Multifamily Residential

Development
Overview
This chapter focuses on multifamily residential development, primarily rental income property, but
it also covers topics common to all forms of development. Rather than presenting separate generic
discussions of the development process throughout the book, this chapter begins with a discussion
of income property development and incorporates a detailed discussion of each step of the
development process into its treatment of rental and condominium apartment development. This
chapter primarily addresses rental housing. Condominium development (for-sale multifamily
housing) is similar in many respects to apartment development (rental multifamily housing) except
for the financial analysis. (Several fundamental subject areas, such as site acquisition, the
regulatory process, site engineering, and financial analysis of for-sale condos, are covered in detail
in chapter 3.)
Despite the apparent preference of U.S. households for owning single-family dwellings,
multifamily housing continues to be an essential housing type for a broad range of the
population. Apartments house the young and old alike, whether they are aspiring homeowners,
residents who cannot afford to own a home, or renters by choice—those who choose to rent
apartments even though they could afford to buy a single-family house. To its residents,
multifamily housing offers convenience, afford-
ability, and flexibility. Major demographic trends also exert substantial
influence on multifamily construction. As local growth rates
Like other real estate, multifamily residential
influence the overall demand for units, the composition of
development is highly cyclical. Typically, in times
the population influences the demand for particular types
of low interest rates, multifamily units are built
of multifamily housing. The aging of the baby boomer
by the thousands. Conversely, when interest
generation will continue to play
rates are high (10 percent or above), multifamily
construction slows considerably. However, low
interest rates also make houses more Mu)tlfamiiy Residential Development
affordable, which reduces demand for a leading role in the demand for housing, but
apartments. And in times following deep also echo boomers will have even larger
recessions, rents are often too low to make new numbers than their baby boom parents. As the
apartments economically viable leading edge of the baby boom generation
reaches 65 years old, demand for
retirement housing will increase, as
well as other housing types geared
for the active adult market, assisted
living and continuing care. Between
2010 and 2020, the number of echo
boomers will reverse the declines
in younger households of the last
decade and feed demand for
apartments. Even with only modest
immigration, minorities will fuel 73
percent of

Pacific Station is a mixed-use infill development in

downtown Encinitas, California. The project replaces
an old warehouse and railroad shed with a Whole
Foods grocer, residential condominiums, and 248
underground parking spaces.

147

Professional Real Estate Development

capitalized value—the market value—of the property
at stabilized occupancy and the total development
cost to reach that point. During the feasibility period, the project may be
In general, developers bring a wide variety. of canceled at any time, usually limiting losses to the
backgrounds, approaches, and concepts to their first costs of the feasibility study plus the cost of tying up
projects. The key to success, however, is skillfully the land. Positive information, however, usually
executing the steps in the development process and justifies making the next increment of expenditure to
paying attention to every detail. Jerome Rappaport, Jr., acquire additional information. Project feasibility
states, "The first requirement is for developers to have includes four major activities:
the skill set to cover all of the tasks necessary to
• market analysis;
implement the project, either through their own past
• site selection/engineering feasibility;
experience or expertise on their team. Development is
• regulatory approvals; and
a lot more than site control. It also entails construction
• financial feasibility.
implementation, financial controls, budget compliance,
government relations, neighborhood relations, In some cases, these activities are performed
marketing, and sales. "8 sequentially; more often, they overlap. Developers
must be satisfied, however, that all four activities
have been completed satisfactorily before making a
Project Feasibility final go/ no-go decision. Moreover, developers must
Project feasibility encompasses the full range of
treat the findings of their research objectively and
analyses that a developer must perform before
committing to a given project. As feasibility analysis not become enamored with their site or concept.
progresses, the developer must acquire more Developers rarely close on a site (finalize the
information that will indicate whether it makes sense acquisition) until they are certain that the project
to proceed further. will go ahead; in practice, that means when all
financing commitments are in place for both debt
and equity, and major public approvals have been
Advice on Market Analysis received. For beginning developers, most of the
steps taken during the feasibility period are aimed at
Experienced residential developers offer the following securing financing and ensuring that no unexpected
pointers for obtaining the most useful market data: surprises show up later during construction or lease-
up.
•The results of market analysis should be balanced
with a developer's assessment of his ability to
deliver a particular project. MARKET ANALYSIS
Market analysis occurs both before site selection and
•The determination of how much market share can
after site selection. The choice of sites depends on
be captured is critical. Capturing more than 2.5
percent of any market that absorbs more than the market that the developer wants to target.
15,000 housing units per year is an ambitious Highquality market information is essential to
undertaking. Although a developer in a small town determine accurately what to build, whom to build
may capture 50 percent of a market, the same for, and how much to build.
developer in a large metropolitan area probably
would not capture more than 5 percent. No matter how familiar a developer is with the
local submarket, an up-to-date market study is
•In an unfamiliar market, a new developer may
indispensable, both to support loan applications and
estimate his potential market share by studying
to verify current rents and unit types that are most in
what success other developers have had in the area
demand (number of bedrooms, amenities,
with a similar type of product and sales promotion
configurations, and quality, for example). The primary
program.
benefit of analyzing the market before selecting a site
•It is extremely important to identify the is that such an analysis will help identify the niches in
idiosyncrasies of an unfamiliar market. The the market.
proposed project will likely need to be modified The more clearly a developer defines the target
somewhat to meet local tastes. market, the more specific the requirements are for a
site. For example, when a developer knows who the
•A developer should not rely on the architect to do prospective homebuyers or tenants are—their
the market research. Decisions on project features, preferences, their income level, their family situation
Professional Real Estate Development
such as unit mix, unit sizes, and amenities, should be —then the developer has the facts needed to make
based on solid market research and on the tastes careful decisions. Particular market needs imply
and preferences of the target market. particular site
 151
Multifamily

MARKET ANALYSIS: Jefferson Pointe

Following is a short summary of a market z

study conducted for Jefferson Pointe, a
z
multifamily development in eastern
Pennsylvania. The full study can be found z
online at www.uli.
org/PRED.

MIPF Research analyzed the development potential

for a 234-unit luxury apartment community in West
o
Chester, Pennsylvania, a Philadelphia suburb. The
study was completed in 2006 for the developer, JPI
East, a division of JPI Multifamily, Inc. (The MATLACK ST. MATLACK ST.
developer is now called Jefferson Apartment Group
after a buyout completed in 2009.) The subject
property consists of an Il-acre (4.5 ha) site with an
existing 50,000-squarefoot (4,600 m2) warehouse 152
building to be demolished. The developer projected empty nesters. The development is a four-story,
having the first units delivered in late 2009 and wood-frame building with an above-grade parking
completed in 2010. However, the project was garage that provides all residents with direct
delayed both by a lengthy approval process and by access to their apartment's floor. Project features
the difficulty of obtaining financing during the will include a resident lounge, movie theater,
recession. The project began construction in 2010 fitness center, business center, outdoor pool, dog
with first deliveries in late 2011. At the time of the park, and land. scaped courtyards.
market study, the proposed unit mix consisted of 34
percent one bedroom/one bath; 16 percent one MIPF examined market fundamentals, potential
bedroom/ one bath/den; 43 percent two absorption, resi.
bedroom/two bath; and 6 percent three bedrooms, dent profile, proposed program, and rental rates
with sizes ranging from 658 to 1,523 square feet (61 (base and all. in). Although the Philadelphia metro
—141 m2) and averaging 1,003 square feet (93 m2). area experienced minimal rent growth from 2001
The intended market is high-end young to 2005, it was expected to improve over the next
professionals and five years (see figure B). Following the 2001
recession, apartment absorption in the
FIGURE A I Jefferson Pointe Site Plan Philadelphia metro area failed to keep up with
new supply; however, supply and demand were
forecast to be close from 2006 to 2010 (see figure
C).

West Chester is a high-occupancy apartment

market area and MIPF's forecast indicated that
demand should outpace new supply from 2006 to

Professional Real Estate Development

2010. Like the metro area, West Chester experienced 39 per month. If the site were to capture its fair
minimal or negative rent growth from 2001 to 2005 share, then the units would be absorbed at 22
but was expected to see both strengthening rent per month. Stabilized occupancy
growth and occupancy from 2006 to 2010. Based on
current market absorption and new supply, the study (95 percent) was projected to take ten months:
234 subject units 425 total units of new supply = 55%
predicted an absorption period of ten months with a
subject share
lease-up rate of 22 units per month. For FIGURE B I 471 units absorbed + 12 months = 39 units per
Apartment Occupancy and Rent Growth month
Philadelphia Metro Area 39 units per month x 55% subject capture = 22
100% units per month
Occupancy Forecast 234 subject units x 95% stabilized
Rent Growth occupancy = 222 units 222 units + 22
4% units per month = 10 months

96% To evaluate demand for the project, MIPF

designed a resident survey, mailed to
94% competitive communities regarding the
project's desirability. The survey asked
92% residents to evaluate the site's location, unit
93 95 97 99 01 03 05 06 08 10 types, and amenities. The subject location was
Year viewed as desirable or acceptable by 66
percent of all respondents, making it the
FIGURE c I Apartment Supply/Demand Trends second most preferred site overall. Based on
Philadelphia Metro Area the data collected, MIPF arrived at pricing
5 recommendations versus the competitors. The
• Absorption Forecast New Supply o
survey also looked at resident preferences for
unit types. Based on the survey of residents
and the current unit mix in competitors, MIPF
determined that JPl's proposed program met
the needs of the market (see figure D).
-2
MIPF examined the current competition in the
93 95 97 99 01 03 05 06 08
market to arrive at recommended rental rates.
10
It surveyed nine stabilized properties and one in
Year
lease-up, totaling more than 2,300 units. The
projects averaged 97 percent occupancy. Base
2009, when the project was originally planned to be rents averaged $1.33 per square foot
delivered, ($14.32/m2), while quoted all-in rates were
425 units of new supply were forecast to come $1.37 per square foot (S14.75/m2). On average,
online in the the competitive properties offered base
West Chester market area, meaning that the subject amenity packages valued at $224 per month.
property's 234 units would account for 55 percent of Figure E shows MIPF's recommended rents in
the new supply. relation to the competition. MIPF determined
Absorption for 2009, meanwhile, was forecast at rents for the property by adjusting rents at
471 units, or competitive properties for age and amenities to
derive a "stripped rent." These age-adjusted
amenity-stripped rents theoretically factor out

Professional Real Estate Development

 the measurable factors influencing rent Preferred (0/0) 28 12 12
performance, suggesting that the remaining Income qualified for 28 11 50 11
differences relate to intangible factors, such as preferred floor plan (
0
/0) Stabilized
location, appearance, and management. MIPF then
Competitors
ran a regression to determine a trend line for the Mix ( 0/0) 37 17 39 7
stripped rents. Based on the survey regarding the Rent/ft2 $1.473 $1.184 $1.298 $1.264
project's desirability, MIPF determined a premium of Unit size (ft2) 873 1,045 1,140 1,387
6 percent on top of the stripped rent trend line for Occupancy (0/0) 98 99 97 92
the subject property. Lease-Up Competitor
Mix (0/0) 44 6 45 5
MIPF recommended base monthly rents averaging Rent/ft2 $1.348 $ 1.300 $1.168 $1.261
$1.49 per square foot ($16.041m2), and an all-in Unit size (ft2) 844 977 1,203 1,340
rent with premium amenities and parking of Sl.62 Proposed by JPI
per square foot ($17.44/m2). Base amenities at the Mix ( 0/0) 34 16 43 7
subject property were valued at $273 and would Unit size (ft2) 790 906 1,154 1,361
position its rent, including amenities, near the top FIGURE E I Rent Recommendations
of the existing market. Premium features on top of The Subject's Base and Stripped Rent
the base rent at the subject property included Position
$1.60 -Base Rent Subject
computer desks ($25 value), entry -Stripped Rent
hall closets ($3), kitchen islands ($20), $1.50 Spring - Jefferson at Windsor at

patios/balconies ($5), and parking spaces (first space $1.40 Base Rent Average House Brandywine
Westtown
$100). According to the resident survey conducted by Valley
$1.30 Claremont
MIPF, there are relatively few features for which Sharples Works
Windsor at at Eagleview
Windermere
more than half of those surveyed would be willing to
Exton
spend extra. On average, those surveyed were willing rossin
$1.20 Stripped Rent Average
to spend $154 extra for their preferred package of
Camden -
amenities. $1.10 Valleybrook
Cornerstone Terrace

$1.00 850 900 950 1,000 1,050 1,100 1,150

MIPF's conclusion was that the proposed
800
development would be appropriate for the Average Unit Size (R)
market, given feedback from the resident
survey, the performance of existing supply,
and projections for future supply and
absorption.
Source: Greg Willett and Janine Steiner at Real Page, Inc.,
authored this market study. The synopsis was prepared by
Lily Gray, student at Harvard Graduate School of Design,
November 201 1.

FIGURE D I Proposed Program versus

Resident Survey and
Competitors
UNIT TYPE (BED-BATH)
1 -den, 3-2,
1-1 2-1 2-2 3-2-aen
Target Market Survey Data
Presently occupied ( 0/0) 29 17 41 13

Professional Real Estate Development

 15

Professional Real Estate Development

requirements. If a need for high-end apartments is • identify holes in the market—market niches
identified, for example, a developer should be willing where demand exceeds supply and locations and
to pay more for a superior site with special amenities, circumstances that offer special opportunities to
such as views, trees, water features, or recreational build project serving a particular market;
opportunities. • define the target market for the project as
Developer Marvin Finger's niche is the high-end narrowly as possible—number of units needed
rental market in major cities around the country. The
with particular designs, amenities, unit
Finger Companies concentrate on developing
characteristics (number rooms, size, and mix of
innercity sites in the affluent parts of town, focusing
units), and rent range;
on upscale residential communities. "We identify the
employment base and the retail locations where • develop a market strategy—whether to compete
affluent renters would likely spend time. Further, we directly with other projects or to look for market
bracket the price of the land to what we can afford niches.
based on the final product appropriate to that
Once a site is selected, the submarket should be
market.
analyzed in much greater detail. By collecting
The market study in the early stages does not
submarket information on rents, unit sizes, types of
need to be as comprehensive as it will have to be in
renters, levels of activity, and vacancies for each
the future. Market information is not only time-
unit type, a developer will be able to determine
consuming but also expensive to obtain, and a
how best to position a project. A project-by-project
developer should concentrate on specific issues:
catalog of existing multifamily developments in the
• What geographic submarkets have the greatest submarket should be created and used to decide
need for apartments/condominiums? whether to engage direct competition with other
local properties or to cater to a market niche that
• What product type is in greatest need?
shows need and little competition.
• What product types are attractive to renters/buyers and
why? Developer Marvin Finger says that once a site is
placed under contract, "market analysis goes right
• Who is the target market? What are the
to the top of the list of due diligence. In my firm,
demographic characteristics (age, income,
we send in-house staff people to interview
household size) of potential renters/buyers who
have the greatest need for apartments? property managers and analyze the current needs
of tenants in properties that we consider to be in
• What types of units or unit sizes are expected in this
the same market and price range. Often we follow
market? What is the appropriate rent/price range?
that up with a professional management company
• What types of features, amenities, and services do
to confirm our findings.
renters/buyers expect?
Location, site, and market potential determine the
appropriate product to be developed. An urban locale
The focus should be on greatest need rather than on demands a different type of residential development
vacancy rates or hottest areas, but a low vacancy rate from a suburban one. The typically higher price of
points to a need. Need is measured by the relationship urban infill land requires higher densities. Greater
between demand (the absorption rate for new units) automobile dependency in suburban communities
and supply of units (existing and anticipated) for a necessitates more parking. A historic neighborhood
particular submarket. The submarket is identified not might have specific height and architectural controls
only by geographic area but also by product type and that dictate development parameters for a particular
renter profile. site. A waterfront site with panoramic views is better
Developers often confuse existing supply with need. used for luxury condominiums than for entry-level
Certainly, historic absorption rates of existing supply housing.
are an important source of information for predicting The identified market segment should suggest
future absorption, but because a particular product special types of development. If the research detects
type is absent from an area does not necessarily mean strong demand from young families with small
that demand exists for that product type. Often a children, then the project should be planned with
product type is not there because there is no demand this market segment in mind, and the greatest
for it. percentage of units should be large enough for such
In summary, the goals of the preliminary market households. Professional Real Estate Development
analysis before site selection are to If the target market is young, first-time renters, a
 of and

154
moderately priced project with few amenities and maximum unit space for the dollar might fit the bill.
A growing elderly population might suggest a need

Professional Real Estate Development

for a retirement community and elder care facilities. for metropolitan statistical areas [MSAs]) and then
Amenities, features, design, and unit size should proceed to the locality where the project is to be
reflect residents' needs and should be determined located. Ultimately, it will focus on the narrow
through market research. submarket area where the project will compete
Although it is frequently easy to continue directly with other similar projects.
developing and marketing rental products that have The narrow submarket is defined as the area of
leased well in the past, it can be rewarding, both generally comparable population characteristics
financially and in terms of serving a public need, to and is usually limited to one or two surrounding
develop a new type of product. However, in times of neighborhoods. Although the employment center
economic stress, it may be harder to finance or corridor that the project serves generally
innovative product types. Comparable residential defines the broader
projects might not currently exist in the immediate
market area, but if the demand analysis shows a market, the primary market area is usually restricted
to a radius of two or three miles (3—5 km) around
need, the analyst should explore the possibilities. In
the project and may even be smaller, especially if
an overbuilt market, consideration of less standard
freeways, railroads, or other physical barriers exist
types of development may lead to better
between neighborhoods. It may, however, be larger
opportunities but will require looking beyond the
if the proposed product is very specialized, or if the
immediate market area for examples of successful
market area contains few direct comparables. An
comparable projects.
understanding of local renters and competitive
Traditionally, the largest multifamily housing
projects is essential for determining the market
markets have been those at both ends of the
area.
housing cycle: young singles and couples, and older
A secondary market area should also be defined.
empty nesters. In addition to these age-related
This area includes apartment projects that may not
cohorts, lifestyle niches provide further market
potential. They include people in all income and be directly competitive but offer an alternative to
age brackets who traditionally would purchase a renters who are less sensitive about location.
single-family home but for any number of reasons The importance of defining the correct market
choose multifamily living instead. In many area cannot be overemphasized. All too often,
instances, they make up target markets for more beginning developers omit competing projects or
innovative product types. include an area so large that absorption rates are
overestimated. In addition, many market areas are
DEMAND AND SUPPLY. A formal market analysis hard to define because they have no particular
increases in importance as developers move farther identity in the marketplace. This lack of identity
away from familiar locations and product types. poses problems not only for market definition but
Beginning developers are unlikely to have the also for future lease-up and sales because projects
firsthand knowledge of local market conditions perform better in areas that have distinctive
required to compete successfully and therefore identities. Creating a market identity where none
need to make an extra effort to collect reliable exists can be quite a challenge.
market information before making even basic Various factors are considered in delineating the
decisions about site selection. target market area for a proposed development:

Market Area. The developer's first task is to

Travel Time from Major Employment Centers—
define the geographic study area. The study should
With traffic congestion a serious problem in most
start with the metropolitan area (data are available
metropolitan areas, housing decisions are usually

Professional Real Estate Development

based on proximity to employment. By identifying
major employment centers and making assumptions
regarding acceptable commuting time, market
analysis defines a target market area. Mass
Transportation Facilities and Highway Links—
Commuting patterns and times are based largely on
ease of access; thus, the target market's geographic
size is influenced by the availability of mass transit,
the location of transportation corridors, and the
speed at which they operate at peak travel times.
Convenience of transportation and availability of
public transit are especially important
considerations for multifamily development.
Existing and Anticipated Patterns of Development—
Most urban settings contain areas of both growth
and decline. Growth areas might be distinguished by
desirable attributes, such as proximity to
employment, availability of affordable housing,
physical attractiveness, and/or outstanding
community facilities.

Professional Real Estate Development

 15

Professional Real Estate Development

 over-year change in the number of households,

• Socioeconomic Composition—An area's income, number of those who will need apartments or

age, household characteristics, and other miniums is computed based on historic ratios with
new information about income and preferences
demographic characteristics influence housing
This estimate of annual demand represents the
choice and location (but note that it is illegal in
tion or take-up of units in the submarket for the
the United States to target market segments
Absorption is the most important number in the
based on race, religion, or ethnicity).
analysis because it provides the total quantity of
• Physical Barriers—Natural features like rivers,
that will likely be rented in the submarket for the
bluffs, and parklands, as well as constructed
features like highways or intensive development, These aggregate absorption rates (units absorbed
can sometimes form a wall through which the year) are then broken down into absorption rates
market's boundaries do not penetrate. individual product types and unit types. For
• Political Subdivisions—Municipal boundaries can example, a study that indicates demand for 500
be especially important when adjoining apartments year for a given market area is
jurisdictions differ markedly in political climate, incomplete. It should subdivide that number
tax policies, or status, or hold different attitudes
according to product type: 350 adult units, 100 of
about growth. School district boundaries are
important if households with school-age children which are luxury units, and family units, 50 of
represent a target market segment. For easier which are luxury units.
data collection, it is sometimes necessary to Supply Factors. The supply of housing includes
manipulate a target market area to conform to a the existing housing stock, the units currently
political jurisdiction, such as a county or planning under construction, and the units planned for the
district in a county or city. future. The vacancy rate is usually considered the
most important indicator of market need, but it
Demand Factors. On the demand side, the market
can be misleading. For example, vacancies may be
study measures the number of households with 40 in older buildings without central air
particular age, size, and income characteristics. conditioning but as low as 5 percent in newer
Market research firms employ many statistical buildings. Equally important, a 15 percent vacancy
techniques to refine their estimates of the number rate in a submarket with only 1 00 total units may
of households, but their basic approach is the same be quickly absorbed, pecially if a new company is
and takes into account the following factors: planning to move into area; elsewhere, however,
15 percent may indicate very soft market. A more
• employment growth in basic industries
meaningful measure is
(manufacturing and other industries that
generate sales outside the city);
number of months it will take to absorb the
• employment growth in service industries (retail, existing and planned inventory. This number is
local government, real estate, professionals, and based on estimated demand as measured by the
others whose activities support the local
absorption rate expressed in units per month. The
community);
computation illustrated in the next subsection.
• percentage of growth expected to occur in Information about the existing housing stock
employment in the city and submarket; and vacancy rates can best be determined by
• socioeconomic characteristics, such as personal inspection and interviews with managers
of surrounding apartment complexes. Even though
population, age, education, income distribution,
such information may be proprietary, most
and household size and characteristics—families managers are willing to cooperate, especially if the
with children, couples without children, singles, developer promises to reciprocate when the
divorcees with children, and so on; and project is completed. Neighboring property
• in- and out-migration. managers are usually willing to share formation
because they realize that in the future it be
Each factor must be carefully analyzed so that the important to cooperate with one another about
developer understands the characteristics of the target
bad tenants, break-ins, and other issues of mutual
population groups. From these statistics and other Professional Real Estate Development
market surveys, the market analyst estimates the
concern. Other sources of information include local
number of new households moving into an area or being real estate boards, local homeowners and
created by marriage or divorce from within the area (by apartment associations, public utility companies,
 the
cond
o.
comb
ined

absorpyea
r. market
units
year. per for

per

say,
150

very
percent

esthe a
total

the

is

inwill

Professional Real Estate Development

156
The most common mistake that developers sliced by half or more to lease up properties with high vacancies.
make in estimating supply is to ignore units Although a superior project may beat the competition even if its
on the drawing board—that is, projects that rents are 10 to 20 percent more, at a 30 to 50 percent discount,
competitors will take away tenants. Therefore, no matter how
have not been announced and do not yet
superior one's property is to the competition's, the market study
appear on any standard sources, such as city should compute absorption based on a pro rata capture rate. It is
building permits. Often, local brokers, acceptable to include higher capture rates as well, but among
bankers, and architects are the best-informed financial scenarios should be one that shows lease-up based on
sources concerning planned units. Of course, the more conservative pro rata capture rate for estimating
many such units may never be built and some absorption.
planned projects may never get off the Net Market Absorption and Months to Absorb
ground, but the most likely estimate of the Current and Projected Inventory. The decision
number of units that will be built should be concerning whether the market is strong enough
included in the projections of future supply. to proceed with project development depends on
one of the key outputs of the market analysis—
Capture Rates. The percentage of total demand
the number of months required to absorb the
in the submarket that a project absorbs (units
current and projected inventory of units in that
leased or sold per month) is the capture rate. A
submarket. This figure should be broken down
fundamental principle of market analysis is that, in
according to the different unit types planned for
the long run, a project will capture its pro rata
development. For example, the market study may
share of total supply. If a project has 200 units and
show a short six-month inventory of one-
total supply currently available for leasing is 2,000
bedroom units but a long 24-month inventory of
units, the developer's expected capture rate is 10
three-bedroom units. The number of months to
percent of the total supply. This capture rate is
absorb the inventory should preferably be 12 or
multiplied by the demand. In the example above, if
fewer for apartments. Twelve to 18 months is
demand is 100 units per month, the developer's
considered soft but not impossible; longer than 18
pro rata capture rate would be ten units per
months should be avoided unless the developer
month. At this rate, it should take 20 months to
has truly strong reasons to believe that his
lease up 200 units.
product will be absorbed significantly faster than
The most common mistake in market analysis is
to assume that one's project is better than the the competition's.
competition's and will achieve a higher capture To illustrate, suppose that the market analysis
rate than that indicated by the pro rata share. The indicates demand for 1 ,200 middle-income adult
fallacy here is that competitors faced with losing apartments per year in the developer's
market share will eventually cut prices to attract submarket. Suppose further that the current
more tenants. In the long run, projects are inventory of existing vacant units is 500
unlikely to capture more than their pro rata apartments with another 500 units under
share, no matter how much better they are than construction and that the developer is aware of
the competition because of competitors' reducing 400 units on the drawing board. Suppose the
their prices to a level where they recapture their developer
share of the market. This situation is exactly what
happened in the recession of the late 1980s and
early 1990s. Although it took longer than Wolff Waters Place in La Quinta, California, is an apartment
expected for owners to slash rental rates—often complex affordable to low-income families. The 218 units are
because their loan agreements stipulated that arranged so as to create an attractive streetscape and safe places
rents be at a given rate or higher for loan funding for children to play.
—eventually (often after foreclosure) rents were

Professional Real Estate Development

o
o
z
o

157

Professional Real Estate Development

"The analysis rather

Professional Real Estate Development

 area has a strong market. G.U. Krueger states,
'term sheet market research' trap uses market
to justify predetermined development decisions
than using market analysis as an integral
component of the feasibility analysis. There had
this been enormous pressure to proceed with deals,
is no but now that longer the case, there is an
opportunity for ful research. "11 He also
estimates that he has learned of only half of all units cautions about relying demographics: "
planned (for a total of 800), but of the planned units, Demographics by themselves be wrong, but
perhaps only 60 percent (480) will likely be built.
they are driven by mechanical tions and
Thus, the total supply of units is an estimated 1,480
historical precedents and therefore anything
and the estimated absorption period will be 14.8
months: about behavior. The fact that baby were
supposed to have played such a big role in
500
Vacant units bubble of the 2000s turned out to be faulty it
Units under construction 500 was a misinterpretation of their behavior, which
Planned units estimated to be built 480
wasn't caused by the fact that there were so
Total estimated supply 1 ,480 Total estimated annual many them and that so many of them were
demand 1,200
affluent. It driven by the financing and
Total estimated monthly demand 100
leveraging bubble caused them to behave in a
Number of months to absorb projected inventory =
Total estimated supply + Total estimated demand = certain way. 12
The following guidelines should be observed
1,480
market study to be most useful to lenders,
= 14.8 months
100 investors, and developers:

In this example, if the developer plans to begin 1. Give specific directions to the market
construction immediately and to be open for research firm concerning boundaries of both
occupancy in 12 months, the current and projected primary and secondary areas to be
supply will be only about three months of inventory researched and the types products to be
when the developer's units come onstream.
researched. The larger the boundaries and
What is a reasonable number of months of
absorption of inventory? The lease-up period is derived the greater the number of product the more
from the projected number of units absorbed each expensive the study will be.
month by unit type. A soft market is usually one with 2. Be aware that general statistical information
18 months or more of projected inventory (including is itself inadequate for making market
vacant, under-construction, and planned units). The
decisions.
period required to lease up the project is a critical
component of the budget since it determines the line cal differences exist between market studies that
item for "interest carry during lease-up." Although no collect general statistics on the market and those
widely accepted guidelines exist, it is customary to that gather data on specific projects. The latter is
include a 12-month leasing reserve plus some cushion significantly more expensive but is essential
in the form of a contingency reserve in case leasing developers are certain that the market is good and
takes 16 to 18 months. Although a larger reserve gives the competition is weak. General statistics—
both the developer and the lender additional housing inventory, vacancies, average rents,
protection in case the market turns sour, too large a average unit sizes, number of housing starts in the
reserve will make the project appear more costly than past five years, number and dollar volume of
the competition, which will scare off investors and permits, number of completions—are a useful
lenders. Although reserves should be as large as starting point, but they must be supplemented with
possible, they cannot be too generous or the current survey data from projects in theReal
Professional specific
Estate Development
construction budget will be too high relative to the market area. Even if the market research firm has a
competition. data bank with project-by-project information, the
meaningjust on may not calculadon't say boomers the because

o
f
w
a
s
t
h
a
t

for the

of

types,

by
Criti-

t
y
p
e

u
n
l
e
s
s

Professional Real Estate Development

158

Professional Real Estate Development

 ing supply of units, units under construction, and In the current economic environment, it is more units
on the drawing board. The number of months important to think about what the behavioral of
inventory correlates directly with the amount of characteristics will be moving forward. The tools
interest reserve that developers will need. for identifying behavioral patterns are not that well
4. Hire the best firm available to undertake the market developed study. Firms that specialize in
rental apartments and Once you have examined long-term prospects, look condominiums for particular
market areas have in- at the local economies in which you are operating. formation at their fingertips
that other firms charge A national developer can look at the MSAs where thousands of dollars to
replicate. Developers cer- there will be more growth than others. How well tainly do not want to
pay a firm to collect raw data connected is the local economy in which you are from scratch. They
should evaluate firms on the operating to the global economy and how well can basis of their
information sources and track records: it serve the global economy? Is it being driven by How accurate
have they been in their projections? the manufacturing sector producing goods the rest Which banks
and other financial institutions rely on of the world needs or value-added design (as in their studies?
Silicon Valley)? Stick with metropolitan areas and

A good study of the market for multifamily residen- their hinterlands that service and are connected to

tial development should include the following: the global economy.

If an area is not part of the global
system, it will be hard for it to achieve
any sort of meaningful
1. Figures for the total yearly demand for the metro-economic development unless there is massive politan
area, the city, and the submarket where the government investment.
project is located. Demand refers to the number Leverage was the primary driver in the past cycle. of
multifamily units the marketplace will absorb That may now be changing, and the source of during the
period in which the project will be under income is more important in determining the need construction
and leasing for rental housing.
2. Figures for total supply on a project-by-project You cannot rely on demographic research for basis.
The data on each project should Include small-scale projections. One approach is to talk to
• target market, location, developer, completion date; Realtors in the field and visit projects that are
similar
• number of units by type (one bedroom, two bed- to your concept. You need to know what
you are room, and so on); looking for and get away from the notion that this
• square footage of each unit type; exercise is to justify the decision to your boss or the
• rent or sale price for each unit, along with premi- lender. Talk to sales agents and try to get a
current ums and concessions; buyer profile and then look at the demographic
• vacancies (if possible, by unit type); models.
• amenities of complexes; and Lenders should scrutinize the content and method-
• amenities of individual units (appliances, fireplaces, ology of market analysis as a major component
of and so on). their investment decisions.
3. An assessment of how many units (for rent or for Even market research cannot help you if you do not
sale) the market will absorb each month by unit have a strategy to use that information to maximize

type. Developers should guard against anticipating the asset value. 13 unreasonably large
capture rates and should run stress tests (scenarios) on cash flows assuming they SELECTION
SITE capture only their pro rata share of the market. old real estate adage, the worst

Professional Real Estate

 According to an
Data from geographic information systems make reason for developing a parcel is that you already
market analysis today much more sophisticated own it. Although owning a plot of land may not by than
it was in the past. Also, market analysis today itself be a good reason for developing it, a site should
relies much more on focus groups and interviews to not be eliminated from consideration just
because a determine tenants' needs although focus groups are a developer owns it. Almost every site
is developable for limited sample and one does not know the quality of some purpose. The
developer's challenge is to identify input one will get. G.U. Krueger offers the following the highest and best
use—the use that maximizes the advice from the Great Recession: land value. property's

Multifamily Residential Development 159

Professional Real Estate

 During the acquisition process (see the guidelines in necessary approvals. Options to extend
chapter 3), the ability to buy more time can be crucial especially important in hot markets
for beginning developers. For example, when Peiser where may receive a higher offer from
Corporation and Jerome Frank Investments purchased another
a site in Dallas for a 1 60-unit apartment project, they
had what seemed to be a comfortable 120-day period LOCATION AND NEIGHBORHOOD. It been
during which to close. The project was economically said that the success of a real estate
attractive only if the partnership could obtain depends on three factors: location,
permission to issue tax-exempt housing revenue location, David Farmer of Keystone
bonds available for low- and moderate-income Development ways asks some basic
housing. Approval from the city council was needed to questions when erty: (1) How far is my
issue the bonds.
child's school? (2) my place of
Because housing revenue bonds were a new employment? (3) How far to coffee? (4)
program for the city of Dallas, the city council kept
postponing the hearing date to allow more time to How far to get a tank of gas? be categorized
work out the details of the bond program. by macrolocation factors and cation factors.
Fortunately, the partnership had negotiated the 14
Macro/ocation refers to a proximity to
right to extend the closing by up to three months at major urban nodes, micro/ocation
a cost of $5,000 per month, and the extra time
property's immediate environs. A
allowed the partners to receive the
property's value depends not only on its
current and microlocation but also on how
they are over time.
Both macrolocation and microlocation
The Value of Focus Groups multifamily residential development.
Macrolocation determines what part of the city
For their first project in Barcelona, Jay Wyper, head of
offers the term potential to preserve and enhance
the London office for Hines, had heard that local
imity to downtown and suburban employment
residents refused to buy apartments above the 12th
ters, major growth corridors, medical centers,
or 13th floor. Indeed, there were virtually no towers
shopping and entertainment, regional parks,
taller than this height. This negative viewpoint was a
serious concern as Hines was planning to build new recreation. Microlocation determines how well is
towers in its Diagonal Mar waterfront project that situated in its immediate neighborhood—access
would be 22 stories. Through a series of focus groups, freeways and arterial roads, quality of schools,
the firm discovered that the resistance to taller shopping, daycare, and health care facilities.
buildings resulted primarily from one issue: traditional site is visible from a major road yet situated to
building elevators were small and inadequate and privacy, a sense of security, and a low noise
frequently broke down, resulting in long stairway level.
climbs. Hines, of course, knew how to provide proper The ability to foresee changes in the urban
elevator systems to towers, but the team was before others is one of the hallmarks of the
concerned that perceptions about taller buildings most successful developers. Whether their
among older residents would be hard to change. predictions based on careful research,
They therefore decided to completely alter the target intuition, luck, or some combination of all
market for the project by appealing to a younger, three, successful developers stand the
more active demographic group that would be less
dynamics of location well enough to over the
affected by the traditional bias. They also decided to
challenge the tradition in Barcelona of having three- long term.
foot-wide (0.9 An important component of their success is tied
m) balconies. Wyper thought that larger balconies with the fiscal health of the cities or suburbs where they
enough room for people to eat outside would prove to build. If the level of public services in a city declines,
be very popular. The subsequent success of Diagonal
real estate values decline as well. Successful
Mar is testimony to the value of the focus groups and
developers understand how much they depend on
the company's willingness to challenge traditional
standards where it had reliable data to support the the physical and financial health ofReal
Professional the Estate
communities
change. where they build—which is why so many of them
Source: Gerald Hines, Jay Wyper, and Gregg Jones (Pelli Clarke Pelli are active in community affairs.
Architects), presentation to the joint real estate clubs at
 the closing are
the seller buyer.

has often project location.

Advisors
allooking at
propHow far is
get a cup of
Location
can
microloproperty'
s to a long-term
macrolocation
changing

influence

best longvalue—
prox-
cenregional and a site to parks,
Ideally, a ensure

fabric

are

undersurvive

to

160

preferences are critical components of neighborhoods, however, which often cycle downward
location. The rate of change in most American within 15 to 20 years after they are built. On
neighborhoods is very slow—often 30 to 50 the other hand, some neighborhoods seem only to increase in value,
years from peak to trough It is much faster in often for reasons having to do with not only location but also the
poorly designed or poorly built availability of shopping, open space, and other amenities, and
ongoing investment by private owners to renovate and improve
their properties.
Professional Real Estate
 The character of adjacent areas also affects the o o
use of an undeveloped parcel. If adjoining areas
are compatible, they can enhance the desirability
o
of a proposed multifamily project. When they are
deleterious or conflicting, developers should
proceed very cautiously.
Alterra and Pravada at Grossmont Transit Center in La Mesa, California,
In recent decades, it has been common practice
take advantage of an excellent location. The projects together comprise
to locate higher-density multifamily projects closest
527 units, 80 of which are designated as affordable.
to commercial and industrial districts. Doing so
serves as a buffer to single-family areas and allows
the multifamily residential areas to benefit from
best locations are naturally costlier than those with
proximity to the higher-capacity streets and more
detrimental surroundings but are usually worth the additional
intensive commercial and employment centers that
help support higher population densities. In turn, expense, particularly for high-end development. When
cluster and attached housing is often located as a selecting sites for multifamily uses, developers should look for
buffer between multifamily housing and lower- sites with positive synergy with surrounding uses and avoid
density single-family development. those where uses are not as compatible.
More recently, however, these planning In considering compatibility, developers should be aware
practices have come into question. Local of potential liabilities that could be incurred from building
governments are increasingly willing to view residential units too close to conflicting uses. Proximity to
development proposals in terms of integrating large storage tanks of gas, oil, and other flammable
material should be avoided. Fire protection must be
rather than separating different uses, a point
considered in heavily wooded or fire-prone areas.
illustrated by the increasing flexibility of land use
Generally, protecting the public from such hazards rests
controls through the widespread acceptance of with the municipality through its police powers (including
mixed-use zoning and concepts that have long zoning), but developers also need to protect themselves
been associated with good planning but against possible liability by examining the potential
popularized by the new urbanists. Such conflicting uses near a given site.
development plans permit the mixing of previously
SIZE AND SHAPE. The best size for a site varies according to
separated uses, provided they are properly
local market conditions, including lease-up rates,
designed. The result is often a more varied,
acceptable unit densities, and preferred amenity packages.
efficient, and attractive development.
For example, suppose a developer wants to build a project
A good site for multifamily development is one that can be leased within 12 months from its completion. If
that has positive synergy with surrounding land 15 units can be leased per month (180 units per year) and
uses. For example, a multifamily site in an the product being built has an average density of 24 units
established or emerging suburban business core per acre (60/ ha), then the ideal site would be 7.5 acres (3
offers residents the convenience of employment ha), that is, 180 divided by 24. The size of a site is also
and commercial services within easy driving or influenced by property management considerations.
walking distances. A site in an area with several
other successful apartment projects may also be
161
more desirable than one that stands alone because
of amenities, shopping, and mass transit that are Although the optimum number of units varies with each
attracted to concentrations of apartments. The project, many developers consider 150 or 200 units the
minimum number necessary to support a full-time on-
Mutt,family Residential Development
1
site maintenance staff, and they look for sites that are
large enough to accommodate that many units. In Los
Angeles, where the availability and cost of land make it
very difficult to assemble sites large enough for 200
units, developers often build several smaller complexes
in a neighborhood that are run as a single project with
Professional Real Estate
shared property management and • Will it be difficult for residents to exit the project?
maintenance staffs.
Design options increase as the size of the 162
site increases. A site that is too narrow • How long will it take residents to travel to work schools,
prevents the inclusion of double-loaded shops, and recreational facilities? • Is the site served by
parking or back-to-back units, which may public transportation?
increase efficiency and reduce costs. 15 A site
• Is road construction planned? If so, rentals will be severely
that is too deep, however, may require a loop
road or a turnaround for fire trucks. One impaired during the construction period
should always draw a preliminary site plan to • Are existing roads adequate for the type of development
see how a site can be laid out before going
hard on an earnest money contract. planned? (In general, high-density development requires
Beginning developers should look for collector and/or arterial street access, whereas lower-
individual tracts that are large enough to density development can be undertaken on smaller local
accommodate the type of product they want
streets.)
to build. They should avoid tracts that
require assembling several parcels under
Visibility is critical for marketing and leasing. Prospective
different ownership. The process of land
residents must be able to see a project to know that it is there. A
assembly is virtually a development business
developer can enhance a project's visibility in several ways,
in itself, offering its own risks and rewards.
including using special design elements, special landscaping
Problems in assembling tracts include
features, striking colors, off-site signage, flags, and nighttime
multiple closings, extra legal costs, multiple
lighting, especially of the frontage. The aim should be the creation
lenders, and the possibility that key parcels
of an appealing, distinctive project.
will not close. Incomplete assembly carries
costly penalties for developers, who may
SITE CONDITIONS. Apartment and condominium development
have to pay exorbitant prices for outparcels
offers somewhat more latitude with respect to the physical
or spend extra money on design and
characteristics of a site than do other types of development. A
construction to squeeze as many units as
developer of multifamily residential projects is less constrained
possible on a less than ideal site.
by slopes and by the size and shape of parcels because
ACCESSIBILITY AND VISIBILITY. In evaluating
residential building pads tend to be smaller and more flexible
a multifamily site's accessibility, a developer than pads for office or industrial buildings. Residential building
should ask several questions: layouts can be manipulated to fit odd-shaped parcels.
Nonetheless, a developer must still carefully evaluate every
• How will prospective tenants approach potential aspect of a site, including its slope, geology, soils,
the property? What will they see as they vegetation, and hydrology.
drive to the site that may make it more
or less desirable? (In brochures and
advertisements, developers often select The Alexan Midtown is a 275-unit transit-oriented infill development
the most attractive, although not in Sacramento, California. Parking is provided in a six-level, 414-space
necessarily the shortest, route to a garage—a parking ratio of one space per bedroom.
project from the major roads.)
• How will visitors enter the property? Will
they be able to turn left across traffic?
Can approval for curb cuts and/or
multiple entrances be obtained?
• Will the current roadway network
support the additional traffic generated
by a new development?
Professional Real Estate
Development

Professional Real Estate

 Slope and Topography. Developers have always certainly be unbuildable. A developer should be able to obtain a
been attracted to hilltops and other places rough approximation of how much land lies in the floodplain or
wetlands area by hiring a civil engineer and ecologist/biologist
offering views. Moderately sloping sites are
who has done work in the area.
preferable to steep or flat land. Slopes create
Like floodplains, soil conditions are problematic. Even if a site
opportunities for more looks clean, a developer should always hire a geologist to take
interesting design, such as split-level units and soil samples of a site before purchasing it. Geologists usually take
varied rooflines. They also help reduce the amount at least one core sample near each corner of a property and one
of excavation needed to provide structured parking or more in the center to determine what type of soil is present,
in denser developments (densities greater than 35 its viscosity, its plasticity, its bearing capacity, and the depth of
units per acre [85/ha] usually require some form of the water table and underlying bedrock. Good soil like sandy
parking structure). loam is moderately pervious to water. Clay soils, however,
Improvement costs, on the other hand, rise expand and contract with water, which may cause foundations to
sharply on slopes greater than 10 percent. crack. Impervious soils cause increased water runoff. If rock is
Retaining walls, special piers, and other located near the surface of a site, excavation may cost
foundations can add to the time and cost of significantly more than for a site with deep soil.
construction. Further, some cities—San Diego, for Vegetation. Plant cover provides useful
example—have adopted hillside development information about soil and weather conditions. Red
ordinances that restrict development of steeply maple, alder, hemlock, and willow indicate wet
sloping sites. Allowable densities are reduced on ground that is poorly drained, whereas pitch pine
slopes greater than 15 percent, and development is and scrub oak are signs of dry land and of good
forbidden on slopes greater than 25 percent. 16 drainage.
Flat land may also create additional expense. Efforts should be made to preserve mature trees.
Sewers must slope downward to create flow; thus, Large, healthy trees face several dangers.
pumping stations may be required if a site is Construction activity under a tree can compact the
entirely flat or if part of the site lies below the soil and may kill the tree. Builders often do not like
connection point to the city sewer line. saving trees because it makes their work more time-
Geology, Hydrology, and Soils. In consuming and costl½ Trees often die during
earthquakeprone areas, a geologic survey is construction because of chemical poisoning. Even if
essential. If a site is crossed by fault lines, it may be they survive construction, they often die later
unbuildable. The same is true of a site in an area because their root systems have been disturbed or
with abandoned subterranean mines. Even though because the amount of water they receive has been
building around the fault line or mine may be altered. A developer should consult a tree surgeon
possible, obtaining insurance may be impossible. about saving trees and should clearly mark and
Moreover, proximity to a fault line creates an place a protective barrier around trees that are to
intractable marketing problem. be preserved.
If a site contains, or borders on, a creek or Other forms of vegetation may also require
wetlands area, a floodplain study must be special handling. Grasslands, particularly in coastal
conducted. Areas that are wet only part of the year areas, are a crucial component of erosion control.
may be considered vernal pools, which may be Many kinds of grasses, vines, shrubs, and
protected under the North American Wetlands wildflowers provide wildlife habitats or are
Conservation Act of 1989.17 Standing water on a included on the endangered species lists, and their
site may also indicate the presence of an preservation becomes a legal issue.
underground stream, which must be located Stormwater. In the past, stormwater runoff has been
because some portion of the site will almost handled by the most convenient method possible: the

Professional Real Estate

rapid disposal of surface water through 163
closed, manmade systems. Stormwater
runoff has often been mismanaged
under this philosophy, aggravating the
velocity and volume of runoff problems
downstream and increasing the
pollution of local streams. Potential
legal issues concerning the effects of
stormwater management on adjacent
properties during and after
construction have led many
jurisdictions to adopt stormwater
management standards restricting the
runoff's quantity and velocity after
development to no more than
predevelopment levels. Many areas
also require filtration or treatment of
stormwater before its release.
Detention and filtration ponds are
common in stormwater management
systems, the former designed to slow
down stormwater runoff and the latter
designed to filter stormwater through
layers of materials, such as sand and
gravel to remove pollutants.

Professional Real Estate

 is

Professional Real Estate

 EASEMENTS AND COVENANTS. An
easement

The preparation of a functional and aesthetic land for whose benefit the easement is created is
stormwater runoff plan requires coordination among the dominant tenement. The land that is burdened
the project's architects, engineers, planners, and used is called the servient tenement. Generally,
landscape architects. Much of the runoff can be easements are created with a specific termination
handled through passive design elements, including they survive indefinitely. Only the beneficiary of the
proper grading, swales, and landscaping materials, easement—the dominant tenement—can
rather than engineering systems. Such considerations extinguish them. Subsequent owners of property
need to be part of the early design plan. Recent trends that have ing easements may have to purchase the
in stormwater management encourage eliminating easement back from the current beneficiaries.
large stormwater ponds in favor of smaller " rain Protective covenants, also called deed
gardens" located throughout the development. Local restrictions, are private restrictions that run with
stormwater management regulations may vary by the land; that is, once created, they remain in force
state or locality. for all future buyers or heirs. Deed restrictions may
Existing Buildings. In most cities, developers must be created property owner at any time. Once
receive approval to demolish any structures on a site. created, however, they remain in force unless all
Historic structures are protected, but even parties subject to covenants agree to remove them.
nonhistoric buildings usually require demolition Developers usually establish deed restrictions at the
permits. Before purchasing a site for major
time they subdivide, or plat, a property. Some
renovation or redevelopment, developers should
covenants expire automatically after a number of
make certain that they can evict the current tenants.
years under state statute as in Texas and Florida,
Eviction can take a long time—often four to six
but others never expire. To be enforceable,
months or more—and can be expensive, especially if
covenants must usually be filed with county
relocation assistance is required from the developer.
In extreme cases, the developer may be required to recorder and thus will appear in a title search.
find or build the tenant a comparable unit. Developers must carefully review any and all
deed restrictions, for deed restrictions can kill a
ENVIRONMENTAL ISSUES. Environmental due diligence is project after developers have invested many
required now for every development site (see chapter months of time and money. In Dallas, for example,
3). A preliminary Phase I environmental site assessment
(ESA), performed for as little as $1 ,000 to $3,000, gives one case involved subdivision that still had single-
the developer a history of the property and indicates the family-only restrictions in place despite the
need for any further investigation. Every potential lender presence of many nonresidential uses. A developer
requires at least a Phase I ESA report, so a standard part
of purchase contracts is that the offer is subject to the bought property in that subdivision, assuming that
buyer's determination that no significant environmental the existing nonresidential uses effectively voided
problems exist. the restrictions. Although the developer may have
Many urban infill sites have at least one
been able to overturn the restrictions in court, he
environmental issue. In most cases, no remediation is
necessary, but if dirt must be removed or, in the worst found that no bank would lend him money on a
case, groundwater is contaminated, cleanup costs can site that had restrictions against the intended use.
be enormous. The seller is responsible for cleanup, but
once the buyer has closed, he becomes part of the UTILITIES. Water, sanitary and storm sewers, electricity,
chain of title and may be liable in the future. In any gas, and other services are critical factors in site
case, the cleanup must be completed before lenders selection. Before purchasing a site, a developer should
will finance new construction. Because environmental always confirm that services not only are nearby but
problems are so prevalent, lenders seek environmental also have available capacity. It is not unusual, for
insurance policies and guarantees from companies to instance, for a major waterline to run adjacent to a
indemnify them from problems. The insurance can be property but be unavailable to that property because
costly, but it has made many sites developable that the line's capacity is already committed or because the
were not so before.18 city is concerned about a loss in water pressure. To
verify that service is available, Real
Professional a developer
Estate should never
simply take the word of the land seller and should
instead visit the appropriate city departments or retain
a civil engineer to do so.
called or unless date

exist-

by a

the

the

even

164
Development

Professional Real Estate

 Water and sanitary sewer services are the most costly who bear the risk of obtaining necessary approvals and
utilities to bring in from off site. When water and sanitary entitlements (see chapter 3) and then sell the fully
lines must be brought in, the developer should undertake entitled land to another developer to build out the
the work rather than wait for the city or utility company to property. Developers often receive the highest return on
do it to ensure that the work is performed concurrently their investment from successfully obtaining
with the project. Electricity, gas, and telephone services entitlements because they incur the highest risk.
are usually provided by private utility companies. Except Even where land is appropriately zoned, no guarantee
for remote sites, those utility companies usually provide exists that developers will be able to build what they want
service to the site at no cost to the developer since they to build. In some jurisdictions, additional hurdles must be
recover their investment through charges to the end user. overcome, such as approvals from design review boards
Each locality has its own fee structure and method of and neighborhood planning committees. Setback, parking,
handling utility services. environmental, air quality, and fire code regulations affect
A developer should ask several questions about utilities: the density that developers can achieve on a parcel,
irrespective of the allowable density under the zoning.
• How long will it take to obtain service? The regulatory process is described more fully in chapter 3.
• How much will it cost? The following issues arise frequently with multifamily
development.
• When is payment due?
Zoning. Zoning determines the building envelope and the
• When does one have to apply for service? density for a site. Specific issues that are usually covered in the
• Are public hearings involved (they may cause delays and zoning code include the number of units allowed, parking
increase the political risk)? requirements, height limitations, setback restrictions, floor/area
• Is the provision of service subject to any potential ratios, and unit size requirements. Some zoning codes give actual
moratoriums? density constraints, for instance, up to 24 units per acre (60/ha),
whereas others stipulate minimum land area per unit, such as
• Are easements needed from any other property owners 1,500 square feet (140 m2) of land per unit. The other major
before services can be obtained? zoning constraint for apartments is parking. A common
• Is the capacity of the service adequate? requirement is one parking space per bedroom (up to two
spaces for a three-bedroom apartment) plus spaces for visitors.
Some municipalities with scarce water have responded A developer may petition to change the zoning or obtain a
by imposing high water hookup fees on residential variance, but it is often a long and arduous process, especially if
building permits. Others have imposed strict higher densities are involved.
requirements for conserving water, flow-restricting Many suburbs are very hostile to multifamily housing, and
devices on plumbing features, installation of drought- NIMBYism (the not-in-my-backyard syndrome) tends to focus more on
tolerant landscaping, and, in some extreme multifamily development than on any other product type. Jerome
Frank, Jr., advises, "For a beginning developer, it's very difficult—
circumstances, partial or total moratoriums on
unless the land is already zoned—to find and develop a piece o
development until new water supplies are available. property that needs rezoning. Find land that's already zoned and pay
Developers should check the availability of water at a site for the zoning. Marvin Finger adds, "Even extremely low-density
and, if it appears that supplies are limited, understand upscale developments represent nothing but evil to the
fully what will be required before a supply can be hooked surrounding single-family owners. To overcome this perception, you
up to a site. have to employ the premier professional, who would probably be an
attorney, to negotiate your case in that neighborhood. It cannot be
REGULATORY ISSUES. The regulatory process has done in house. 20
become increasingly difficult, and the ability to secure Developer Ken Hughes advises beginning developers to
the necessary regulatory approvals has become the avoid landmarks commissions for historic structures: "In
developer's primary concern in many communities. The Texas, if you go through a landmarks commission review
process, there is no opportunity for appeal. It is not territory
increasing complexity of development regulation has
for the inexperienced developer." He adds, "We do not like to
created a whole new field of development—developers

Professional Real Estate

build replicative architecture on infill lots in historic districts. If we are interested in building a more contemporary structure,

165

Professional Real Estate

Professional Real Estate
 EiiiU Etc

The Cork Factory is a renovation of an abandoned factory

in downtown Pittsburgh. The redevelopment includes 297
apartments, ground-level retail space, and 427 parking
spaces.

we can avoid the landmarks commission by going

directly to the planning and zoning board. "21
Mixed-Use and Transit-Oriented Development. Two areas where cities tend to be more favorably
inclined toward higher-density development are near transit stations and close-in neighborhoods where
they are favoring mixed-use development. Many cities have transit-oriented development (TOD) overlay
districts where they encourage apartments and higher-density development. The California Depart-
are usually wood frame and therefore especially prone ment of Transportation recommends that
communi- to the risk of fire. Fire codes determine the number of ties establish minimum zoning
densities in TODs that stairways each unit requires as well as the maximum are equal to the
maximum density the market will distance each unit must be from a fire hydrant. The support.22
Projects within TODs typically have lower codes directly affect the number of units that can be parking
requirements (maximum one per unit) and placed on a site as well as the cost of building them. receive
preferential treatment for public approvals. Many communities encourage developers to install Ken
Hughes cautions, however, "Most transit authori- fire sprinklers in their apartment projects by
imposties do not know how to acquire land or develop it; ing stringent requirements on wood-frame
construe therefore, most stations are not amenable to higher- tion without sprinkler systems.
Beginning developerS density development. Between 30 and 40 stations will should consult
architects who are familiar with local be opening in the Dallas area, but only about five or fire
codes and the type of product under consideration six of those are appropriate for high-density develop-
to determine the best way to meet fire regulations. ment." Hughes adds, "People view no change
as Even if fire sprinklers are not required by code, it is preferable to better change if they do not
know how advisable to install them. The complex will be more to define 'better.' The developer must
clearly know competitive when it comes time to sell it and insurwhat makes projects work; people
recognize this even ance costs will likely be lower.
if they don't know why they work. The developer is Rent Control. Developers considering multifamily the
'imagineer' who must understand what people re- rental housing projects must consider the degree Of spond
to emotionally even if they cannot identify it. "23 rent control prevailing in the area and local politicians
Fire Codes. Fire codes have particular importance general attitudes about rent control. Rent control for
residential construction because residential buildings ordinances often restrict potential developers' and

Professional Real Estate

estors' ability to obtain the rent required to make the developers because seller financing is often
ject feasible. available. The development process is shorter and
Apart from the obvious economic disadvantages less risky than in other types of multifamily
rent control that restricts rent increases, residential development, and the amount of money
velopers find financing harder to obtain for developers must raise is also usually smaller. The
ojects in communities with rent control. Rent major risk involves the inability to handle interest-
ntrol laws differ dramatically from community to carry during an extended sales period and cost
mmunity. Most rent control laws exempt new overruns for renovation expenses to upgrade the
ojects. Many laws also allow the landlord to raise units. Condo conversions tend to occur in waves.
nts to market rates when a ten- Beginning developers should be wary of the high
t moves out (called vacancy decontrol). Cities that number of units available for conversion to
ohibit vacancy decontrol also typically prohibit (or condominiums from apartments built during the
ake it very onerous to remove) any rental units from period leading up to the financial crisis.
e housing stock for conversion to condominiums. The Conversions are subject to special regulations in many
reat of rent control can hurt developers almost as communities. Concerns about preserving their rental
uch as its enactment. Even if existing rent control housing stock have caused cities such as New York and
gulations exempt new buildings, the possibility of a San Francisco to pass laws that limit or complicate
ure referendum or a vote by the city council to place condominium conversion. Before entering the conversion
w buildings under rent control creates uncertainty business, developers should carefully investigate local
out one's ability to raise rents. This uncertainty makes procedures, which can be time-consuming and intricate.
more difficult for developers to raise the necessary The advice of a local attorney who specializes in
uity and debt financing at favorable rates. condominium conversion is critical and should be sought
Building Codes. Building codes are legal before developers commit to a project.
ocuments that set minimum requirements for Developers should be wary of litigation over
anitary facilities, electrical work, lighting, construction defects. Such litigation resulted in
entilation, construction, building materials, fire frenzied activity in California in the 1990s among
afety, plumbing, and energy conservation. They attorneys who organized condominium associations
re local laws that vary from city to city. The to sue their developers before a ten-year time limit
nited States has no uniform building code, but on construction lawsuits expired, resulting in a
ne of four separate model codes is generally used dramatic decrease in new condominium
s the basis for a municipality's set of regulations. construction. Changes in liability laws combined
lthough the trend is toward greater uniformity, with tighter construction supervision have restored
evelopers must still deal with a diverse set of condominium construction activity somewhat, but
odes that is often applied inconsistently. concerns about litigation still overshadow the
A major problem for developers is that governments market. Savvy developers employ an inspector to
do not accept responsibility for review of the plans. photograph the project in great detail during
Although one department may review and stamp a construction. Not only does this documentation
plan approved, the local government's field inspectors,
help protect the developer against construction
who exercise considerable control over a project, often
defect litigation but it also makes the contractor
more conscientious, knowing that his work will be
interpret the codes differently and do not advance an
inspected before it is covered up.
opinion before construction. To make the process of
Exactions and Impact Fees. To recover what is
obtaining permits as smooth as possible, developers
perceived as the public cost of new development, local
should work with local development professionals ordinances often require developers to dedicate land,

Professional Real Estate

and consultants. Any questions about interpreting the
local building code should be addressed as early as
improvements, or fees as a condition of approval. In the
possible in meetings with those in the building past, such dedications were primarily for the basic
department who check plans. During construction, it infrastructure necessary to serve the development site,
is helpful for the developer to build a strong working such as on-site roads and utilities. Now, however,
dedications or exactions are often required for off-site
relationship with code enforcement officials—in
improvements above and beyond the immediate
particular, building inspectors. infrastructure needed for a development site, including
improvements to arterial streets, flood-control facilities,
Condominium Conversions. Condominium
sewage treatment plants, schools and parks, fire and
onversions—the conversion of rental units to for-sale
units—provide an attractive entry point for beginning

Professional Real Estate

167
police stations, open space, or almost any other Evaluating financial feasibility for all income
public necessity. 24
Despite many alternatives for property development involves several stages of
financing capital improvements, including taxes, analysis, each more detailed than the previous one,
from land purchase to a final go/no-go decision on a
general obligation bonds, revenue bonds, tax
property, How much analysis is necessary before
increment financing, user charges, special
purchasing land? Experienced developers working in
assessments, and special districts, the trend has their own area know from experience what they can
been toward more widespread use of exactions by spend They know the local market and therefore
local governments.25 know when they see a good deal.
Some local governments have adopted standards Beginning developers, however, must overcome
for exactions, whereas others determine exactions several handicaps:
project by project, thereby complicating a
• lack of experience in determining a workable price;
developer's ability to predetermine a project's
feasibility. When no standards exist to measure • lack of visibility in the brokerage community, hence
exactions, developers can use exactions levied on hearing about deals only after larger players have
rejected them; and
similar developments in the area to estimate
exactions for a feasibility analysis. • less staying power, so they must be more careful
In small developments, which characterize the about which deals to pursue.
lion's share of multifamily housing developments, Sophisticated developers perform a sequence of
exactions will more likely be made through impact financial analyses for income properties, starting with
fees rather than dedication of land and simple capitalization analysis and ending with monthly
infrastructure improvements. A requirement for cash flow analysis of the development period. The
dedication of parks, schools, and other public main difficulty in terms of financial feasibility studies is
facilities would be too great a burden for a small site. understanding what type of analysis is appropriate at
Instead, fees are combined with those obtained from what stage. Too much detail too early is a waste of
other small developments to provide the necessary time and money. Too little detail gives insufficient
public improvements at some off-site location. A information on which to base informed decisions.
2008 national survey found that for apartments, Analysis of any income property (as distinct from for-
impact fees averaged $7,092 per unit, about $4,200 sale property discussed in chapter 3) involves five
lower than for single-family units. The largest fees stages:
were for roads, water, wastewater, parks, and
schools. Other impact fee categories included Stage 1 (the pro forma statement)—Simple
drainage, library, fire, police, and general capitalization of pro forma net operating income (NOI
government. 26 when it reaches stabilization;
Stage 2—Discounted cash flow (DCF) analysis of
FINANCIAL FEASIBILITY ANALYSIS The next annual cash flows during stabilized cash flows of
important step in feasibility analysis is financial
the operating period;
feasibility. In essence, this analysis is the one
lenders require to ensure that the project will live Stage 3—Combined analysis of the development and
up to its performance expectations. How one operating periods;
analyzes the financial feasibility of apartments is
similar to the process used for all income property. Stage 4—Monthly cash flows during the developme

Professional Real Estate

 The steps of financial analysis begin with a simple
back-of-theenvelope capitalization and end with a
multiyear discounted cash flow analysis that
includes returns to investors or joint venture period; and
partners. Stage 5—DCF analysis for investors.

FIGURE 4-2 | The Development Period and the Operating Period

Operating Period

84-120

Development Period
Month
Earnest Money

Contract Start Construction Leasing Sale of projectComplete

into

Combined Development Period/Operating Period

Development
This chapter concentrates on Stages 1, 2, and 3, and a property is sold. Stage 2 analysis is used to evaluate this
before-tax version of Stage 5.27 The spreadsheets used as operating period. It is the developer's version of
examples are from West River Commons in Minneapolis, the architect's sketch pad. Just as the architect draws
Minnesota. A narrative describing this project appears at many versions of a building before settling on the final
the end of this chapter. Of all the stages of analysis, Stage design, the developer goes through many iterations of
2 is the most important. It is known by various names, Stage 2 analysis as he obtains better information. For
including discounted cash flow analysis, multiperiod cash the first iteration, rents, expenses, costs, and other
flow analysis, and justified investment price analysis. assumptions are crude estimates based on cursory
Appraisers do a form of Stage 2 analysis when they evaluation. By the time developers are ready to commit
compute the unleveraged returns on a building from the to the earnest money contract (that is, remove any
time of stabilized occupancy to final sale in seven or ten contingencies that may allow them to get back the full
years.28 purchase deposit on the land), they should have the best
It is helpful to distinguish the development period from information possible about the property's expected
the operating period (figure 4-2). The development period performance. This information forms the basis for
runs from the time the developer purchases the land computing expected returns to the developer and
investors—assuming the property is purchased at the
through lease-up of the property. Although the operating
given price. If the property is to be built, then the total
period begins when the property is put into service,
estimated project cost from inception to stabilized
appraisers and lenders typically evaluate the property
occupancy is used instead of the purchase price.
from the time it reaches stabilized occupancy, ruormally
90 or 95 percent (5-10 percent vacant). This period is the
time that the permanent mortgage is typically funded
(although in some cases, the permanent mortgage may be
funded in stages). The operating period ends when the

Professional Real Estate

 The stages of analysis correspond to major hurdles in mixed-use project involving both income-producing uses
the course of financing a project. Stage 1 is the (rental apartments and retail) and for-sale uses
developer's first cursory analysis based on simple pro (townhouses) significantly complicates the analysis
forma income and cost estimates. Stage 2 justifies the compared with an apartment analysis by itself. The Stage
overall value of the investment as an operating real 1 analysis consists of five subparts beginning
estate venture and is given to mortgage brokers and
lenders who will provide permanent financing. Stage 3
gives the developer a picture of the overall
development, from inception through final sale. Stage FIGURE 4-3b I STAGE 1b:
4 is given to the construction lender in support of the
estimated construction loan required and interest reserves
Pro Forma NOI
FIGURE 4-3a I STAGE l a: Rental and Sales Revenue Summary
No. of Area/ Rent/ Total
Apartment Unit Types Units Rent/Ft2 Unit (ft2) Total Ft2 Month/Unit Annual
Rent
1 Bedroom, 1 Bath 10 $1.13 800 8,000 $900 $108,000
1 Bedroom, 1.5 Bath 27 $1.10 956 25,800 $1,053 $341,100
2 Bedroom, 1 Bath 8 $1.03 1,138 9,100 $1,169 $112,200
2 Bedroom, 2 Bath 6 $1.21 1,450 8,700 $1,750 $126,000
2 Bedroom, 2 Bath, Den 2 $1.02 2,450 4,900 $2,495 $59,880
Total Apartment Rental Revenue 53 $1.10 1,066 56,500 $1,175 $747,180
Total Retail Rental Revenue 4 $1.31 1,981 7,925 $2,592 $124,437
Other Rental Revenue $18,300
Other Miscellaneous Revenueb $2,400
Total Apartment Rental Revenue 57 $1.15 1,130 425 $3,767 $892,317
Retail Tenants
Restaurant 3 $1.25 2,333 6,998 $2,916 $104,970
Dry Cleaners 1 $1.75 927 927 $1,622 $19,467
Total Retail Rental Revenue 4 $1.31 1,981 7,925 $2,592 $124,437
Condominium Homes
Condominium Homes 3 $162.50 2,000 6,000 $325,000 $975,000
Total Sales Revenue $162.50 2,000 6,000 $325,000 $975,000
aother Rental Revenue includes additional revenue derived from leasing space at the property. Examples of Other Rental Revenue include
leases for parking, rooftop telecommunication devices, storage space, and billboards.
bother Miscellaneous Revenue includes additional revenue as a result of conducting daily business activities. Examples of Other
Miscellaneous Revenue include late fees and penalties, forfeiture of deposits, and lost-key fees. Specific to this case, miscellaneous revenue
from participation in the tax increment financing program accounts for the majority of the line item amount.
during construction and lease-up. Stage 5 is given to potential Annual
investors in support of the returns they will receive if they Factor Revenue/Cost
invest in the property under a specific deal structure.
$892,317
($44,616)
STAGE I—SIMPLE CAPITALIZATION. Figures 4-3 to 4-9
($4,462)
illustrate the stages of analysis for West River Commons,
$843,240
a new 75,000-square-foot (7,000 rn2) mixed-use project
by the Lander Group in Minneapolis. The project has 53
3.00% of Effective Gross $25,297
rental apartments, three for-sale townhouses, and 8,000
Revenue
square feet (743 rn2) of retail space. (See the West River
$1,950 per unit $103,350
Commons case study at the end of this chapter.) It should
1.36% of estimated total $135,000
be noted that a
project cost
$400 per unit $21,200
$500 per unit $26,500
square foot ($1,750/m

Professional Real Estate

 2
$150 per unit $7,950 ) for 2,000 or
$319,297 $162.50 per feet (186 rn).
$523,942
by the prior Rental and Sales
and Bad Debt are customary

shown. In the pro forma,

against 53 units. For expenses
cost used to estimate for the
apartment and any subsidies.
salary, administrative,
with the rental summary, loan computation, and
development cost, and ending with the simple return
computations.
Stage la—Rental and Sales Revenue Summary. Stage 1
Amortization (years) 30
analysis is used to develop the two simple return Debt Based on Loan to Value (LTV)
measures common to all income properties— overall Maximum LTV Ratiob 75.00%
capitalization rates and cash-on-cash returns. To Maximum Loan Based on LTV for Income Property $6,549,280
compute these ratios, begin by projecting NOI, project Using Debt Coverage Ratio (DCR)
Monthly NOI $43,662
development costs, and leverage (maximum mortgage
Maximum DCR 1.20
amount) for the proposed project. Figure 4-3a shows the
Maximum Monthly Payment (NOI/DCR/12) $36,385 Maximum Loan
rental and sales revenue summary. For West River
Based on DCR for Income Property $6,234,849
Commons, the 53 apartment units range in rent from
Maximum Loan (Lesser of LTV or DCR Result)
$900 to $2,500. Rents per square foot typically fall as unit
size increases, although in this case the two Maximum Loan for Income Property $6,234849 Add: Loan for For-Sale
bedroom/two bath units have the highest rents per Propertyd $682,500

square foot. Rent on retail space is $1.31 per square foot

Total Initial Project Debt $6,917,349
($14/m2) per month. The three condominium units sell
for $325,000 each,
aThe pro forma NOI figure is provided by the prior eponymous exhibit and does not include any revenues from the condominiums.
bThe assumed interest rate and loan-to-value reflect the availability Of financing that was current at the time of the project.

Cln calculation the typical ends valuation with selecting of pure income properties, the maximum based debton the lesser of two loan values, LTV or DCR.
dlt is assumed that an additional loan in the amount equal to 70 percent of the condominium sales revenue is provided by the construction loan lender.

Professional Real Estate

 Dev
elo
pm
ent

FIGURE 4-3d I STAGE I d: Development Costs

Professional Real Estate