How Real Estate Developers Think

Based on interviews in Portland, Chicago, Miami, and Minneapolis/Saint Paul, How Real Estate Developers Think depicts the entrepreneurial personality of the developer, explores the meaning of "good design," and examines the economic risks and rewards of development.

How Real Estate Developers Think
Design, Profits, and Community

Peter Hendee Brown

2015 | 336 pages | Cloth $79.95 | Paper $34.95
Public Policy | Business
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Table of Contents

Prologue. A Brick Wall in Evanston

Chapter 1. Developer as Visionary
Chapter 2. Deal Makers
Chapter 3. The Real Estate Development Process
Chapter 4. Developers and Their Architects
Chapter 5. Good Design
Chapter 6. Selling Real Estate
Chapter 7. Market Cycles, Leverage, and Timing
Chapter 8. Profits, Values, and a Sense of Purpose
Chapter 9. The Creation of Place and Culture
Chapter 10. Developers and the Community

Notes
Index
Acknowledgments


Excerpt [uncorrected, not for citation]

Prologue
A Brick Wall in Evanston

We used to call them our town founders and we honored them by erecting their statues in our town squares. Today we just call them "developers."
—Andrés Duany, Miami architect and planner

The Costs of Opposition

In 2002 a Chicago developer named Neil Ornoff hired the architect David Haymes and his firm, Pappageorge Haymes, to design a twenty-unit residential project on a corner site at 525 Kedzie Street, in Evanston, Illinois, a northern suburb of Chicago. "The alderman—the city councilman—was really fearful of the people who lived in the adjacent building and were concerned about losing views they had across the vacant parcel, so he asked the developer to work with them," recalled Haymes. "We designed a beautiful building," but the design required a small portion of the building to be a little bit taller than what the height limits in the code allowed. The site plan also required the developer to seek relief on a parking rule that required a twenty-foot setback from the street to the building face to allow for on-street parking for the property, even though all of the parking for the building was going to be accommodated onsite, within the building, and concealed from view. These were routine and modest variance requests but, as Haymes recalls, "The neighbors simply said no, we are going to oppose the project."

So Haymes went back to the drawing board and redesigned the façade on the side of the building that faced the neighbors, adding articulation and setbacks that made the building look better from the neighboring property but increased project costs. This time the neighbors said, "No, that is a very nice design, but we are still going to oppose it." So the developer said, "That's it—we will build it 'as-of-right,'" which means per the letter of the code and without any variances. Haymes redesigned the building, eliminating the small portion that was to be taller and changing the site plan to accommodate the required twenty-foot setback. He stripped off all of the articulation and setbacks on the side facing the neighboring building because there wasn't room and the developer no longer felt the need to incur the costs required to curry favor with the neighbors. "We gave them an unadorned brick wall facing their building because we had to push our own building so far back on the property." In the end, it took the developer and his team more than two years to obtain the approvals required to build a small, twenty-unit condominium project and by then it was late to market. The project opened in 2007, just as the housing bubble burst. The condominium units failed to sell out at pro forma prices so the developer was unable to fully repay the construction loan. The bank foreclosed on the property and sold it to another owner who converted it to apartments.

In addition to providing architectural design services to developers, David Haymes and his partner have done some small development projects themselves and Haymes is also the head of his own community organization, so he has seen development from those viewpoints too. "There are still some in my community group who harbor those really harsh feelings about developers; they just don't want change. They don't trust developers because anything a developer does is going to be a change, and so they hammer any developer who comes in. Fortunately," says Haymes, "over time, my community group has become more sensitive and understanding of what development is. We have also come to understand that we are better off having a say than not being involved at all, because if you take the attitude that you don't want to talk to somebody then you are going to have to live with the consequences."

Haymes sympathizes with how the public views developers but at the same time he finds that the whole process is far too distrustful to be productive. When Haymes presents at a public meeting, his job is to support his client by positively representing the project, but Haymes says he almost always fully backs and believes in what he is doing for that client. "That is why it is disturbing for us when the developer really is making an honest and forthright effort but he's being abused and we are being called liars and whores." Haymes is disturbed not only because the developer's efforts are being minimized, but also because good things for communities are being passed up—like what happened in Evanston.

In what became a lose-lose outcome, the developer spent extra time and money in a costly and fruitless effort to secure the support of the neighbors. But at the same time, in overplaying their hand the neighbors failed to stop the project and also still lost their views across the vacant parcel, views that were not really theirs to begin with. In giving up their leverage they also gave up views of a more handsome façade from their own windows in exchange for a plain brick wall. By forcing the developer into an as-of-right design, the neighbors forfeited the opportunity to let the developer of the adjacent property increase the value of their own property by building a more attractive building next door.

Unfortunately, for everyone involved, the neighbors misunderstood that the developer had rights and options too. Indeed, his best option was to give up trying to do a more creative design that required minor variances and settle for an as-to-right design that complied with all codes and regulations and could be administratively approved without the need for zoning commission review and a public hearing. The developer could no longer bear the carrying costs on the property, the uncertainty of the approvals process, and the related risk of being late to market. He needed to regain control of the project.

More important, the developer understood the neighbors' strategic position better than they did themselves—certainly better than they understood his position and particularly his property rights. If the neighbors had only been able to see the project from the developer's viewpoint, they may have realized that taking an absolute position—opposition—was a risky strategy that was not necessarily in their own best interests. Then they may have been more open to a collaborative approach and the ability to influence the design in a way that would have maximized the benefits flowing from the project to them and to the larger community.

A Common Story

Unfortunately, this is a common story and anyone who lived in an urban neighborhood in the 2000s and since can probably remember attending a meeting of the neighborhood organization and hearing a contentious debate over a similar project. Nearby neighbors of development projects deserve consideration, and savvy developers know that they will gain public support and attract more potential buyers and tenants if they listen and adjust their designs to reflect the community's feedback and concerns. But how can community members most effectively use their influence to improve the design of a project? Which things can a developer change, which are nonnegotiable, and how can the neighbors tell the difference? How can the neighbors even tell the difference between a good project and a bad one? What powers do members of the community have to influence private business decisions through the public regulatory review process? And what should the neighbors do when a developer walks through the door with a proposal for a project?

The most common strategies are apathy or opposition. Apathy means de facto support and forfeiture of the opportunity to become engaged and to contribute useful local knowledge to improving the project for all parties. Blanket opposition, on the other hand, signals the end of a discussion rather than the beginning of one, and, again, it turns away from the opportunity to positively influence a project. When community members stop talking to developers, they give up whatever voice they do have in shaping projects in their community. Worse, as in Haymes's story, successful opposition may kill a good and creative proposal only to pave the way for something of lesser quality. The answer lies somewhere between the simple extremes of apathy and opposition—in conversation, compromise, and understanding. Before neighbors and community members can effectively participate in this kind of conversation, they must come to a better understanding of developers and, before that, they must first acknowledge their own motives, interests, and fears.

Fear of Change

Buildings made of glass, stone, and metal make us think of permanence. But cities are fluid and ever-changing places where, over time, streets, infrastructure, public spaces, and buildings are constantly being built, improved, demolished, and replaced. For the people who live next door to a potential development site, such as a vacant lot or an old obsolete building, this means something new will be built on that property sooner or later and it is not a question of if but of when. Yet change is frightening and many people are more comfortable with the familiar, in part because they have difficulty visualizing how a proposed project might actually look and fit into their community. Fear of the unknown begins with rumors of a potential development and increases when community members see the first images of the proposed project at the neighborhood meeting. For people who are not in the development business, it can be difficult to know what to focus on, what to worry about, and how to try to influence the project. Neighbors also have a relatively brief period of time to review the proposal and offer their feedback to the developer and city officials in community meetings and at public hearings. And if the project is approved they know that the inconvenience and aggravation of construction will soon follow.

For a typical project all of this may take less than two years but in the heat of the moment some community members will be unable to pull back and take the long view of this relatively brief period of stress and discomfort. They will have difficulty imagining how the completed development might improve their own lives and make their community a better place—for years, decades, and even centuries to come. It can bring new benefits to the community, including more neighbors, businesses, services, bars, restaurants, retail shops, and perhaps even a grocery store. The development will also increase the tax base and cause the city to increase spending on infrastructure, parks, and other public facilities. And a real estate development project represents a significant and concentrated investment in the community that usually increases surrounding property values. But well before any of these good things will happen, those community members must attend that first public meeting where they learn that change is coming—and that the person who is delivering that change is the real estate developer.

The Stereotypical Developer

Each year, on the first day of the real estate development class that I teach, I ask my students, "What words come to mind when I say 'real estate developer'?" Their answers include "rip-off artists," "greedy," "bloodsuckers," "bulldozers," "used-car salesmen," "devils," "rich white men," "opportunists," and so on. They pile it on and I have difficulty writing everything on the board fast enough. Then, after most of the class has exhausted itself, someone nervously chirps, "entrepreneur" or "creative" or "visionary" or "risk taker," and a more positive, if shorter, list emerges.

Like my students, I suspect that many people believe that developers are rich, greedy, and driven by profits alone; that they know little about planning or design; that they are egotistical if not arrogant and often untrustworthy; and that they neither understand nor care about the impacts of their projects on nearby residents and the larger community. But developers are not all the same and as in any other business or industry, while there may be some "bad" ones, there are many others who have made and continue to make important contributions to cities and communities. As with other industries and government agencies, sensational media accounts of the antics of a few often overshadow the good efforts of many others who quietly go about doing their work. Many people have never met a developer and they know of only the famous and larger-than-life Donald Trump. Some have met developers at neighborhood meetings and others through the experience of buying a new home or condo. And then there are those pervasive stories and sometimes all-too-personal experiences with developers that reinforce the stereotypes listed above.

To the people who buy or rent units or space in their finished buildings, developers can be known to overpromise and underdeliver, hyping their projects in the beginning but cheapening them in the end. To architects, contractors, and other members of the project team, developers are seen as risky clients to work for, because they are known for squeezing their team members' fees when they are negotiating contracts at the beginning and then withholding payments for completed work, particularly when times get tough. And many members of the broader community, particularly architects, think developers either do not know or do not care about good design. Rather, they think developers always take the cheapest route by dumbing down design and reducing material quality to maximize profits. Many people conclude that cities are not as good as they could be because of the work of developers. So when community members make suggestions in neighborhood meetings like "can't you just make it shorter, give it more articulation, use better materials, put the parking underground," and so on, their suspicions are reinforced when the developer's answer is more often "no" than "yes."

And developers seem so different from the rest of us. They appear to enjoy great wealth, dress well, drive fancy cars, own several homes, take exotic vacations, go cruising on their yachts, fly around in private planes, and live in a world that is completely different from our own. They can also be charming, charismatic, bright, knowledgeable, and fun to be around and talk to. They hobnob with local politicians and business leaders, are often viewed as local celebrities and important civic leaders, and can seem bigger than life in person. So when they come to neighborhood meetings they generate feelings of ambivalence from community members who find themselves attracted to these important and alluring people while also feeling distrustful of their motives and methods and, in some cases, jealous of their lifestyles.

But stereotypes can be misleading: While they are often rooted in truths, these generalizations fuel the public's distrust by painting all developers with the same brush. In the near term, distrust and misunderstanding reduce the potential for collaboration between developers and members of the community and the chances for developing the best and most creative projects for communities and cities over the long run. And stereotypes are often one-sided and do not reflect other important truths.

For developers to remain in business they must finance and sell a product in advance, for a price that is greater than its costs. Their projects can take years to complete so inflation and unforeseeable market forces make cost control more difficult and increase uncertainty. They must walk a fine line with their buyers, attracting them with a compelling vision while managing expectations for perfection within the limits of reality. They want happy buyers but they cannot earn a profit if they capitulate to requests for things they are not contractually obligated to provide. They must also be tough negotiators with their team members because the sum of the costs of their work—design services, construction materials and labor, and other products and services—must be less than the final sale price. They often do care about good design, because good design sells, but it is good design in the eye of the average potential buyer, rather than those of the elite design professional. And often the buyer's idea of good design can lead to projects that make for good communities in the long run. More important, the neighbors' seemingly reasonable questions and suggestions for improving the design by reducing height and density and adding setbacks don't reflect the increase in costs—and decrease in profits—that those changes often cause. And despite the impressions of wealth that they may project, many developers are just one bad deal away from serious financial hardship and there is no guarantee of endless riches or that the next project will be a success. Development is a very risky and complex business, which is why more people don't do it.

For many community members, real estate developers remain a mystery, and because we don't really understand who they are, what they do, and why they do it, we are in a difficult position when it comes to working with them. And that's why we need to come to a better understanding of developers, because they are going to keep on developing, and their buildings will remain with us long after the construction dust has settled. The purpose of this book is to begin building that deeper understanding.

Understanding Developers

This book takes the position that developers are people whose interests, motives, and actions can be easily understood and that a more complete understanding will lead to better outcomes for neighbors, communities, and cities, as well as for developers. This new understanding will help everyone from academicians who study urban development and public policy to elected officials, city planners, architects, and others who work with developers. Most important, it will help community members—like those neighbors in Evanston—when they find themselves sitting across the table from a developer who is planning to bring change to their neighborhood.

This book is based on interviews with more than one hundred people involved in the real estate development business in Chicago; Miami; Portland, Oregon; and the Twin Cities of Minneapolis and Saint Paul, Minnesota (although the emphasis is on development in those first three cities). Together, the stories from these developers and their projects paint a vivid picture of what is common to the real estate development process. They also offer vivid contrasts that illustrate how development is a distinctly local activity that is influenced by climate and geography as well as by the unique social, political, and economic cultures of different cities. An understanding of what is common and what is different will help community members, elected officials, and others participate more productively in the development process in their own communities.

Chicago has a very large population and dense urban development patterns that were created before the proliferation of the automobile and suburbanization. Despite being located on the open prairie, it grew up on and is bounded on the east by the edge of Lake Michigan, where density is at its greatest. Chicago is also the birthplace of the modern skyscraper, so for these and other reasons, urban living—high-density as well as high-rise—is well established. Housing in Chicago is designed for people who live and work in a city where commuting from the suburbs can take an hour or more.

Portland's adoption of an Urban Growth Boundary in the 1970s led to the more recent and rapid development of that city's urban core. Development in Portland was also stimulated by significant public investment in transit and public realm infrastructure. The city is dense, efficient, and filled with buildings and places characterized by consistently high-quality architecture and urban design. And Portland's location in the environmentally conscious Pacific Northwest has cultivated an ethic of sustainable development that has been integrated into public policy, design practice, and construction industry standards.

Miami is the product of a major speculative real estate boom in the early twentieth century, and it has seen numerous booms and busts since. It is also a global city, the gateway to Latin America, and an economic powerhouse. Miami experienced incredible growth in the 2000s as people from around the world bought condos not for housing but as speculative investments. Many of those buyers never intended to live in their own units, so layout and function were secondary considerations. More important were striking ocean views, exotic amenities, image, hype, and the seemingly endless potential for big profits from increased appreciation that drove repeated resales and "flipping." To attract these potential buyers, developers relied increasingly on star architects and famous interior designers not just for their design skills but also for their marketing value. This speculation led to overproduction and by 2008, after the bursting of the housing bubble, there were estimated to be more than forty thousand empty condominium units standing on the market.

By highlighting the projects and personal career stories of developers from these three different areas, this book illustrates differences in approach that reflect both individual backgrounds and the influence of local cultures on real estate markets. At the same time, this approach illuminates those traits and characteristics that are common to developers almost everywhere. Understanding both common traits and regional variations is the first big step toward being able to predict what developers working in other communities and cities are likely to do.

The developers profiled here were selected by consulting media accounts; articles in real estate, design, planning, and construction trade periodicals; and industry experts as well as local elected officials, academics, journalists, community members, and other developers. The emphasis was on successful, productive, career developers who had done interesting or important projects; on independent developers of all sizes rather than larger corporate developers; and on developers who worked primarily in urban areas and particularly in city centers. This approach led to a group of developers with diverse backgrounds and portfolios and who operated at different scales, ranging from very small to very large. Many of these developers had experience with several product types but most of them also developed condominiums during the 2000s because cheap and plentiful financing was available for for-sale housing so everyone was doing it. All are career developers who have completed numerous projects, are experienced, and have been generally successful over time. And while most have experienced losses at some point in their careers, when the housing bubble burst in the late 2000s they all stayed in the development business and were hard at work getting new projects off the ground by the end of the decade. By the early 2010s many were back in business developing apartments, senior housing facilities, condos, and other types of products. Importantly, while many of these developers are considered to be "good developers" by their peers and elected officials, city staff, architects, and some members of the community, none are without detractors. Few developers have completed a single project that has satisfied everyone, and criticism has come from various places: the local architectural critic, the district council member, nearby residents of a certain building, the neighboring property owner, or a disappointed buyer. Developers create buildings that change communities, and they construct products that may not meet everyone's standards, so success in one realm does not mean that they are beloved by everybody. Political and community opposition, negative media coverage, harsh architectural criticism, financial difficulties, and lawsuits are part of doing business for all developers, even the "good" ones.

Why It Matters: There Will Be More Development—and More Potential for Conflict

During the first decade of the twenty-first century, an unprecedented amount of money—what the real estate economist Anthony Downs called a "Niagara of capital"—flowed into the U.S. real estate market, fueling the overproduction of for-sale housing that led to the bursting of the housing bubble in 2008. That bubble was caused by developers, homebuilders, banks, and all of the people who bought and sold homes hoping to make a huge profit from what appeared to be rapid and never-ending appreciation in home values. Three years later, by 2011, America was still recovering from a protracted recession, investors were still sitting on the sidelines, banks were still not making loans, and many developers were struggling to initiate projects in the face of scarce capital and a dead market. Glum developers, architects, contractors, lenders, and many other industry professionals said things like "we will never see a boom like that again," "we will not see any high-leverage deals again for a long time," and "we have seen the end of urban redevelopment as we know it." But despite their dire predictions, by 2014 we were seeing all of those things again as the new boom in apartments that roared to life in 2012 was still going strong.

Real estate boom-and-bust cycles play havoc with people's confidence and emotions in the short run but they obscure important long-term trends. Three major forces have historically driven and will continue to drive new development in the United States over the long term. First, there is a constant need to replace aged building stock. Second, we must house a continuously growing population—projected to increase by 86 million, from 314 million to 400 million, between 2012 and 2050. Third, a constantly changing demand for new product types reflects shifting demographics and tastes—from "lifestyle" retail centers in the suburbs and luxury apartments in the city to senior housing everywhere to accommodate the huge and growing segment of the population that is sixty-five and over. But in addition to these three drivers, the beginning of the twenty-first century ushered in a fourth—"the flight to the city."

By the 2010s it had become clear that a massive demographic rearrangement of American cities, what Alan Ehrenhalt called "the great inversion," was under way. For the first time in history, new immigrants were moving straight to immigrant communities in the suburbs rather than to their traditional enclaves in city centers. At the same time, unlike previous generations, young middle-class millennials—people born between 1981 and 2000—chose not to move back to the suburbs where they were raised but to move to urban centers instead. Also, unlike previous generations, many of the baby boomer parents of those millennials—people born between 1946 and 1964—chose to abandon their empty suburban nests, follow their children, and move to the city too. These boomers, their children, and other people with the financial means had discovered something important: City living is good for you. In Triumph of the City: How Our Greatest Invention Makes Us Richer, Smarter, Greener, Healthier, and Happier, Edward Glaeser cites numerous studies that show that people who live in cities experience a higher quality of life than those who live in suburbs and rural areas.

These four major trends will ensure that development continues in our communities for the foreseeable future—we simply cannot put our heads in the sand, stop the clock, or pull up the drawbridge. We live in a society with a market economy and in a democracy that values personal rights, including property rights. A real estate development is a business venture financed by private investors and lenders who take serious risks with the objective of earning significant profits. Developers are therefore reluctant to let community members have much influence over costs, design, marketability, and profits when they have no financial stake in the project. On the other hand, development affects everything from home values and views to the use and enjoyment of public streets so members of the community feel they should play a stronger role in shaping projects. The underlying source of conflict is that a real estate development is a private enterprise that is acted out on a very public stage. A primary purpose of this book is to help community members understand how they can maximize their influence on that private enterprise by seeing the project from the developer's perspective.

Selling Dreams and Building Communities

I used to work for a developer named Bob Lux who would say, "We don't sell real estate, we sell dreams." What he meant was that it is often easier to sell an idea—by appealing to people's inner idea or image of themselves—than it is to sell an actual piece of real estate. Sales agents know that it is often easier to sell a home before it has been built than after, and the reason is because reality is rarely as good as our dreams. In our dreams, we do not see marred paint, dented appliances, or poorly located light switches nor do we see low ceilings, small rooms, and even smaller windows. But when we walk through an actual home, these and countless other flaws become apparent, even in the best-designed and highest-quality projects. Unlike mass-produced products such as automobiles, buildings are custom-built every time with human hands so it is much more difficult to ensure a consistently high level of quality. Even if one could it would not matter because nothing is perfect except dreams, so that is what developers try to create when they first begin to envision new projects. As they refine and adapt their vision, they must bring everyone else along with them—local politicians, city planners, architects, neighbors, lenders, investors, sales agents, tenants, and potential buyers—and make it their vision too.

If developers succeed in getting those visions built and sold, they may live to see them transformed by time and use from speculative projects into accepted or even beloved parts of a neighborhood or community. But we seem to have forgotten that developers have always played a central role in the creation of home and community, as underscored by Andrés Duany's comment at the beginning of this prologue. People are often wary of "developers" when they are starting a new project, but over the years completed projects blend into and create the fabric of neighborhoods. Indeed, developers have always built our cities, using private capital, and if you look around any city, most of what you see was once a developer's vision. So a second purpose of this book is to place that short, stressful period—community review, city approval, and construction—into a broader context that recognizes the positive impacts that developers and their projects can have on our communities.

Blueprint for the Book

Each chapter of the book begins with an outline of ideas related to development and is followed by stories of developers, their careers, and their projects that illustrate those ideas. This approach provides a theoretical framework through which to view developers while at the same time it takes the reader inside the mind of developers to show how they think. This approach also begins to demystify developers by revealing them—through their own words and stories—as people whose motives and actions can be understood. The chapters build on one another, beginning with what developers do and how they think about opportunities, process, design, sales, risk and reward, reputation, the creation of place and experience, and their role in the community. The book concludes with suggestions for how to think more objectively about developers and how to work more effectively with them. The emphasis throughout is on revealing what motivates developers so that members of the community can better understand how and where they can best exert their influence to achieve the maximum positive effect. Based on a simple variation of the serenity prayer, the objective of this book is to help people who study or work with developers to accept the things they cannot change, identify those things that can be changed, and develop the wisdom to know the difference.

This book focuses primarily on the development of city center sites for multifamily residential projects—for-sale condominiums and rental apartments—and for mixed-use projects that include a combination of housing, commercial office, and retail. This represents just a fraction of the much larger industry of real estate development that encompasses urban commercial and retail development as well as suburban development. Real estate development in the suburbs ranges from subdivisions of for-sale, single-family homes, townhomes, and condominiums to apartments, commercial office parks, industrial warehouse and light assembly buildings, and retail centers. These product types are as important as those developed in central cities and they are produced in great volume in our suburban nation. The risks and rewards for the suburban developer as well as the strategies and aptitudes required for success are somewhat different but the principles are the same, and many of the conclusions in this book apply to all developers. Projects in city centers, however, more directly affect nearby residents, face greater scrutiny, and present greater risks to developers but they are also going to become increasingly prevalent in the future. Chapter 1 explores how development has changed over time and how it has remained the same, beginning with the story of a development that started on a hilly pasture more than two hundred years ago.