When Michael Reynolds looks back at the condominium scene in 2009, he’s happy just to call himself a survivor.
The Oakland, Calif.–based developer started two local condo projects between 2006 and 2009, adding to a metro pipeline of 11 other deals under way during that time. Yet, only two of those 13 projects survived, and they both belong to his company, Embarcadero Pacific.
“[That] was without having the keys tossed back, or the equity totally wiped out by the lender,” he says.
Taking a conservative financing approach certainly helped him weather the storm. But the true saving grace was Reynolds’ patented strategy of leasing the units before selling them. It’s a plan he follows regardless of whether the condo market is soaring or tanking, a road map honed over a quarter century with Embarcadero Pacific and Bond Street Advisors.
The Bond, a 101-unit boutique condo development in Oakland’s Jack London Square, is a prime example of this strategy. When The Bond opened its doors in 2009, many local condo developers were leasing up their units, by necessity. But there was one big difference separating Reynolds from the pack: They hadn’t planned on renting, and they paid a hefty price for that lack of foresight.
Armed with a five-year plan, The Bond had near full occupancy for three straight years under a low interest-rate scenario, creating great cash flow as Reynolds rode the rent escalation wave and waited. And today, The Bond is selling units at prices twice as high as what it could’ve commanded back in 2009.
Reynolds stayed ahead of the curve, ironically, by taking a back seat.
An Exit Strategy, Or Two
For Reynolds, being patient is about more than just timing a market cycle. It’s an all-encompassing approach to ensure success.
In fact, timing a market cycle doesn’t even come into play. Whether it opens a building in a robust or rotten for-sale environment, Embarcadero Pacific’s buildings always hit the ground running as rentals.
“We’ve had buildings we’ve opened up in a robust for-sale market and have continued to lease,” Reynolds says. “It’s difficult to underwrite new construction as a rental today and hold for a condo exit. It’s a conservative strategy, but it keeps us as a player in the Bay Area market.”
Sometimes, Embarcadero Pacific rents out a building’s units for as little as two years, and sometimes for as many as four. So, while other condo developers rent only when they have to, Reynolds rents because he wants to.
“We approach each investment with an eye toward two ways out,” he says. “We underwrite, finance, and capitalize our projects based upon a stable pro forma rental income.”
Reynolds structures his capital stack as though he’s building luxury rentals. Many condo buildings that go straight into the sales market require a healthy mix of equity, debt, and mezzanine capital. But Reynolds only uses traditional bank debt and private capital. One of the upshots is a lower required level of interest reserves from the construction lender.
“You can substantially lease up the building in five to eight months, rather than carrying enormous interest reserves for the perceived absorption of condominium sales,” he says. “Your loan value then goes down as your interest reserve component falls.”
That approach also decreases insurance costs: In California, the developer can delay buying an owner-controlled insurance program until it begins selling the units. And the strategy yields real brick-and-mortar benefits; namely, in mitigating physical risks, such as the possibility of building defects.
So, Reynolds’ plan isn’t just about financial engineering—it’s also an opportunity to give the building a test drive and iron out any kinks before selling a single unit.
“When the first storms come in, you find out where the leaks are,” Reynolds says. “Or when the first mechanical issue comes up, you find out what’s going on and you correct it.”
Other benefits of his five-year plan include getting a better handle on operation costs. Ultimately, though, it’s all about having control over your own future.
“It’s the best strategy for private capital; it’s not the best for institutional,” Reynolds says. “We can call our exit. We can time our market exit better than a forced out-of-the-gate sale as condominiums to pay back an institutional partner or even a highly leveraged mezzanine debt situation.”