GRAHAM STREET LOFTSCASE STUDY

Denise MejiaAaron Ray

USP 423 Monday 1 June 2009

TA B L E O F C O N T E N T S

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Project Initiation 3

Developer Profile 3

Site Selection, Acquisition & Control 4

Recent Area Investments 6

Development Program 7

Market Analysis 9

Market Comparables 10

Socioeconomic Analysis 11

Design Development & Floor Plans 12

Public/Private Agreements & Approvals 15

Construction Plan & Capital Budget 16

Marketing & Leasing 17

Current Unit Leasing 19

Management Plan & Operating Budget 19

Economic Analysis & Profitability 20

Forecast A pro forma 21

Forecast B pro forma 22

Critique & Evaluation 23

Works Cited 25

P R O J E C T I N I T I AT I O N

In June 2007, work began to construct the Graham Street Lofts development, located on

the corner of Martin Luther King, Jr., Boulevard and Northeast Graham Street, situated in

Portland's Eliot neighborhood. Graham Street Lofts is a mixed-used commercial and residential

building, originally intended to be sold as condominiums. Problems encountered during

construction and the initial sales period

forced the developer to temporarily shift the

project to a leased property, although it is

still the developer’s intent to sell the units as

condominiums at a later time.

The project comprises 12 residential

and commercial units, including some large

units approaching 2,000 square feet in size, as

well as retail storefront and commercial live/

work space. Although other projects nearby

also contain a mix of residential and

commercial use, Graham Street Lofts is the

only project in the immediate area that

specifically addresses the live/work market.

D E V E L O P E R P R O F I L E

The developer and architect of Graham Street Lofts is Hilary Mackenzie, principal of

Mackenzie Architecture, based in Portland. Mackenzie Architecture is intentionally a small

firm providing a full range of architectural and planning services to clients in the Pacific

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FIGURE 1. Location of Graham Street Lofts in relation to the PSU Campus (Google Maps).

Northwest. She has a diverse portfolio which includes single family residences, multifamily

apartments and studios in urban and suburban settings.

She has extensive experience designing retail and commercial space in a variety of

urban and rural settings. Her firm emphasizes energy efficient structures uses innovative

materials and techniques. Some of the firm's work can be seen in Washington Park, Portland

Heights, Spring Street, and Lake Residence. Although she has developed speculative single-

family projects in the past, Graham Street Lofts is the firm's first speculative, mixed-use

development.

The developer agreed to meet with us twice in May 2009 to discuss the project and its

development, and to tour both the residential and commercial spaces. The developer interview

yielded much of the data in this case study.

S I T E S E L E C T I O N , A C Q U I S I T I O N & C O N T R O L

The project is located on Martin Luther King, Jr., Boulevard in northeast Portland, a

major north-south route. Daily traffic volumes are about 29,000 cars per day, more than most

other city streets and much higher than in many residential or business districts. MLK is

classified as a Major City Traffic Street and a Major Transit Priority Street, and such, the street

carries a significant amount of cargo and commercial traffic (Bureau of Planning &

Sustainability).

The developer acquired the Graham Street Site in1991 as part of a larger land purchase

which included adjacent lots to the west and north of the development site. As shown in Figure

2, she continues to control these lots, although lots to the north and east of her holdings have

been redeveloped, and include retail, restaurant, commercial office, and residential uses. Prior

to the construction of Graham Street Lofts, the site contained a surface parking lot.

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Lots immediately adjacent to Graham Street Lofts include the Standard Dairy building, a

mixed-use redevelopment of a historic industrial property, the former American State Bank

building which has recently been occupied by a fitness center, studios and production facilities

for Portland Community Media, and some limited street-level retail storefronts to the north and

south of the building along Martin Luther

King, Jr., Boulevard. A structure on the lot to

the north has been renovated and currently

houses the developer's offices. The developer

has decided to offer the lot to the west for sale,

but indicated that she would seek to control

the development of that site through a build-

to-suit agreement or other sale provision in

order to preserve the views of downtown

currently enjoyed by residents in the upper

half of the building.

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FIGURE 2. Lot map showing developer holdings and adjacent parcels (PortlandMaps.com).

Parcel currently o!ered for sale by developer.

Graham Street Lofts parcel

Parcel owned by developer, location of developer o"ces

Adjacent lots not owned by developer; recently redeveloped

FIGURE 3. Transit classifications for streets located near Graham Street Lofts. Red Star indicates property location (PortlandMaps.com).

Major freeway ramps located near the project provide access to I-5, I-405, and I-84. The

neighborhood has extensive bus transit service, and MAX light rail is located along Northeast

Holladay Street, less than a mile away from Eliot’s southernmost boundary. TriMet buses run

along MLK every 15 minutes or better daily (TriMet).

The MLK Corridor is designated as a Main Street in the Metro 2040 regional land use

plan. Densities in the area are double those found citywide, at 11.0 people and 4.6 households

per acre (Bureau of Planning & Sustainability). The building is near two significant employment

centers -- Legacy Emanuel Hospital to the west, and the Lloyd District to the southeast.

There are two elementary schools and various private or specialized education facilities

within walking distance of Graham Street Lofts, including Irvington and Boise-Eliot

Elementary Schools and the Harriet Tubman Leadership Academy. The Matt Dishman

Community Center is a short walk from the property, as are Irving and Unthank Parks. The

Boise-Eliot Community Garden is also within walking distance.

Over the past ten to fifteen years, the surrounding neighborhoods have made significant

progress attracting new investment. Selected recent developments are shown in Figure 4, and

include new residential, commercial, and retail properties. The decision to build Graham Street

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FIGURE 4. Map of recent area investments and developments. Red star indicates location of Graham Street Lofts (Google Maps).

Lofts emerged from the developer's observations of these improvements: as residential prices

and demand continued to increase, she assumed that the neighborhood would support new

residential and retail development well into the future. Moreover, she saw an opportunity to

address the emerging market for live-work space, which had not yet been offered in the area.

D E V E L O P M E N T P R O G R A M

For Graham Street Lofts, the developer envisioned creating a mixed-use, highly-efficient

building that matched both the scale and what she perceived as the evolving needs of the

neighborhood. At the time, there was a lack of multi-family housing in the neighborhood that

was sized to accommodate young, growing families.

On the ground floor, the developer opted to include four Live/Work spaces, a relatively

new and emerging use in Portland designed to meet the needs of small businesses, particularly

artists, in need of a small residence immediately adjacent to a small work or storefront space.

Recent building code changes have enabled developers to build these mixed residential-

commercial spaces, but even with these changes, the code regulations governing these spaces

remain complex. Where these types of units have been built, they tend to be much more

expensive than "pure" residential or commercial units (Smith).

The building is a demonstration project using an alternative building material called

Performwall, a lightweight and versatile alternative to reinforced concrete walls made of

recycled polystyrene pellets mixed with cement. Recycled materials comprise 85% of each

panel (Trilogy Materials, Inc.) The building is the first mixed-use, multi-family unit in Portland

to use Performwall, although the material has been used in similar projects in Europe for some

time.

At Graham Street Lofts, 10-inch Performwall is used on the building exterior as well as in

walls between each unit, which can be finished either with a direct stucco application or with

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more conventional drywall finishes.

Performwall offers superior seismic strength

and has a four hour fire rating, and provides

excellent heat and noise insulation. In our on-

site walkthrough with the developer, we found

the ground-floor units to be very quiet with

minimal traffic noise, despite being in very

close proximity to busy traffic on Martin Luther

King, Jr., Boulevard.

On-site parking was also envisioned to

encourage sustainable practices by supporting

transit and alternative-fuel vehicles. Ten spaces

of parking are available on-site, yielding a ratio

of 0.8 parking spaces per condominium unit.

Limited on-street parking is also available nearby. One space is provided with each live/work

and two-story residential unit; owners of one-story units can optionally purchase one of the

two remaining spaces. Electric car charging outlets are also provided in the lot. Stormwater

runoff from the lot and the building's roof is collected and treated in on-site bioswales and dry

wells.

Despite the building's highly sustainable design, the developer opted not to pursue

LEED certification. In the developer's view, LEED certification is oriented towards

demonstrating improved traditional building techniques in larger development projects, and is

not as relevant to innovative building materials and techniques, especially in smaller projects

such as Graham Street. The developer estimates that the project would immediately qualify for

LEED Silver, and perhaps LEED Gold certification; she also estimates that ongoing energy use to

be "very competitive" with more renown LEED-certified projects in the region.

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FIGURE 5. Close-up view of Performwall material, showing recycled polystyrene pellets mixed with cement.

Certification costs are often estimated to be up to 3.3% of total development cost for LEED

Silver projects, or 5.0% for LEED Gold projects (Nicolow). Using these rates, the cost to certify

Graham Street Lofts would be estimated between $102,000 and $155,000, too high a cost

considering the return, according to the developer.

M A R K E T A N A LY S I S

The building includes a total of twelve units: four live/work units on the ground floor

and eight residential units on floors 2-4. Residential units vary in size from approximately 1,050

square feet to nearly 2,000 square feet, with two basic designs: two bedroom units on one story

and three-bedroom units on two stories. Live/work spaces are generally 1,150 square feet. The

arrangement and size of each unit is shown in Figure 6.

It is difficult to compare Graham Street Lofts with other developments because of the

innovative design, materials, and diverse neighborhood. Another complicating factor was the

inclusion of live/work space, a relatively new product that has not yet developed a true

standardized meaning in the marketplace, particularly due to differing levels of finishing in

various live/work units in the area. As a result, we were able to find reliable live/work

comparables for leased property, but not for property sales. Discussed later in greater detail, the

unanticipated switch from condominium units to leased units further complicated the

development of true comparables

for comparison.

We examined comparable

residential and commercial units

on both a for-sale and leased basis,

to address the mix of sold and

leased space within Graham Street

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4th Floor

3rd Floor

2nd Floor

1st Floor

Unit 91,927 ft2

Unit 101,786 ft2

Unit 111,769 ft2

Unit 121,769 ft2

Residential

Unit 51,198 ft2

Unit 61,065 ft2

Unit 71,065 ft2

Unit 81,065 ft2

Unit 11,170 ft2

Unit 21,137 ft2

Unit 31,150 ft2

Unit 41,150 ft2 Live/Work

FIGURE 6. Diagram showing unit sizes and locations of di!erent uses at Graham Street Lofts.

during its interim leasing period. These comparable properties are shown in Figures 7 and 8. For

the live/work spaces, we have chosen to base our comparison on other street-level commercial

space in the area, because the live/work space within Graham Street Lofts is roughed out only,

similar to other commercial space in the area. Additionally, we have attempted to reflect

Graham Street’s emphasis on sustainability and efficiency in our selection of comparable

properties, although there are few projects in the area that have employed similar innovative

building materials and techniques.

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FIGURE 7. Live/work and residential lease comparables for Graham Street Lofts.

Comparable Type

Location Rent/ mo.

Size (ft2)

Rent/ ft2

Dist. (mi)

Comments

Leased CommercialLive/Work

3934 NE MLK Blvd $2,475 1,650 $1.50 0.6 Triple net lease

5265 NE MLK Blvd $1,525 1,104 $1.38 1.6

5400 NE 30th Ave $1,000 760 $1.32 2.2

Graham St Lofts $1,300 1,157 $1.12 Averaged for leasable units

Leased Residential

303 NE 16th Ave $1,150 705 $1.63 2.1

1231 NE MLK Blvd $1,368 1,045 $1.31 0.8 Close to light rail, Lloyd Ctr

1425 NE 7th Ave $1,199 1,000 $1.20 0.8 Close to light rail, Lloyd Ctr

Graham St Lofts $1,700 1,456 $1.17 Averaged for leasable units

Location Sale Date

Sale Price

Size (ft2)

Price/ft2

Dist.(mi)

Comments

4138 N Montana #6 May 2008

$248,500 837 $296.89 1.14 Near Mississippi St, which drives up per-ft2 cost. More compact layout than Graham Street.

Graham St Lofts July 2008

$341,500 1198 $285.06

2645 NE 7th Ave #1 June 2008

$433,030 1677 $258.22 0.2 Not on major street or bus line; 1-bedroom with loft space comparable to two-bedroom at Graham

FIGURE 8. Residential condominium sales comparables for Graham Street Lofts.

Prices at Graham street Lofts are considerably lower on a per-square-foot cost than other

similar developments in the area. We believe this because of the developers urgent need to

generate cash flow and to mitigate losses from the unsold units. Two developments that we

believe to be fairly comparable to Graham Street Lofts are the Sacramento Lofts and 12.5 Lofts.

We found these developments to be similar because of the materials used, innovative design,

and the niche market that it advertises to.

A disadvantage that Graham Street Lofts has to both of these comparables is that it is

located directly on a highly trafficked street which could be interpreted as unfavorable because

of the noise and low pedestrian traffic for the live work spaces on the first floor -- on the other

hand, what is seen as a disadvantages for some could be an advantage for others. For example,

the Graham Street site offers excellent road and transit connectivity, and is in close proximity to

major employment and commercial centers, including downtown Portland.

S O C I O E C O N O M I C A N A LY S I S

The 2000 Census counted 18,177 people

living in the Northeast Martin Luther King, Jr.,

Boulevard Commercial Corridor (number 2). The

corridor is defined as the area within one-half

mile on each side of MLK Boulevard, stretching

from Northeast Killingsworth Street to the north,

to Northeast Hancock Street to the south. This

area is one of the most ethnically and

economically diverse areas in Portland -- 57% of

residents are ethnic minorities. Housing prices in

the area appreciated at a much higher rate than

in other areas within the city, rising 330% between

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MLK Corridor

Citywide

ETHNIC & RACIAL COMPOSITION

White 43% 76%

Black 38% 6%

Hispanic 10% 7%

Native American 1% 1%

Asian 2% 6%

Pacific Islander 1% <1%

Multiracial 5% 4%

AGE DISTRIBUTION

0-17 24% 21%

18-34 32% 29%

35-64 35% 39%

65+ 10% 12%

FIGURE 9. Selected demographic statistics for the MLK Corridor as compared to citywide averages (Commercial Corridor).

1994 and 2004.

Despite this rapid growth, median household incomes remain significantly lower than

other neighborhoods, at $39,334 compared to $52,020 citywide. In addition, there are slightly

more children and slightly fewer elderly residents than the citywide average (Bureau of

Planning and Sustainability). Renters outnumber homeowners by 2-to-1, but this margin has

almost certainly declined as new residents have moved in.

Institutional uses account for a much higher share commercial activity in the MLK

corridor than in other areas of the city. Institutions total 13% of all businesses in the area,

compared with just 4% citywide. Institutional employers provide 28% of jobs in the area, nearly

triple the citywide average and second only to office employment. Retail businesses provide

21% of area jobs, compared to 34% citywide. Total employment per mile in the area is 16% less

than citywide averages, but the average size of businesses in the area is about the citywide

average, with slightly more than 50% of businesses having 1-4 employees (Bureau of Planning

and Sustainability).

The neighborhoods surrounding Graham Street Lofts were areas of disinvestment and

high crime in the 1980s and early 1990s. More recently, crime data indicate that the Eliot

neighborhood had a lower crime rate in 2008 than Downtown, the Lloyd District, or the Pearl,

and a crime rate in line with other areas in inner Northeast and North Portland. Eliot has

dramatically lower rates of person and violent crimes than other areas; in 2008, for example,

there were fewer property and behavioral crimes reported in Eliot than in the Pearl District, the

Lloyd District, or Downtown (Portland Police Bureau).

D E S I G N D E V E L O P M E N T & F L O O R P L A N S

The design of each residential unit includes at least one outdoor patio or terrace, with

built-in design elements intended to provide privacy for each residence's outdoor areas.

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FIGURE 10. Floor plans for first and second stories of Graham Street Lofts.

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FIGURE 11. Floor plans for third and fourth stories of Graham Street Lofts.

Premium-quality appliances and interior finishes are used to appeal to more affluent buyers

entering the neighborhood. Each unit includes a hydronic radiant heating system built into the

floors, powered by on-demand hot water heaters with a reserve tank. In two-story

condominium units, the upper floors are carpeted, but the hydronic system is combined with a

small in-wall fan for heating. Large windows provide plentiful natural light, further reducing

energy use.

Residences face west, toward the parking lot. There are no internal corridors or common

spaces in the building: access to upper-floor residences is provided by two staircases in the

parking lot, each serving four of the eight residential unit. No elevator is provided, however,

which eliminates access for those with disabilities to the residences.

Live/work spaces face east, toward Martin Luther King, Jr., Boulevard, and also include a

rear entrance facing the on-site parking lot. These units are offered as roughed-in spaces. Floors

(which contain hydronic radiant heating) have been poured, along with one half-width wall

near the midpoint of the unit, but other walls and ceilings are otherwise unfinished. A shower

curb and basic utility hookups are provided. The plan for unit 4, a live/work space on the

ground floor, shows a sample build-out of one live/work space.

P U B L I C / P R I VAT E A G R E E M E N T S & A P P R O VA L S

The developer attempted to simplify the development process by avoiding public/

private partnership agreements, and by following design standards already sanctioned by the

city. She has previously served as a member of Portland's Planning Commission, and was

therefore very familiar with provisions and standards set in Portland code, as well as best

practices to avoid the public design review process which can be costly and time-consuming.

The lot is zoned for Central Employment use with a design overlay, designated as zone

EXd by the City of Portland. The zone allows mixed uses and is intended for areas in the center

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of the City that currently have predominantly industrial-type development (Portland City Code

Title 33 Chapter 140). Adjacent lots share the same EXd zone designation and are intended to

have compatible land uses, including those on the same block, as well as those across Martin

Luther King, Jr., Boulevard and Graham Street. Buildings in this zone have a maximum height

of 65 feet with FAR of 3:1, with no minimum setback. Ground-level storefronts must meet

Ground Floor Window Standards.

Residential uses are allowed, but are are not intended to predominate or set

development standards for other uses in the area. Other allowed land use activities include

general retail and office facilities, most manufacturing uses, institutional use, and certain

industrial uses. The intended uses for Graham Street Lofts are generally compatible with

surrounding uses, which include low-rise retail, office space, restaurants, institutional use, and

household units. The lot is not within an urban renewal zone, but is eligible for programs such

as PDC Storefront Improvement, Home Buyer Opportunity Area incentives, property tax

exemptions for transit-supportive residential or mixed uses, and enterprise zone benefits.

Although many projects opt to pursue exceptions to design standards through the

design review process, the developer felt that she would have more freedom by staying within

the boundaries of the design standards as set in code, because other elements of the project

would not be up for review and critique. According to the developer, design review constrains

architects to "designing by committee", but by taking fairly simple steps to adhere to design

standards in code, architects can be more creative and ultimately design better buildings, and

do so with less time and administrative overhead.

C O N S T R U C T I O N P L A N & C A P I TA L B U D G E T

According to the developer, the total development cost of the project was approximately

$189 per square foot, yielding an approximate construction cost of $3.1 million, including both

soft and hard costs. Despite the use of highly innovative materials as discussed earlier, the

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developer estimates that these materials and techniques added no more than 10% of a premium

to development costs.

The developer reported relatively good relations with city permitting and inspection

officials during the design and construction phases of the project. Although this was the first

time the Performwall material had been used on a project of this scale in Portland, building

inspectors worked with the contractor to develop methods of inspection and verification that

were only minimally disruptive to the project's schedule.

The project suffered an unanticipated delay during construction due to the sudden

death of the prime contractor. Finding a new contractor who was experienced with the

innovative materials in use was difficult, causing an estimated 5 month delay according to the

developer. Originally, completion was anticipated in the first quarter of 2008, but with the

delay, units were not on the market until the start of the third quarter of 2008, as the housing

and credit markets continued their rapid deterioration. Further disputes with the contractor

complicated marketing and leasing after the project was completed.

M A R K E T I N G & L E A S I N G

Units at Graham Street Lofts were placed on the market in July 2008, and two sold

quickly: one residential unit and one live/work unit, at prices that were in line with or

exceeding the market averages at the time. For example, the residential unit sold for $341,500, or

approximately $285.06, nearly 10% more per square foot than a comparable unit at the nearby

12.5 Lofts.

Unit sales were halted soon thereafter, however, due to ongoing contractor disputes

which led to the filing of a contractor lien against the remaining units in the project. The

dispute was resolved in late 2008, but market changes in the interim drastically reduced the

prospects of new sales at the developer's target price. Moreover, lack of cash flow during the

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construction delay and contractor dispute seriously harmed the developer's finances.

ShoreBank Pacific, the project's lender, denied initial attempts by the developer to restructure

the project's finances which placed the development in further jeopardy.

The developer claims that ShoreBank Pacific had relatively little experience with

projects similar to hers, and that inexperience complicated her effort to find a solution to the

project's serious financial difficulties. Initial requests to change the focus of the project to a

rental property were denied by ShoreBank Pacific, due to very low loan-to-value ratios of the

project. The lender could have forced the developer into bankruptcy, along with subsequent

foreclosure proceedings on the building, but they recognized that as a type of "mutually-

assured destruction" according to the developer.

Eventually, a compromise was reached which allowed for the project to be temporarily

leased with long-term plans to return units to the condominium market once conditions

improved. ShoreBank agreed to refinance the project's debt, although they provided only a one-

year note to the developer, at a rate that the developer did not disclose but which is likely to be

significantly higher than previously-planned financing.

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FIGURE 12. Photograph of two-story residential unit interior.

Leasing began in January 2009,

and as of May 2009, all residential

units and all but one live/work

unit had been either sold or

leased. The developer signed one-

year leases with tenants,

providing some flexibility to

renew or cancel leases after a year

depending on future market

conditions. As shown in the

rental comparables identified for

the project, leases are lower than

the market averages, reflecting

both the larger size of these units, as well as the urgency of the developer to secure tenants and

generate revenue as quickly as possible.

M A N A G E M E N T P L A N & O P E R AT I N G B U D G E T

The intention for Graham Street Lofts was for units to be sold as condominiums, so there

was no long-term management plan or operating budget envisioned as part of the project's

development. The developer is currently the owner and property manager for the all of the

units except for the two units that had sold initially when they were being sold as

condominiums.

As mentioned earlier the units are being leased and only for a one year period. At the

end of the year period the developer will re-evaluate the demand for condominiums, and

depending on the market, the units may be marketed for sale, most likely on a rolling basis to

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Unit #

UnitType

Size (ft2)

Lease Price or Sale Amount

1 Live/Work 1,170 Not Leased (Asking $1,300)

2 Live/Work 1,137 Sold July 2008 for $245,000

3 Live/Work 1,150 Leased: $1,300

4 Live/Work 1,150 Leased: $1,300

5 2 Bedroom 1,198 Sold July 2008 for $341,500

6 2 Bedroom 1,065 Leased: $1,400

7 2 Bedroom 1,065 Leased: $1,400

8 2 Bedroom 1,065 Leased: $1,400

9 3 Bedroom 1,927 Leased: $2,200

10 3 Bedroom 1,786 Leased: $1,900

11 3 Bedroom 1,769 Leased: $1,700

12 3 Bedroom 1,769 Leased: $1,900

FIGURE 13. Current lease/sales status of Graham Street units.

secure positive stable cash flow even during longer than usual vacancy periods that may be

required to prepare the units for sale.

E C O N O M I C A N A LY S I S & P R O F I TA B I L I T Y

In our economic and profitability analysis we constructed two unleveraged pro forma

forecasts reflecting two different potential outcomes for the project, in a sort of best case and

worse case scenario. Our objective was to see which plan would yield a higher internal rate of

return and to determine which scenario would be the most viable for the project. These pro

formas are shown as Forecast A and Forecast B in Figures 14 and 15, respectively.

The first scenario, Forecast A, is an unleveraged pro forma that spans a period of five

years and assumes that the developer will return units to the condominium sales market as

current leases expire. In year zero we have a outflow of equity that sums a total of $3,06,678.

This outflow includes an assumed acquisition cost as well as construction costs of $3,100,000.

Our construction cost includes hard and soft costs.

We developed an assumed lot acquisition cost because the developer built Graham

Street on a lot that she had held over the long-term. Our assumed acquisition cost estimates

what the lot would have sold for just prior to the start of construction in 2007, and is based on a

comparable lot sale made at approximate the same time in the same neighborhood: a 13,699

square foot lot located at 3500 NE Martin Luther King, JR. Boulevard which sold in April 2007.

In year one there was a sale of two units that gave us a inflow of cash equaling $586,500,

and a base rental of $84,400 from leasing revenue of the other 10 units for a period of six

months. We have assumed a 2.5% increase in rental units for the following 4 years to reflect

inflation and we also have assumed that the condominium market will begin to stabilize at the

begging of year three including the sale of several units. That is accounted for in years three

through five. With condominium sales we also have a inflow of HOA fees.

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Our operating expenses are 25% of our leased unit revenues. At the end of year 5 all the

units have been moved from rental/ leased units to condominiums sales. This gives us a

internal rate of return of 9.351%

In our second scenario, Forecast B, we also ran an unleveraged pro forma, but in this

specific scenario we assume that the building will remain a rental property over the next ten

years, at which time it will be sold. At the beginning of year four we adjusted the rate rentals by

a 5.3% to remedy the current below-market rents being charged. Each year also includes a 2.5%

CPI adjustment. We maintained the same initial investment of $3,06,678 in year zero, as well as

the sale of the two units in year one. We kept a operating expense of 25% from gross leased

revenue. At the end of 10 years we have a reversion value of $1,580,865 assuming a

capitalization rate of 10%. At the end of year 10 we have a internal rate of return of 0.97%

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Year 0 Year 1 Year 2 Year 3 Year 4 Year 5Rental Revenue $84,400 $189,600 $123,600 $46,800 $0Sales Revenue $586,500 $0 $1,267,243 $1,548,392 $735,000Other Income (HOA Fees)

$756 $3,075 $10,347 $18,933 $23,113

Potential Gross Income

$671,656 $192,675 $1,401,190 $1,614,125 $758,113

Turnover Vacancy $0 -$18,960 -$18,540 $0 $0General Vacancy $0 -$28,440 -$12,360 $0 $0E!ective Gross Income

$671,656 $145,275 $1,370,290 $1,614,125 $758,113

Operating Expenses -$21,100 -$47,400 -$30,900 -$11,700 $0Net Operating Income

$650,556 $97,875 $1,339,390 $1,602,425 $758,113

Equity -$206,678Construction Cost -$3,100,000Property cash flow -$3,306,678 $650,556 $97,875 $1,339,390 $1,602,425 $758,113

Internal Rate of Return

9.351%

FIGURE 14. Forecast A pro forma analysis, showing projected profitability if units are returned to condominium market in the short-term.

The calculated internal rate of return of 9.351% from the first scenario firmly

suggests that the investment most certainly would be most profitable if the developer

was able to sell the units as condominiums and avoid keeping them on the market as

leased/ rental units.

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Year 0

Year 1

Year 2

Year 3

Year 4

Year 5

Year 6

Year 7

Year 8

Year 9

Year 10

Ren

tal Reven

ue

$84

,40

0$18

9,6

00

$200

,028

$205,0

29$210

,154$215,4

08

$220,79

3$226

,313$231,9

71$237,770

Sales Reven

ue

$586

,500

$0$0

$0$0

$0$0

$0$0

$0O

ther In

com

e (H

OA

Fees)$756

$3,075

$3,075

$3,075

$3,075

$3,536$3,536

$3,536$3,536

$3,536

Po

tential G

ross

Inco

me

$671,6

56$19

2,675

$203,10

3$20

8,10

4$213,329

$218,9

44

$224,329

$229,8

49

$235,507

$241,30

6

Tu

rno

ver Vacan

cy$0

-$18,9

60

-$20,0

03

-$20,50

3-$21,0

15-$21,54

1-$22,0

79-$22,6

31-$23,19

7-$23,777

Gen

eral Vacan

cy$0

-$7,80

0$0

$0$0

$0$0

$0$0

$0Effective G

ross

Inco

me

$671,6

56$16

5,915

$183,10

0$18

7,60

1$19

2,314$19

7,40

3$20

2,250$20

7,218$212,310

$217,529

Op

erating

Exp

enses

-$21,100

-$47,4

00

-$50,0

07

-$51,257-$52,539

-$53,852

-$55,198

-$56,578

-$57,99

3-$59

,44

2

Net O

peratin

g

Inco

me

$650

,556$118

,515$133,0

93

$136,34

4$16

0,79

1$14

3,551$14

7,051

$150,6

39$154

,317$158

,08

6

Equ

ity-$20

6,6

78D

evelop

men

t C

ost

-$3,100

,00

0

Reversio

n V

alue

$1,580

,86

5P

rop

erty cash

flow

-$3,306

,678

$650

,556$118

,515$133,0

93

$136,34

4$16

0,79

1$14

3,551$14

7,051

$150,6

39$154

,317$1,738

,951

Intern

al Rate o

f R

eturn

0.9

7%

Assu

med

C

apitalizatio

n

Rate

10.0

0%

FIGU

RE 15. Fo

recast B p

ro fo

rma an

alysis, sho

win

g p

rojected

pro

fitab

ility if un

its held

as rental u

nits in

the lo

ng

-term.

C R I T I Q U E & E VA L U AT I O N

The Graham Street Lofts project is quite different from some other properties that we

have examined in the course this term. Its scale, design, uses, and financial circumstances make

it a challenging, yet interesting case to evaluate. In many ways, the project stands at a

crossroads today, facing financial constraints and a difficult real estate market as the clock is

ticking towards an upcoming refinance of its interim financing later this year.

We found the building design to be appealing and inviting, and probably appropriate in

light of the market and neighborhood conditions that existed at the beginning of the project.

The building is innovative and fresh, and was probably very attractive to buyers in the market

at the time that it was completed, as exhibited by the quick sales that ensued.

Although the developer could not have anticipated the sudden death of her prime

contractor during the project, we found that lack of experience by perhaps both the developer

and the lender contributed to the project’s unfortunate and catastrophic delays. Even the

developer commented that her biggest lesson learned was that spending more up front to

secure the expertise needed could have allowed her to minimize the delays stemming from the

unexpected contractor switch.

We’re also puzzled to an extent by the lender’s hesitance to allow leasing to begin

considering the very poor market conditions in late 2008 and the project’s desperate need for

revenues to cover debt service. Better decisions in both of these cases may have shortened the

delays in bringing these units to the market, but they would not have eliminated them, nor

would they have effectively avoided the financial difficulties encountered by the project as the

real estate market imploded.

In our view, this property vividly illustrates how changing perceptions of risk and

return dramatically impact real estate values, and how projects once seen as good investments

can quickly change to be unacceptable risks in the eyes of lenders. In Forecast B, for example,

we assume a capitalization rate of 10%, well above the rates of 6% or lower that were seen just a

Mejia & Ray / 23

few years ago. At a 10% capitalization rate, our project’s internal rate of return is less than 1%. At

a 5% capitalization rate, however, the project returns nearly 6% – a low return, to be sure, but in

better economic times, Forecast B could be a viable alternate plan in the case of market failure. I

today’s market, however, both forecasts call for the project to lose money over the long term, as

the rates of return in both cases almost certainly fall below the borrowing costs being incurred,

particularly considering the short-term financing that was hastily arranged while the project

was in deep distress.

This project also calls into question the viability of live/work commercial space, at least

as it was envisioned by the developer. Live/work space became a popular idea locally that

aimed to provide low-cost alternatives for artists and small, creative businesses to legally live

and work in the same location. Although code changes have legitimized this arrangement, the

costs of these spaces are prohibitively high for startup companies or budding artists. The

roughed-in space at Graham Street Lofts is unlikely to be affordable for many potential tenants

because of additional costs to finish the spaces prior to occupancy, under codes that apply the

stricter standards of commercial and residential spaces. These units, in fact, may turn out to be

the most expensive class of commercial spaces to purchase and prepare for occupancy.

The result, unfortunately, is a relatively dead street face along Martin Luther King, Jr.,

Boulevard in front of Graham Street Lofts. There are no true retail storefronts in the building –

indeed, only one live/work tenant even has a sign posted to advertise his business. The

characteristics of the busy MLK corridor certainly play a factor here, but we suspect that more

conventional commercial/retail space may have been more attractive to the market, and may

have provided a more active streetscape that would further improve the surrounding area.

Graham Street Lofts is likely to play a positive role in the neighborhood’s continued

improvement into the future, although it is unlikely to be an exceptionally profitable project.

Still, we believe that the project illustrates important lessons of anticipating and mitigating

complicating factors throughout the course of real estate development.

Mejia & Ray / 24

W O R K S C I T E D

Bureau of Planning and Sustainability. (2004). Portland Commercial Corridors Study: NE MLK

Jr. Blvd. City of Portland. Retrieved February 16, 2009, from http://

www.portlandonline.com/planning/index.cfm?c=38607&a=82947.

Nicolow, J. (2008). Measuring the cost to become LEED certified. Building Operating

Management. Retrieved May 31, 2009, from http://www.facilitiesnet.com/green/article/

Measuring-The-Cost-To-Become-LEED-Certified--10057.

Portland Police Bureau. (2009). CrimeMapper. City of Portland. Retrieved from http://

www.gis.ci.portland.or.us/maps/police/.

Smith, K. (2006, August 22). Does live-work work in Portland? Daily Journal of Commerce.

Retrieved May 31, 2009, from http://www.allbusiness.com/north-america/united-states-

oregon/4077785-1.html.

Trilogy Materials, Inc. (2005). Performwall Panel System. Retrieved May 31, 2009, from http://

www.performwall.com/product.sstg.

TriMet. (2008, October). Facts about TriMet. Retrieved April 7, 2009, from http://trimet.org/pdfs/

publications/factsheet.pdf.

Mejia & Ray / 25