Development-The Good, Bad and Ugly

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It is highly likely that development of all types will remain subdued for a few more years. Although developers are hoping to start projects that had been put on the shelf in 2007, the reality is there is, and will remain, very limited construction financing. The construction financing that will be available is low leverage and usually requires a personal guarantee. I am working on financing two development projects in Manhattan right now for very credible developers, and the projects make very good economic sense from a cost and market basis, but finding construction funding that is priced at an economic level, and that does not require large personal guarantees is extremely difficult. Nonrecourse financing is possible but the cost of capital becomes equity like so it is not conducive to making the project economically viable and the risk justified if you pay for equity but it comes in the form of debt.

The other mitigant to new development is the fact that you can still buy existing projects at less than development cost. This will remain the case for another two years or maybe longer in many parts of the country. It is likely that you will still find properties to acquire through note purchases or direct property buys which are discounts off of replacement. If they are not then why buy them. Even with renovation costs and remarketing costs added, they are often better values than development. How long that lasts is very market driven. Prices in Manhattan and Washington have risen already to levels where the trade off is less apparent than it is in many other parts of the country.

In many locations the government programs which were designed to foster development are being severely reduced. California may cut out redevelopment funding. In many cities and states the incentive programs of the past are being reduced because they need the cash for other things, they need the taxes that they had forgiven and they will be raising fees and other costs to get developments approved. While some states will be happily inducing companies to move from California and its increasingly burdensome laws and regulations, and from Illinois with its high taxes, there will generally just be less funding for development. It is comical to watch the California delegation come to Texas this week to find out why so many companies moved from California and why so many go to Texas. It just shows you how completely out of touch the California legislature is that they have to go to Texas to figure it out. All they had to do was ask all the companies who are packing up each week and leaving. While they were in Texas this past week even more new burdensome and costly regulations were being put in place in California. Obviously Obama and Harry Reid also do not bother to listen to all the companies who talk about why they move operations from the US. Taxes and regulations. Both California legislators and the Democrats in Washington are so ingrained that companies are bad and unions are good, that they are deaf to all of the noise about burdensome regulations and outrageous rulings. Just look at what happened to Boeing this week. They build a new factory in South Carolina and start hiring several thousand new workers at good salaries. Along comes the union run NLRB to say they are not allowed to open their new plant because they have to either make it union or they have to build a new plant in Washington State that will be union. This is so beyond anything that has ever been done by government, to tell a company they have to build a factory where the union says they should build it, that it defies imagination. While this will not stand when tried by a rational court, it magnifies why the US is not adding jobs the way it should at this stage of a recovery. Obama puts a union lawyer in charge of the NLRB in a recess appointment, stacks the board with union people, and then claims the White House had nothing to do with this.

After that insanity see how many large companies rush to build new plants in the US even though it makes a lot of sense now with the dollar in deep decline.

Bottom line to all of this is if you can get a new project developed in the next couple of years at a cost that makes good sense compared to buying an asset, and if you can get it leased up at good rents, then you will have an asset of real value because there will be so little else built to compete with your new project for several years. There is a lot of land that is entitled that never got built out and can no longer be carried by the original developer or the lender who now holds it. It may be worth considering buying some of that well located land at deep discounts and starting on the approval process now, in anticipation of being able to build in two years, and still being ahead of the wave, but with very inexpensive land basis which will make your project more easily financed and able to charge good rents as the only new property in an area. When everyone else starts to develop again you will then be a seller before things get over built again. Just don’t develop in California. It is not likely to get any better given the leftist politics of that state legislature.

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Joel Ross began his career in Wall St as an investment banker in 1965, handling corporate advisory matters for a variety of clients. During the seventies he was CEO of North American operations for a UK based conglomerate, and sat on the parent company board. In 1981, he began his own firm handling leveraged buyouts, investment banking and real estate financing. In 1984 Ross began providing investment banking services and arranging financing for real estate transactions with his own firm, Ross Properties, Inc. In 1993 Ross and a partner, Lexington Mortgage, created the first Wall St hotel CMBS program in conjunction with Nomura. They went on to develop a similar CMBS program for another major Wall St investment bank and for five leading hotel companies. Lexington, in partnership with Mr. Ross established a hotel mortgage bank table funded by an investment bank, and making all CMBS hotel loans on their behalf. In 1999 he formed Citadel Realty Advisors as a successor to Ross Properties Corp., focusing on real estate investment banking in the US, UK and Paris. He has closed over $3.0 billion of financings for office, hotel, retail, land and multifamily projects. Ross is also a founder of Market Street Investors, a brownfield land development company, and has been involved in the acquisition of notes on defaulted loans and various REO assets in conjunction with several major investors. Ross was an adjunct professor in the graduate program at the NYU Hotel School. He is a member of Urban Land Institute and was a member of the leadership of his ULI council. In 1999, he conceived and co-authored with PricewaterhouseCoopers, the Hotel Mortgage Performance Report, a major study of hotel mortgage default rates.