The Great Recession has claimed among its victims some of the industry's largest owners and developers. Fairfield Residential, Bethany Group, Lembi, Babcock & Brown, Opus Corp.—the list goes on and on and will likely swell before the next upturn.
But some developers are surviving, even thriving, in today's market. Why? Because in business, as in the animal kingdom, survival is measured by adaptability. And that's exactly what these firms are doing—uncovering new profit centers and alternative financing sources or turning their attention to recession-resistant sectors. In a few cases, the push to adapt has meant re-engineering business models.
For instance, one Midwest owner and developer is considering opening a lending unit through a joint venture with an FHA lender. The company spoke anonymously since the venture is still in the planning stages. But this firm also offers construction and management services and sees the potential lending unit as a gateway to offering other services to owners.
Or consider Laramar Group, which has mapped out a variety of new profit centers to combat the recession. Rather than huddle around its property management division to generate additional fees— something many developers have done— Laramar has gotten creative. And they're not alone: Here's a look at five developers who have found ways to usher themselves through the recession. The common thread among them? A restless entrepreneurial spirit and an inability to sit still and let the recession win.
“As I look at the industry, what I don't see right now is very much creativity,” says Lee Harris, president of Overland Park, Kan.-based real estate firm Cohen-Esrey. “Property management is not the answer; it pays the bills ”¦ but if you want to thrive, you better get really creative.”
When he saw the recession on the horizon, Dave Woodward, CEO and managing partner of the Denver-based Laramar Group, went on the offensive. Laramar was mainly a value-add developer in the past, but as its acquisition/rehabilitation business dried up, Woodward began looking for alternate revenue sources.
The most creative of these ventures involved the company's revenue management software. Woodward saw that many smaller multifamily firms were interested in the technology but also turned off by the software's cost. It's not just the software's sizable price tag that's a concern but the infrastructure necessary to run the program, such as hiring dedicated staff.
This dynamic is especially true in today's environment. Firms are desperately trying to wring every last cent from their rent rolls but are much less inclined to make new capital expenditures.
So Laramar, an early adopter of the Alpharetta, Ga.-based Rainmaker Group's LRO software, turned its existing investment into a new business line. Beginning in 2009, Laramar started offering third-party revenue management services through an arrangement with Rainmaker Group. When smaller firms approach Rainmaker with interest in the software—but are leery of adding more staff—the software company refers them to Laramar.
“We already have the people and the systems so it's relatively easy for us to add additional properties,” Woodward says.
“It's almost immediately an additional profit center for us.”
And he didn't stop there. Two additional initiatives have laid the groundwork for ongoing expansion. Laramar believed that the first wave of multifamily foreclosures in 2008 was just a precursor. So in January 2009, the company began aggressively marketing its property management services to some of the industry's largest lenders and special servicers, seeing them as a new, unwitting ownership base.
“We frankly got our foot in the door early before some of the other fee management companies were able to establish relationships,” Woodward says. “We saw early on where we thought the opportunities were going to be and jumped on them.”
Laramar entered 2009 with a management portfolio of about 20,000 units. By year's end, that figure grew 50 percent to 30,000 units. The company has received management assignments from former Fairfield clients and is talking to the special servicers handling the Babcock & Brown and Bethany portfolios about potentially managing some of those assets.
Lastly, Laramar set up a new receivership division in early 2009 to capture another coming wave of distress. That division, which had no units under management in mid-2009, now manages more than 4,100 units at 51 properties in seven states. “This was not something that Laramar had done in the past, but now it's a profit center for us,” Woodward says. “And who knows what that could grow into.”
The distressed management focus has led to geographic expansion. More than 3,000 of the units that Laramar picked up in 2009 were from the defaulted Lembi portfolio in San Francisco. So Laramar targeted Northern California as a growth area, and the company now manages an additional 3,000 units in the region. Laramar hired about 100 new employees in the Bay Area last year, even as it made cuts in its construction group, reflecting the firm's aggressive shift. Laramar has dubbed its Bay Area initiative “Laramar Urban,” a new brand that the company is marketing in other large metros.
Ultimately, Laramar's three new initiatives helped offset NOI declines in other areas of the company. Bolstered by this new cash flow, the company is now working on raising money for its next acquisition fund, which it hopes to close by the end of the year. “If we didn't have growth in our fee management, we probably would've had to cut deeper in our construction group and into our investment side,” Woodward says. “We maintained a Florida and a California investment office because we think it was the right strategic move to have staff in place ready to make acquisitions in this next cycle.”
Finding Strength in Diversity
That next investment cycle will likely include a continuation of today's overriding trend to diversify. For many, that's meant moving to recessionresistant sectors such as student housing as a way to keep the development pipeline humming.
That's exactly what Buckingham Cos. is doing. The Indianapolis-based developer and manager began in 1984 when company president Brad Chambers, then a 20-year-old college student, bought a single-family rental. Chambers would go on to acquire one community a year after that, and the company began new construction development around 1990.
Today, the firm employs 450 people, owns about 5,500 units, and manages another 13,000 as a third party. Buckingham hasn't had to lay anyone off during the recession. In fact, the company's corporate staff has grown by 20 in the last two years. One of those hires was Brent Little, who previously led the student housing platform at Place Properties, helping to give the Atlanta-based company a national presence. Little hopes to do the same at Buckingham.
Buckingham broke ground on its first two higher education developments in 2008, one adjacent to the University of Notre Dame campus in Indiana and another near the University of Kentucky in Lexington. Those two deals will be completed by mid-year, and Little is already hard at work on expanding the company's higher education focus.
Buckingham hopes to start three more developments this year, one of which is a student housing deal across from the Indiana University/Purdue University Indianapolis campus.
For the past six recessions, enrollments have continued to increase in major colleges and universities, and the current recession is no different. “Obviously there's no appetite for condos right now; the appetite for large, high-density urban deals has pretty much dried up as well; and conventional deals are tougher to get financed,” Little says. “And so student housing is one of the safe havens essentially in the multifamily industry right now.”
Little was with JPI in the late 1980s and early 1990s and sees parallels between then and now. Some of the industry's largest developers, including Trammell Crow and Lincoln Properties, stopped developing during that downturn, but JPI invested heavily. By 1995, the firm was the largest multifamily builder in the country. “That's the opportunity out there today. This is the bottom of the market,” Little says. “So build into the down market and sell in the up market five years from now.”
Going Back to the Drawing Board
Sometimes, you have to throw out your old business plan, even if it was your company's guiding document for decades. At Columbus, Ohio-based Wallick Cos., management decided to retool just before the recession took hold, paring down a business unit that was the foundation of the company for more than 40 years.
Wallick began life in 1966 as a construction firm, and the company's management and development efforts grew out of that focus. But over the years, the construction division began weighing the company down through its massive overhead expense. So the company cleared house and started again, focusing exclusively on in-house jobs for deals it owns or manages as a third party.
“The emphasis of the business has gradually changed over the years,” says Howard Wallick, one of the company's three owners. “For over 40 years, it was a construction business, but we see ourselves primarily as a management business now.”
To that end, the company merged with Cincinnati-based Stern-Hendy at the beginning of 2009, which grew its management portfolio by 40 percent to about 12,000 units. All of those new fees coming in the door have allowed the owner, manager, and developer to pursue some development work. For the first time in the company's history, it will use historic tax credits this year on a rehab of the Berwick Hotel, built in 1894 in Cambridge, Ohio.
“A recession is a good time to grow, which we've been doing over the past 18 months,” Wallick says. “The Stern- Hendy deal has given us a steady cash flow through the recession, and it has positioned us to be able to really go after those tax credits.”
Beefing Up Building
On the flip side, Cohen-Esrey has transformed itself from a services-oriented business to a full-scale development operation over the past 15 years. The firm has concentrated on a variety of asset types: value-add market-rate deals, historic renovations using historic tax credits (HTCs), and affordable housing development using low-income housing tax credits (LIHTCs).
“The only way to make a development operation work is to have a pipeline that's so full with such diverse projects that it doesn't matter what's happening in the marketplace, you've got something always popping for you,” Harris says. “That's what we've been able to do, but it's taken us at least four years to ramp it up.”
Still, the firm is keeping its options open. Cohen-Esrey is putting together a value-add acquisition fund that will target properties in the $3 million to $10 million range of 150 units or more that need rehabilitation. The company hopes to raise around $50 million.
Ultimately, this focus on construction means that when Cohen-Esrey needs permanent financing, it taps the FHA. But one of its favorite executions doesn't need any hard debt at all. Cohen-Esrey has done a number of smaller historic seniors housing renovations using LIHTCs, as well as federal and state HTCs.
The company also sees opportunity in buying LIHTC properties that are coming out of compliance and can be turned into market-rate units. Cohen-Esrey is currently mulling two such acquisitions for properties it manages.
THE LANDMARK GROUP
Taking Haven in Equity
Indeed, HTCs have become a preferred financing vehicle for market-rate and affordable housing developers alike. With conventional equity hard to come by, and smaller leverage levels on debt, HTC deals have become a popular way to keep the pipeline flowing. The credits fetch a much higher price than LIHTCs, and large investors such as Sherwin Williams and Chevron are still very active.
The Landmark Group has several hundred units in market-rate HTC deals under development in Georgia, North Carolina, South Carolina, and Virginia. One advantage to using HTCs is the amount of equity provided, which lowers the need for debt.
“I've got 40 or 50 percent equity out of the gate with historics, so it's not as though I've got the same amount of risk,” says Jim Sari, former CEO of Winston Salem, N.C.- based The Landmark Group, who started Sari & Co., a Landmark affiliate, in January. “That insulates me a little bit and lets me gamble a little harder than the next guy.”
Like Buckingham Cos., The Landmark Group believes that, contrary to popular belief, now is the best time to build. “I'm trying to get as much development going as I can right now,” Sari says. “Since there's been no construction starts for two years, if you can bring on a product in 2012 or 2013, you're not going to have any competition.”
But finding construction debt is diffi cult. Many banks have raised liquidity requirements to very high levels, and at the same time, the bid/ask spread for acquiring historic structures remains wide. So The Landmark Group found a way to kill two birds with one stone. Sari often puts a building's owner into the deal, helping to satisfy a bank's requirements.
And though the owners don't have any real control, they make money on the backend. If a building is worth $1.5 million, Sari will pay the owner $500,000 at closing, and the extra $1 million comes through 30 percent of the developer's fee and 30 percent of the back-end.
“I only have to come out of pocket $500,000 to close it, then I can use that $1 million in building equity as owner's equity to meet the bank's lending requirements,” Sari says. “You basically just have to make stuff up in this environment—whatever it takes to talk the banker off the ledge.”
Talking a banker off the ledge has become a very valuable skill. Fannie, Freddie, and the FHA say they're open to negotiations, but many developers prefer dealing with smaller regional banks. The Landmark Group has had to renegotiate several deals during the downturn and was successful, mainly because it dealt with smaller banks.
“One reason I survived all this was I had over $50 million outstanding with a local bank with a $1 million guarantee—they couldn't afford to take me out,” Sari says. “When you're dealing with HUD, Fannie, and Freddie, you're such a blip on the radar, they can just write you down.”
Sari decided to not pay off his $50 million bank credit line. The developer, who has never defaulted on a loan, believed that should he pay off the line, he would have very little cash left and the bank would then turn around and not extend him another line. “I've seen that happen to a lot of friends in this business,” he says.
10 lessons to help savvy developers survive—and thrive— during the Great Recession.
1. Generate additional revenue. Every company has a latent revenue source hiding somewhere in its business plan, but sometimes it takes a recession to smoke it out. For example, many developers with construction divisions are now marketing those services to third parties for the first time.
2. Diversify. Focusing on multiple asset types such as seniors and students, or alternative financing vehicles such as historic renovations can insulate a developer when conventional financing dries up. As in the case of Overland Park, Kan.-based Cohen-Esrey, a diverse development pipeline ensures that one sector's strength can offset another sector's decline.
3. Build now. Forward-thinking developers such as Winston Salem, N.C.-based The Landmark Group are eager to break ground this year and deliver units into a constrained marketplace.
4. Buy low. Indianapolis-based Buckingham Cos. is currently reevaluating its property management and construction software systems, believing that now is a great time to make such a capital expenditure. “It's a good time to be doing it, from a vendor perspective, because people are eager for business,” says company president Brad Chambers.
5. Buy your own note. The Landmark Group bought back one of its own notes from a failed bank for a fraction of the original size. The rehab loan was for more than $6 million, but once the bank failed, the company was able to buy it for just $1.4 million from the FDIC. The company is currently eyeing two more notes that are now under the FDIC's control. “It pays to look at what notes you have with a bank that may have failed,” says former CEO Jim Sari.
6. Renegotiate your bills. Many firms have achieved savings by renegotiating vendor contracts, as well as aggressively appealing 2009 tax assessments. For instance, Houston-based REIT Camden Property Trust saved a sizable $1.3 million last year by aggressively appealing property taxes.
7. Make the cuts count. When companies look to make staff reductions, they often trim around the edges and don't cut deep enough. If things aren't as bad as you thought, then you can always rehire those laid off. But if things really are as bad as you thought, at least you took a necessary hard step. Columbus, Ohio-based Wallick Cos., which significantly cut its construction group, rehired two construction managers once the recession started easing.
8. Plan for doomsday. While optimism is nice, it's not a business plan. Try to project the depth of the recession with a matrix of best-case, likelycase, and worst-case scenarios, advises Dave Woodward, CEO of Denver-based Laramar Group. Plan around the worst case, but hope for the best case.
9. Be too early, rather than too late. “If it looks like an artificially-induced liquidity bubble, sell,” advises Rich Kelly, vice president of Dallas-based LumaCorp. In early 2007, Kelly advised owners to sell—advice that he took for a couple of his underperforming assets at the peak of the market. “We should've done more,” he adds.
10. Amp up marketing. When LumaCorp. saw the recession coming, it increased its marketing dollars, specifically on the Web, and has been quick to institute specials in response to the market. “You don't get anything for an empty unit,” Kelly says.