It’s said that developers have short memories. That’s probably true. But coming out of this downturn, some developers (who are actually getting projects in the ground) are changing their strategies after suffering through 2008 and 2009. Here are four of the lessons they've learned.
Lesson #1: Consider the finished lot model; it makes more sense.
Before the downturn, a lot of homebuilders got overextended with land that needed time in the pipeline for re-zoning. Though not as highly publicized, the same thing happened to apartment owners in the last boom.
“That [entitlement risk] is where everyone lost a lot of money when the party ended,” says Jim Butz, CEO of McLean, Va.-Jefferson Apartment Group and former president of JPI East. “If you were re-zoning a deal in early in 2008, you would have written off all of that money. JPI did, and all of our competitors did it, and that’s very painful.”
That has changed Butz’s strategy this time through the cycle. “We are looking for sites that are zoned and we are not taking entitlement risk,” Butz says. “We may have to take those on eventually, but we’re trying to be prudent and not take on deals that have re-zoning risks.”
Lesson #2: Don’t count on everything breaking right.
Rick Hausler, a partner in Tyson’s Corner, Va.-based Insight Property Group and former president of McLean, Va.-based Ketter has been through recessions in the '80s, '90s, and, of course, the downturn of 2008 and 2009. Through that experience, he’s learned that things don’t always go right.
“[Living through recessions] increases how you gauge expectations,” Hausler says. “You won't flip six heads in a row. Maybe there will be two or three tails.”
So developers shouldn’t go into a deal expecting things like construction cost overruns, schedule delays, approval delays, flat rent growth, increased interest rates, and greater competition to line up. But that doesn’t mean playing it too conservatively, either. “If you don't have some optimism about success, you won't do anything,” Hausler says. “You can't take on projects where you bank on everything happenning right. Of course, you can’t plan for everything to happen wrong. There's no stopping that.”
Lesson #3: Put more skin in the game.
Butz says one of the problems at JPI wasn’t financial engineering. Through its partnership with GE Capital, it always put a sufficient amount of equity in its deals. That wasn’t the same for other developers. Some people may have put down as little as 10 percent. Upon lease-up, after the market tanked, they were upside down.
Butz saw what happened with other companies and is sticking with 35 percent non-recourse equity in his deals. Some developers are also putting in more equity than even the banks are asking for. For instance, Bill McDonald, executive managing director of the East Region for Dallas-based Mill Creek Residential Trust told Multifamily Executive a couple of months ago that the company is putting in 35 percent equity on deals, even if it could put in less.
“We could get close to 70 percent leverage,” McDonald says. “We’ve been focused more on 65 percent. We used to supply 25 percent equity. It’s more conservative than that now. If you have a well-located project and 35 percent equity, you should in pretty good shape.”
Lesson #4: Understand that outside forces ultimately control your fate.
Developers can talk about more discipline, but ultimately what they say probably doesn’t matter. It’s the equity and banks that need to be on board.
For instance, some developers almost got blank checks from their equity sources. That’s changed. Now equity drives the train. Debt could be even tougher. The reason a lot of developers are putting in more equity is because their debt sources require it. “Right now, the banks are scrutinizing these people up one side and down the other,” says Greg Bonifield, a partner with Arlington, Va.-based Woodfield Investments.
And Bonifield, for one, welcomes some of this scrutiny. “It's going to be incumbent upon debt and equity to stick with the professionals who have a long history of successful multifamily development and keep it from getting frothy,” he says.