Over the last couple years, the development market has returned to fundamentals. The wounds of the downturn are still fresh, and investors, developers, and banks are more cautious, putting their money behind only what looks like a sure thing. As a result, we’re seeing more tenant-driven development and less speculative development. For example, in the Boise area, we have seen two significant projects break ground in the last year: Eighth and Main (a high-rise office building) and Village at Meridian (a retail lifestyle center). Both projects were over 75 percent pre-leased prior to going vertical. We’re also seeing a lot of owner-user product being developed, such as automotive dealerships.
Speculative, capital-driven projects that don’t fit an existing market need are just one risk that developers should avoid. As more developers return to fundamentals, here are three ways projects can go wrong and how to avoid them.
1. Misreading the market. Never assume that there’s more demand for your proposal than there actually is or act as if the trends from the last couple years will last indefinitely. Pursue projects driven by a market need rather than one pushed forward by capital in search of a return. Before starting a project, know exactly what you’re going to build based on your target market. Know who the users (buyers or tenants) will be, what rent or price level they can pay, and what design features they want. Know your competition, not just vacancy rates but also how much new product is coming to market. And, while this might sound self-serving, do a market study to get a critical, objective look at your project’s potential absorption rates and rent levels to get a clear sense of the project’s feasibility.
2. Losing out in approvals and entitlements. Many developers underestimate the potential for neighborhood opposition to a development. Failure to get approvals has derailed many a project; I’ve experienced this when trying to develop apartments and senior housing in single-family residential areas, for example. Even if you buy a site where the zoning allows you to build, if the property backs up to neighbors, they might appeal to the city council at a public hearing, and regardless of whether the law’s on your side, the democratic process can put enough pressure on elected officials to kill a project. Developers should approach projects fully appreciating this potential. Obviously this issue is location-specific, but one of the better ways to hedge your risk is to option a site instead of buying it outright, or set a closing contingent upon approvals. Another option in the face of such risks is to negotiate a discount on the site to provide a cushion if the project can’t move forward.
3. Choosing the wrong architect. Hiring the architect is one of the most important decisions in the development process. When potentially millions of dollars are at stake, it pays to find an experienced architect. I once worked on a project with an architect who had misread the building code and had designed a building twice as big as the code would permit. We almost lost the deal, and we wasted months and tens of thousands of dollars. When seeking an architect, ask a trusted colleague for a recommendation and choose a firm in touch with the market that can design the product so it’ll be well received by the end user.
The development business is certainly risky, and there’s no shortage of horror stories of developers that have lost millions. At the same time, it can be a very lucrative business. It’s a classic illustration of risk versus return. By sticking to the fundamentals and pursuing market-driven projects, developers are better able to limit their risks and boost their returns.
Author: Robin K. Brady