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Real Estate 101 for public officials

Real Estate 101 for public officials. June 15, 2012. Urban Land Institute Prince George’s County . Topics we plan to cover. The challenges of contemporary development (infill, TOD, value-add conversions) (30 minutes) The development process and project viability (40 minutes)

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Real Estate 101 for public officials

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  1. Real Estate 101 for public officials June 15, 2012 Urban Land Institute Prince George’s County Urban Land Institute Real Estate 101 for public officials

  2. Topics we plan to cover • The challenges of contemporary development (infill, TOD, value-add conversions) (30 minutes) • The development process and project viability (40 minutes) • Real estate finance (30 minutes) • The market • Capital sources and rates of return • The capital stack  • Using public-private tools (40 minutes) • Round table discussion (30 minutes) Urban Land Institute Real Estate 101 for public officials

  3. Learning Objectives: • Obtaining the best outcomes for the community based on understanding how real estate development works. • Connecting the entitlement process to the development process to achieve community goals.  • Standards for deals that are fair and defensible to the public. • New ways of thinking about how to create better projects that meet community goals within the parameters of the real estate financial requirements.  3 Urban Land Institute Real Estate 101 for public officials

  4. Charles A. Long Charles A. Long Properties, LLC charlesalong@gmail.com Developer specializing mixed use development in California, US Consultant on redevelopment, capital finance and economic development Instructor for ULI Real Estate School on development process, public-private partnerships and sustainable development Former city manager of Fairfield and interim manager in Mammoth Lakes, Hercules and Pinole, CA Author of “Finance for Real Estate Development “ published April 2011 Served on 14 ULI advisory panels, chairing panels in Salem OR, Boise, ID and Dallas, TX. Masters in Public Policy, UC Berkeley; platoon sergeant, US Army Urban Land Institute Real Estate 101 for public officials

  5. Finance for Real Estate Developmentpublished by ULIApril 2011 Urban Land Institute Real Estate 101 for public officials

  6. Introductions • Your objectives from this course Urban Land Institute Real Estate 101 for public officials

  7. The challenges of contemporary development “Transformation from a car-dominated tangle of offices, malls and auto dealers into a livable city” East 14th St., San Leandro, CA 7 Urban Land Institute Real Estate 101 for public officials

  8. Development today is more complicated physically and economically • More urban and mixed use • Public benefits more important • More complicated economics • More conversions from old uses • Less leverage and no “value add” financing • Density confusion Appleton Mills, Lowell, MA West End Commons, Oakland, CA Lakeside Steel Plant, Chicago 8 Urban Land Institute Real Estate 101 for public officials

  9. Private sector needs help Obsolescence Barriers—Southwest Center Mall Market for retail too weak to reposition the center for retail. Development plan to create Town Center project with 600 residential units and plaza. New circulation. New parcelization. Five property owners Poor circulation Urban Land Institute Real Estate 101 for public officials

  10. Walkable, sustainable places are more valuable Urban Land Institute Real Estate 101 for public officials

  11. Mixed use is hard to do Community acceptance and entitlement risk Sector differences in market strength Parking costs and layout Resizing the infrastructure Financing challenges Conflicts among uses Getting the density right Silver Spring Town Center Urban Land Institute Real Estate 101 for public officials

  12. Mixed use financing challenges Cost of capital for unitary development configuration Longer absorption period for retail Valuing income and for-sale Federal pre-sale requirements for condo projects Liability on for-sale residential Interconnected parking and operations 12 Urban Land Institute Real Estate 101 for public officials

  13. Entitlement process now is more challenging • More public involvement • More review steps • Skepticism about density. • Development impacts must be funded • Pre-development risk results in missed opportunities. Alameda NAS, Alameda, CA Urban Land Institute Real Estate 101 for public officials

  14. The Great Recession has changed the capital stack Equity Much higher equity: now 35% or more—recourse provisions tighter Mezzanine or performing debt Disappearance of "Gap" financing to pay for “value-add” conversions Debt Much lower debt: now 65% or less Urban Land Institute Real Estate 101 for public officials

  15. The result of the changes to the capital stack OVERALL PROJECT RETURNS MUST BE HIGHER TO ATTRACT CAPITAL Urban Land Institute Real Estate 101 for public officials

  16. Development today is inherently public private • 665 rental units; 25 percent affordable • New, one half acre park • $160 million private cost • $50 million public investment Uptown, Oakland, CA 16 Urban Land Institute Real Estate 101 for public officials

  17. Mission Bay San Francisco, CA • $400 million of infrastructure • Cleanup of site • Public transit links • 41 acres of open space • Financed with “land secured” bonds

  18. Inherently public/private because: • Insures capture of public benefits in the entitlement process. • Addresses greater economic risks and physical complexity. • Integrates service costs into project economics • Brings non-project related resources to enhance private project viability • Aids in site assembly • Enhances co-development opportunities 18 Public Private Partnerships for Transit Oriented Development

  19. And yet, neither sector fully understands the other • Public: • Weak understanding of the private real estate process and economics • Unrealistic, irresponsible or constraint-driven deal making • Inconsistent and unreliable performance on commitments. • Private sector: • Uncertain about how to craft a partnership with a public entity. • Frustration with process and constraints • Failure to capture opportunities 19 Urban Land Institute Real Estate 101 for public officials

  20. Ultimately, this is about governance • Have a shared vision for the future---build a community consensus. • Set clear, predictable and high development standards. • Develop the competence to understand constraints and opportunities in real estate economics. • Build partnerships with the private sector based on fiduciary principles that protect the public interest. • Have strong leaders and committed citizens

  21. It’s about leadership • With a focus on transit-oriented development, redevelopment, revenue creation and smart growth, the Council is encouraging a more business-friendly Prince George’s County by expanding economic opportunities and commercial development. • Excerpt from Prince George’s County Annual Report

  22. It’s about competing effectively as a quality place to live. Urban Land Institute Real Estate 101 for public officials

  23. Prince George’s County has tremendous potential 15 Transit Stations 2,200 acres of vacant land within ½ mile of stations. Source: Andrew Scott, Maryland Department of Transportation

  24. What makes great communities?

  25. Knowledge you need • Risk Profile of the development process • Development finance • Project viability • Deal standards • How to use the tools Urban Land Institute Real Estate 101 for public officials

  26. Organizational norms you need • Leadership • Community vision • Collaborative decision-making across departments • Delegation of authority to carry out the mission. Urban Land Institute Real Estate 101 for public officials

  27. Group discussion • What challenges do you perceive that Prince George’s County faces in achieving high quality development? • Got examples? Urban Land Institute Real Estate 101 for public officials

  28. The Development Process and Project Viability Urban Land Institute Real Estate 101 for public officials

  29. Development is… a separate self financing enterprise that goes from small to large. 29 Urban Land Institute Real Estate 101 for public officials

  30. The Development Process has three phases Urban Land Institute Real Estate 101 for public officials

  31. 80% to 90% of project value is created in the pre-development phase Acquisition, design, entitlement, financing, risk management Project Value 31 Urban Land Institute Real Estate 101 for public officials

  32. Pre-development work manages risk for all phases By the start of construction, risks should be reduced to factors that have already been addressed and are controlled through good management. 32 Urban Land Institute Real Estate 101 for public officials

  33. Pre-development can be expensive and time consuming ($100 million project) Urban Land Institute Real Estate 101 for public officials

  34. Questions • Why do developers have the highest risk of losing money before construction starts? • What implications does this risk profile have for developers in Prince George’s County? • What measures has Prince George’s County taken that address this risk profile? Urban Land Institute Real Estate 101 for public officials

  35. Project viability and residual land value 35 Urban Land Institute Real Estate 101 for public officials

  36. Three elements to evaluate project viability: • Project Value: based on either total sales or on valuation of the stream of income • The Hurdle Rate: The minimum rate reflecting the cost of capital and time that the capital is used. • Project Costs: A valid estimate. 36 Urban Land Institute Real Estate 101 for public officials

  37. A Project is “viable” if VALUE minus COSTS is sufficient to pay: • Developer profit • Cost of Capital 37 Urban Land Institute Real Estate 101 for public officials

  38. PROJECT VALUE BASED THE MARKET • Income projects (retail, office, apartments, etc.): INCOME DIVIDED BY A “CAP RATE”. • For Sale Project: (primarily residential) Gross sales less marketing 38 Urban Land Institute Real Estate 101 for public officials

  39. How to value an “income” project. Income project produce annual income from rent, maintenance charges and other sources. Apartments, offices, retail stores, business parks are all, usually, income projects. The income after expenses is called “Net Operating Income” of NOI. It is the same as annual profit. The market values the NOI using something called a “capitalization rate”. 39 Urban Land Institute Real Estate 101 for public officials

  40. A capitalization rate is simply an shorthand indicator of market strength. Net Operating Income (NOI) Cap Rate= Project Value NOI Project Value= Cap Rate High cap rate indicates market weakness and low cap rate indicates market strength. 40 Urban Land Institute Real Estate 101 for public officials

  41. Cap rates reflect market sentiment Urban Land Institute Real Estate 101 for public officials

  42. Cap rate is the inverse of the P/E ratio used in the stock market Cap rateP/E Ratio 2% 50 3% 33 4% 25 5% 20 6% 16.7 42 Urban Land Institute Real Estate 101 for public officials

  43. Some stock P/E ratios Average S&P stocks 15.5 General Electric 14.31 Microsoft 19.96 Starbucks 45.22 Whole Foods Mkt. 32.18 What does a high P/E (or low cap rate) signal about expectations of growth in income? 43 Urban Land Institute Real Estate 101 for public officials

  44. Pop quiz 1What is the project value? NOICap Rate $3,000,000 5% $3,000,000 6% $2,000,000 4% $2,000,000 5% 44 Urban Land Institute Real Estate 101 for public officials

  45. Web sites where you can obtain current market data Real Estate Research Corporation www.rerc.com Real Capital Analytics http://global.rcanalytics.com/ National Council of Real Estate Investment Fiduciaries (NCREIF) http://www.ncreif.com Urban Land Institute Real Estate 101 for public officials

  46. DETERMINING THE HURDLEThe cost of capital is the blended cost of equity and debt over the time to construct. Example Cost of equity: 20% per year (30% of costs) = 6% Cost of debt: 5% per year (70% of costs) = 3.5% TOTAL ANNUAL COST OF CAPITAL = 9.5% If a project takes 2 years to construct, cost of capital is: 9.5% per year or a total of about 20%. Urban Land Institute Real Estate 101 for public officials

  47. Typical hurdle rates based on duration of development period 1-year: about 10% 2-years: about 20% 3-years: about 30% Urban Land Institute Real Estate 101 for public officials

  48. Hurdle rates for other capital structures and construction periods Urban Land Institute Real Estate 101 for public officials

  49. THE COSTS: A realistic cost estimate includes: • Building costs • Site Development (demolition, grading, utilities and landscaping) • Parking (may be included in building for some types of projects) • Connection and impact fees • Offsite costs such as traffic signals or road improvements • Design (architecture, engineering, consultants, etc) • Marketing (brokers, advertising, etc.) • Construction management • Financing /legal/administrative • Taxes during construction • Contingency: 10-15% in early stages DO NOT LUMP COSTS YOU CANNOT CUT THE BOARD LONGER Urban Land Institute Real Estate 101 for public officials

  50. OK. Once you have Project Value and Hurdle Rate, then you can determine how much you can afford to spend on a project compared to what it is estimated to cost. Project Value Maximum supported investment = 1 + hurdle rate If estimated project costs exceed the Maximum Supported Investment then the project is not viable and the developer will abandon the project. 50 Urban Land Institute Real Estate 101 for public officials

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