Real Estate Principles: A Value Approach

byUMIT SARHAN

Process of development Operation: ongoing management

A use in search of a site:◦New locations for expanding franchise.◦Need for a new school.

A site in search of a use:◦Raw land in path of urban growth.◦Land adjacent to new freeway intersection.

Resources in search of an opportunity:◦Pension fund with money to invest.◦Private investor looking for high-yield

investment.

1. Establishing site control2. Feasibility analysis, refinement, and

testing3. Obtaining permits4. Design: Architect and other professionals5. Financing6. Construction7. Marketing and leasing8. Operation

Wide differences in access to land. Land already owned.

◦ Dream case. Land assembled for specific purpose.

◦ Difficulty of land assembly often justifies government involvement in urban renewal.

◦ Assembly of land for Walt Disney World—devised elaborate blind entities to acquire all of the pieces of land to eliminate a “hostage/holdout” situation.

The builders have since excavated a 10-metre pit around Yang's house, so he is holed up there without water or electricity, threatening to use his martial arts skills against anyone who tries to dislodge him.

Source: CBC News; AP

Source: AP

Options: right (but not obligation) to purchase land in future before a certain date, at a predetermined price.◦ This gives time to developer for conducting

feasibility analysis, run construction and environment evaluation, to obtain necessary zoning, etc.

Joint venture: landowner puts land into development in return for share of profits.◦ May do joint venture with future tenants as well.

Financial feasibility question: does the value, when built, exceed the cost?◦ An application of NPV analysis.

Tests and surveys that may be necessary:◦ Soil tests.◦ Environmental tests.◦ Critical habitats (Endangered Species Act).◦ Seismic tests (earthquake vulnerability).◦ Archaeological (prehistoric ruins).

Multiple layers of permits may be needed.◦ Site plan review. ◦ Regional and environmental impact review.◦ Zoning change.

Site plan review: an inevitable hurdle.◦ Complex set of issues.◦ Rules and criteria involve interpretation by authorities.◦ Neighbors usually resist change.◦ Negotiation is critical skill: important to building support

of authorities and citizens in advance.◦ Negative decision can kill a project in one meeting.

NIMBY: not in my back yard. BANANA: build absolutely nothing anywhere

near anything. “Every successful developer is a good

negotiator …. Through a thicket of obstructions and objections.”

Architect: represent developer in hearings for permits; provide pre-design schematics of user functions and resulting spatial interactions; provide complete design; serve as project manager. Land planner: creates development layout or “map.” Landscape architect: Shapes topography, soils, vegetation, and other objects around a structure to harmonize with and enhance it. Engineers: soil, mechanical, electrical, civil, etc.

Toyota Motor Sales USA likes green the way Henry Ford liked black…the division's new Torrance, California, headquarters is one of the largest environmentally friendly building complexes in the U.S… All good intentions aside, Toyota went green more for the payback than the praise. At a minimum…the Leadership in Energy and Environmental Design (LEED)-guided design for the complex had to surpass a 10 % return on investment. "The project focused on long-term operational savings to increase the rate of return."

Source: CFO.com.

Development has a sequence of financial needs:◦Land acquisition and preconstruction.

◦Construction.◦Gap or “mezzanine” financing.◦Postconstruction.

Land acquisition cost: cost of the land. Preconstruction costs (“soft costs”): title

examination; feasibility analysis, market research and testing, permitting process (legal and architectural fees).

Typical dilemma: developer faces capital constraint, but banks and other institutions are reluctant to lend on asset with no cash flow.

Solutions: use of option, joint venture, and equity partners.

Covers soft costs and hard costs (for direct costs of materials, labor, etc.).

Typically from a bank. Floating rate is popular (over prime rate

or LIBOR). This type of financing is less risky than

land acquisition financing: No title, environmental or ecological risks; permits all in hand.

Construction is a complex organizational problem with dozens of subcontractors and hundreds of steps.

General contractor: oversees and controls project.

Construction manager: liaison and representative of developer during construction.

Marketing normally is carried out by an “outside” broker.

Effective management is important to maintain and increase value.

1. Layout: homesite is cleared and staked out.

2. Excavation: grading with proper drainage.

3. Footing: foundation’s foundation, a concrete base below the frost line, upon which the foundation sits.

4. Foundation 5. Framing: floor, wall, and roof framing

forms the "skeleton" of the home. 6. Mechanicals: heating, cooling, plumbing,

electrical systems. 7. Insulation

8. Drywall 9. Flooring 10. Trim: a carpenter installs doors,

cabinets, and molding. 11. Paint 12: Final trades: light fixtures, faucets,

commodes, and appliances. 13: Carpet/wood flooring and final cleaning.

Asset management: asset manager deals with physical, financing, or ownership structure of the property.◦ Managing the principal’s RE portfolios◦ Refinancing◦ Expansion◦ Making recommendations for buying and selling

properties Property management: property manager is

responsible for day-to-day operations of the property.◦ Marketing◦ Selecting tenants◦ Collecting rents

Asset manager (who has RE expertise) usually work for institutional investors (who do not have RE expertise).

Usually requires an advanced degree.

Before property is acquired:◦ Finds specific assets in which owner/client can

invest.◦ Researches/arranges the financing.◦ Negotiates acquisition price.◦ Oversee due diligence and closing process.

Compare to asset managers of stock or bond portfolios.

After property is acquired:◦ Monitor and control operating performance.

Site visits, property tax assessments, etc.◦ Report value-enhancing opportunities for

rehabilitation, historic preservation, modernization, and conversion.

◦ Suggest strategies for lowering owner’s cost of capital.

◦ Be aware of opportunities to restructure equity ownership.

◦ Continually reassess sell vs. hold decision.

Portfolio theory Asset pricing Capital market (financing) Urban economics (location) Investment value analysis Appraisal Property management Get an MBA, MSRE, or MSRED.

Prudential Real Estate Investors (PREI) is the real estate investment management business of Prudential Financial. PREI, comprised of fund management centers in the US in Parsippany, New Jersey and Atlanta, Georgia; and globally in Munich, London, Singapore and Mexico City; is supported by a network of local offices throughout the world. PREI’s specialized operating units offer a broad range of investment opportunities and investment management services in the United States, Europe, Asia and Latin America. As of December 31, 2006, PREI managed $36.9 billion of gross assets ($26.2 billion net) on behalf of more than 400 clients and is ranked among the largest real estate investment managers.

www.prudential.com/prei

Often needs to report to an asset manager. Detail-oriented.

Marketing the property◦ Leases are perishable assets.◦ Independent brokers are usually paid on a

commission basis. Selecting tenants

◦ Credit tenants. Vast majority of potential tenants are not credit tenants.

◦ Tenant mix. Signing leases Collecting rent Repairing and maintaining property Communicating with owners Maintaining tenant relations

University education rarely focuses on this profession; the closest one may be hotel management.

A number of professional and trade organizations (education providers) exist: ◦ Institute of Real Estate Management (IREM)◦ Building Owners and Managers Association

International (BOMA) Human skills.