become more difficult as the world has grown more complex, and developers' and professionals' insights help frame the development process in human terms.

In addition to the various profiles, the book focuses on three developers and three projects. One profile is of Russell Katz, a young developer who was originally trained as an architect. An ardent supporter of green buildings, one of his goals in developing Elevation 314, a four-story, 52-unit apartment complex, is to demonstrate the potential of environmentally friendly architecture.

The other project involves two residential towers developed in Cambridge, Massachusetts, by Dean Stratouly of Congress Group Ventures. Museum Towers is the story of a development in a pioneering location.

In addition to Katz's and Stratouly's experiences, Appendix A of this edition includes an account of Whit Morrow's Europa Center. Originally interspersed throughout the pages of previous editions of this book, the case study of Europa Center has changed as this book has changed. In the first edition, Morrow recounted in his own words all phases of the development process for this Class A office building: from conception through planning, permitting, financing, and construction to completion, leasing, and ongoing management. In subsequent editions, we learned how the building functioned over time and about the need for related development.

These projects tell stories of unexpected complications and their resolution through the words of the developers.

To begin the discussion of the development process, this chapter lays out the functions of the process and its many players:

• The definition of real estate development;

• The eight-stage model of real estate development;

• The characterization of developers and their reputations;

• The development team;

• The public/private partnership;

• Market and feasibility studies; and

• Design.

The next two chapters complete the introduction by defining the playing field — the spatial economics of the contemporary city — and then defining the roles of the various participants in the process. Chapter 2 describes the raw materials of the development process — demographics — while Chapter 3 adds detail and contemporary color to the process and the players.

Part II presents a long-term historical perspective on real estate development in the United States. Part III then covers the financial mechanics that support development decision making. Finance is not the goal, however; rather, finance constitutes the logic that allows the developer to bring together several participants (each with its own set of objectives) in a coordinated effort that will ultimately make a profit. The book then proceeds through the eight-stage model to look in detail at decision making in the real estate development process.

DEFINING REAL ESTATE DEVELOPMENT

A real estate development starts as an idea that comes to fruition when consumers — tenants or owner-occupants — occupy the bricks and mortar (space) put in place by the development team. Land, labor, capital, management, entrepreneurship, and broadly defined partnerships are needed to transform an idea into reality. Value is created by providing usable space over time with associated services. It is these three things — space, time, and services — in association that are needed so consumers can enjoy the intended benefits of the built space. Although the definition of real estate development remains simple, the activity continues to grow more and more complex. The product of the development process — a new or a redeveloped project — is a result of the coordinated efforts of many allied professionals.

Developments do not happen without financial backing and often require multiple agreements to be negotiated by multiple financial players. Only then can physical construction or reconstruction be started, involving the myriad of design professionals, construction workers, engineers, and so on. Before, after, and during the process, the developer works with public sector officials on approvals, zoning changes, exactions, building codes, infrastructure, and so on. Increasingly, community groups in many cities demand to be key players in the development process, and the time needed to work with them has to be factored into the development equation. Finally, selling or renting the space to users at the intended (or higher) price is the act that proves the entire project was justified. This consummation requires the expertise of marketing professionals, graphic artists, salespeople, Web site developers, lawyers, and others. The developer must ensure that all these elements — and many more to be identified later in this book — are completed on schedule, are properly executed, and are reasonably within budget.

Today, development requires more knowledge than ever before about the specifics of prospective markets and marketing, patterns of urban growth, neighborhood associations, traffic, legal requirements, local regulations, public policy, conveyances and contracts, elements of building design, site development, construction techniques, environmental issues, infrastructure, financing, risk control, and time management. Ever-increasing capacities and complexities along each of these dimensions have resulted in increased specialization. As more affiliated professionals work with developers, the size of the development team has expanded and the roles of some professionals have changed. Although greater complexity has generated the need for better-educated developers (educated both in book knowledge and hard knocks), it has not changed the steps they usually follow in the development process.

THE EIGHT-STAGE MODEL OF REAL ESTATE DEVELOPMENT

Developers follow a sequence of steps from the moment they first conceive a project to the time they complete the physical construction of that project and begin ongoing asset management or sell the finished product. Although various participants of the development process may delineate the sequence of steps slightly differently, the essence of the steps does not vary significantly. At a minimum, development requires the following elements: coming up with the idea, refining the idea, testing its feasibility, negotiating necessary contracts, making formal commitments, constructing the project, completing and opening it, and, finally, managing the built project. This text seeks to capture that essence in the eight-stage model depicted in Figure 1–1. Succeeding chapters detail the activities that collectively make up the eight-stage model of the development process.

Before proceeding further with the model, a few points about development must be emphasized. First, the development process is hardly straightforward or linear. A flow chart similar to that shown in Figure 1–1 can freeze the discrete steps and guide an understanding of development, but no chart can capture the constant repositioning that occurs in the developer's mind or the nearly constant renegotiation between the developer and the other participants in the process. And don't forget that redevelopment of existing projects requires many of the same steps as development. Moreover, in very large projects, individual development components can be "nested" within a larger development plan. For example, during the development of a large-scale community like Stapleton in Denver, Colorado, individual components of the community may be in different stages while the overall development plan is in stage six — construction.

Second, development is an art. It is creative, often extremely complex, partly logical, and partly intuitive. Studying the components of real estate development can help all players make the most of their chances for success. What cannot be taught are two ingredients essential to the success of the real estate developer/entrepreneur: creativity and drive. At times, a smart developer will choose to move in a different order than the one suggested here.

Third, at every stage, developers should consider all the remaining stages of the development process. In other words, developers should make current decisions fully aware of the implications of these decisions not just for the immediate next step but for the life of the project. By doing so, they ensure that the development plan and its physical implementation come closest to the optimum for the duration of the entire development process and, equally important, for the project's long expected life.

Fourth, the development process requires interaction among the different functions (construction, finance, management, marketing, and government relations) in each of the eight stages as well as interaction of the functions over time.

It is a huge mistake to underrate the importance of asset management and property management after the project is built or to overlook provision for them during design and construction. For example, operating a building with every up-to-the minute technological bell and whistle may require technical competence beyond the general management skills typical of most property managers. In addition, asset managers need to remarket space continually and to upgrade or remodel buildings periodically to keep the space competitive in an evolving market. Institutional investors and corporate owners are also keenly aware of the periodic need for and cost of major remodeling to prolong the economic life of buildings. Careful planning during stages one through seven should enable developers to find ways to minimize the frequency and cost of retrofitting buildings. Whether or not developers manage the property for the long term, they are responsible for considerations involving asset management during the first seven stages. Given that developers' actions largely determine future operating costs and that the expected magnitude of such costs represents a significant part of the project value (i.e., what it will sell for), today's developers focus sharply on making building operations appropriately cost-efficient.

Fourth, although the model for development is based on reality, it also represents an ideal version of the process and gives an elegant means of imparting the information. The various stages of the model assume a well-informed developer, a thorough analysis of the market, accurate assessments of the cost of construction, and so on. They assume a businesslike approach to the process. They do not totally account for the lucky intuitive person who had a gut feeling about something and used all sorts of unconventional means to get the project built. Real estate development has been full of stories of those people whose gut has led them to being very successful in the business. They are becoming less common because of more and tighter regulations, declining amounts of developable land, and so on, but they still exist. You will hear from one such maverick, Pamela Bundy, who is profiled in Chapter 19.

(Continues...)Excerpted from Real Estate Development by Mike E. Miles, Gayle Berens, Mark J. Eppli, Marc A. Weiss. Copyright © 2007 ULI–the Urban Land Institute. Excerpted by permission of Urban Land Institute.
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