real estate financial analysis for planners: a very short ... · two bedroom, fully-furnished...

Real estate financial

analysis for planners:

A very short course

September, 2018

Owen Beitsch, Senior Director CSG

Tom Kohler, Senior Director CSG

• Understand real estate decision making to close

asymmetries of information

• Assure policy objectives recognize role of both the public

and private sectors

• Determine how, when, where and why it may be suitable

to partner with the private sector development

community.

• Basic guidelines for such engagement.

Why this course: Review fundamental principles of

real estate economics and their relevance to

planning and development policies

Quick Takeaway 1

• We can influence some development factors…others not so much.

• Development can be complex.

• Often requires highly specialized skills.

• Development competes with other investment opportunities

• Plans have to be justified financially or unlikely to be built by private entrepreneurs.

Quick Takeaway 2

• High density much more expensive than low density

• Many uses have limited capacity to absorb land costs

• Risk actually decreases as construction begins.

• Equity needs are higher during planning

• Small changes in a pro forma can make a big difference

• Private sector capital and expertise are the primary

contributors to the built environment.

• Every development opportunity not suitable for a

private developer to undertake.

• The typical RFQ/RFP process may obstruct

privatization of development.

• Even the simplest solicitation process requires

extraordinary thought about

‾ Issues the developer faces

‾ What we want at end of the process.

Quick Takeaway 3

Planning for the market

• Real estate prices react to changes in land use, regulations, infrastructure, and incentives.

• Urban planners must understand the relationship among land prices, rents or costs, and value.

• The above have implications for public-private partnerships and how we engage private development

Role of urban planners: land use regulations

and government objectives

To insure consistency with government objectives planners should contemplate how regulations affect the marketplace

Role of urban planners: understanding

infrastructure and government objectives

• The development of infrastructure has an impact on:

– The supply of land which can be developed

– The density at which land can be developed

– The value created for lots or other properties

Role of urban planners: incentives

• Targeted incentives might be a way of encouraging certain forms or behaviors

• These incentives may be financial, but they may simply be regulatory

• May also be administrative or include infrastructure support

Basics of development economics

• Linkage between market and financial feasibility

• Financial feasibility

• Risk/return/time value of money

• Planning considerations

The market is relatively unchangeable

From the New Yorker

2017

3.95%

Market 1: 30-year fixed mortgage rates

08.18

4.59%

08.92

5.84%

•Source(s):; Federal Reserve

Market 2: U.S. new housing starts

•Source(s):; Federal Reserve

Market 3: Gap between formations and starts

•Source(s):Haver Analytics; Federal Reserve

2002 2007 2011 2015

Finished lot 23.6% $ 70,425 24.5% $111,452 21.7% $ 67,404 18.2% $ 85,234

Construction cost 50.8% $ 151,593 48.1% $218,810 59.5% $184,818 61.8% $289,421

Financing cost 2.1% $ 6,267 2.4% $ 10,918 2.1% $ 6,523 1.3% $ 6,088

Overhead 5.5% $ 16,413 7.0% $ 31,843 5.2% $ 16,152 5.6% $ 26,226

Marketing 2.0% $ 5,968 2.5% $ 11,373 1.5% $ 4,659 0.8% $ 3,747

Sales commissions 3.7% $ 11,041 4.3% $ 19,561 3.1% $ 9,629 3.2% $ 14,986

Profit 12.0% $ 35,809 11.1% $ 50,586 6.8% $ 21,122 9.0% $ 42,149

Totals 100% $ 298,412 100% $454,906 100% $310,619 100% $468,318

Market 4: Financial models for homebuilders

• Profits have fallen sharply

Risk opportunity and real estate:

Attributes of real estate

• Often long-term

• Processes involved require technical

training

• Many transactions are complex

• Absence of transparency

• Transactions almost always involve

outside expertise

From the New Yorker


Attributes place an emphasis on value

Fundamental relationships among price, value, and cost to implement a program

• Price, cost, and value are not equivalent

• When cost exceeds value, capital will drift away

• When there is no demand, there is no value

• Appraisals are only as good as the instructions…often meaningless in distinguishing value, cost, and price

Cost

Risk opportunity and real estate: Cost value dilemma

Cost

Value

Gap


Cost: $5,750


Value: $2,950

Cost: $5,750


Value: $2,950 Corrected Value: $2,950

Increasing RISK

Treasury bills

Real estate

Common stock Funds

Risk free rate

Mortgage backed securities

Corporate bonds

Incre

asin

g R

ET

UR

N

Risk opportunity and real estate :

Scale of risk

Activity Target IRR

Existing projects 9-11%

New projects

Land development 15-30%

Single family (for sale) 8-20%

Multi-family (for rent) 9-12%

Office 8-12%

Retail 8-12%

Industrial 8-12%

Public projects 11-16%


Threshold returns

Risk opportunity and real estate

• Deals take many different forms

• Inevitably there is a comparison among options

• Important to emphasize that value and cost are not equivalent

Land values, cost and profitability

Sales price

less

Cost of development

yields

Residual land value

Estimated development costs

• Impact fees

• Backbone infrastructure

• Mitigation requirements

• Site development costs

• Professional or other fees

• Building construction costs

• Contingencies

Sales price

less

Cost of development

yields

Residual land value

Estimated development costs

• Impact fees

• Backbone infrastructure

• Mitigation requirements

• Site development costs

• Professional or other fees

• Building construction costs

• Contingencies

Profit Loss

Land values, cost and profitability

Hypothetical residential alternatives

Wood FrameSurface parking

Wood, some steelTypically podium parking,

Some surface

Steel and concreteStructured parking

High rise (7 or more stories)

Low rise (1-3 stories)Single family, townhomes,

garden

Mid rise (3-6 stories)Higher intensity uses

http://www.apartmenthomeliving.com/apartment_finder/CommunityVideos.aspx?property_id=210232

Hypothetical residential alternatives

Wood FrameSurface parking

Wood, some steelTypically podium parking,

Some surface

Steel and concreteStructured parking

High rise (7 or more stories)

Low rise (1-3 stories)Single family, townhomes,

garden

Mid rise (3-6 stories)Higher intensity uses

As density increases, price per square foot also increases


Less Pricing Flexibility

Economics of Use: Each residential option has

its own capacity to absorb land costs

More Land Costs

As rents are constrained, land prices must adjust accordingly

Development costs

Land costs

Economics of Use: Each residential option has

its own capacity to absorb land costs

Density may not yield improved costs

As density increases, construction costs PSF also increase

High Density M F

Office

Retail

Low Density MF

Single Family

Less Pricing Flexibility

Economics of Use: Likewise, among competing

uses, there is varying capacity to absorb land

and subsequent development costs

More Land Costs

As rents are constrained, land prices must adjust accordingly

Med Density MF


Hypothetical (for sale) alternatives

Concept 1 Concept 2

High density

Density 15-20 units/Acre 60-70 units/Acre

Building Style Garden High Rise

Site 5.0 AC 6.5 Ac

Height 2-3 stories 15-17 stories

Total count 100-125 300-400

Typical unit size 1000 avg 1000 avg

Parking Surface Garage

Constuction Cost $125/SF $175/SF


Preliminary financial feasibility testing

Low density High density High density High density

Per unit (20/Acre) Per unit (60/Acre) Per unit (60/Acre) Per unit (70/Acre)

Revenues (Sales proceeds) 365,000$ 345,000$ 375,000$ 360,000$

Costs

Basic construction 150,000$ 175,000$ 175,000$ 175,000$

Fees, charges 23,000$ 23,000$ 23,000$ 23,000$

Structured parking -$ 30,000$ 30,000$ 30,000$

Financing, marketing, other (7%) 25,550$ 24,150$ 26,250$ 25,200$

Profit (15%) 54,750$ 51,750$ 56,250$ 54,000$

Total 253,300$ 303,900$ 310,500$ 307,200$

Residual land per unit 111,700$ 41,100$ 64,500$ 52,800$

Supportable land per acre 2,234,000$ 2,466,000$ 3,870,000$ 3,696,000$

Cost per acre 2,300,000$ 3,900,000$ 3,900,000$ 3,900,000$

Decision GO STOP ADJUST/GO ADJUST/GO


Timing: Balance of risk and reward

• How and when incentives are applied makes a big difference.

• Risk greatest during planning as land is acquired

• Requirements for substantial equity at this stage

• As building nears occupancy, requirements for capital maximized but obligations shift toward debt

Planning Considerations: Summary

• We can influence some factors…others not so much

• Purported benefits of denser redevelopment in centers

– Cheaper infrastructure

– Reduced automobile commutes

– Complete walkable communities: jobs, housing, recreation and

amenities

• Medium average density may be cheaper than low or high

• Each land use has limited capacity to absorb land costs

• Development has its own unique attributes and financial characteristics.

• These attributes and characteristics set parameters

• Risk actually decreases as construction begins.

• Equity needs are higher during planning.


• Time and risk impact achievement of planning goals

• Value and cost are different

• There are many competitive investment opportunities

• Plans that cannot be justified financially unlikely to be built

• Sometimes small incentives make a difference.


The drive for private participation: Generally

• Leverage of resources

• Creation of alternative debt or financing sources

• Cost savings

• Introduction of industry expertise

• New perspectives on old problems

• Speed and response time

• Shared objectives toward common goals

• Economic stimulusThe challenge is to take advantage of all these opportunities.

The drive for private participation: Specifically

• Thoughts of job creation, retention within the community

• Activate a city owned vacant site

• Cash generated for the jurisdiction – sale or lease brings revenue

• Quiet community concerns about “what would go there”

• Fear of high intensity in particularThe challenge is to take advantage of all these opportunities.

The ultimate goal of any solicitation process is to find,

qualify, select, and negotiate with a development team to

deliver a project that achieves the objectives in a timely

and feasible manner.

• Maximizes the use of each sector’s strengths

• Improved efficiencies/quicker completion

• Shared/allocated risks

• Reduce development risk

• Reduce public capital investment

• Mobilize excess or underutilized assets

• Improved service to the community

Getting to the development we want

City View

The needs of the parties

Public sector

• Long term

• Decided publicly

• Responds to the

public’s interest

• Needs assurance

Private Sector

• Short term

• Defined privately

• Capital

• Markets

• Return on investment

• Flexibility

Gaylord Palms

This process does not have to be complex, but it does need to be well

organized and prepared. Absolutely must minimize conflict and

misunderstanding on all sides.

Getting to the development we want

Concept Is the idea financially and reasonably practical? Can it be done?

Solicitation Procedure

What is the best way to complete the project? How do you choose and contract with the best potential ally or partner?

Implement How do we advance, monitor, control, and assure the project is fulfilled?

Continued Operation

Are the respective parties fulfilling their obligations

Baldwin Park

Alternative approaches

Major steps

1. Confirm the scope and the mission: Define the process and outcome

− Insert clarity and certainty about the objectives

2. Prepare the RFQ/RFP: Know where the process is going

− Control expectations

3. Solicit qualifications and proposals: Ask only for what you need

− Manage requirements to objectives and expectations

4. Evaluate qualifications and proposals: Focus on who and what

− Who is really involved and doing what things relative to objectives

5. Developer selection and negotiations: Allow sufficient time

− Allow more time. Go to Number 1.

• Opportunities and constraints

• Synthesize goals and objectives for property(s)

• Work session with key stakeholders

• Outline timetable and key milestones for

RFQ/RFP

• Outline information necessary to the decision

Confirm the scope:

Define the process and outcome

Prepare the RFQ/RFP:

Know where the process is going

• The focus and objectives should be clear

• The RFQ establishes the baseline ability of developer to implement the

desired project – relevant experience,

– track record,

– financial capacity, equity sources & lending history,

• The RFQ can ask to describe a basic approach about planning, design,

financing, and marketing

• Only by satisfying the requirements of the RFQ will the developer be

provided an opportunity to submit a detailed proposal

Solicit qualifications and basic

proposals: Ask only for what you need

• Carefully identify and outline content to match what you need

• Identify target prospects

• Establish timetable

• Establish rules for evaluation & conveyance

• Advertise & distribute

• Respond to questions from prospects

• Accept responses

Evaluate qualifications and proposals:

Focus on who and what

• Capacity of proposal to meet plan goals

• Economic and physical issues

• Practicality of land use plan

• Review designs, budgets, and specifications

• Evaluate credit history & financial capacity

• Review ownership & management

• Evaluate overall business deal

• Respective roles of public & private parties

City Commons

• Once the commitment is made to solicit the private development interest, then there must be a well established course of action .

• We must be prepared to speak openly and candidly with our developers

• We can only speak if the process is well articulated and we understand why and where it will [or will not] work as expected.

• Much of the time can occur at the beginning.

• It requires multiple complex processes occurring at once

• It will take much longer than expected.

Developer selection and negotiations:

Allow sufficient time


• Don’t let the RFQ or RFP obstruct the process.

– Both the RFQ and RFP need to fully anticipate the end state

– Appraisals are only as good as the instructions…often meaningless to the problem in the RFP

– The initial design or development schemes may be poorly defined

– Timing and phasing

• Public and private are different businesses with different objectives

– Time and money evaluated differently

– Can be very difficult to identify shared objectives

• Process often more political than anticipated …can

reduce perceived savings…may increase cost

• Asymmetry of information

• Expectations are often misplaced

• Likely to be more reliance on shared financial resources

than expected

• Basis of opportunity and terms of subsequent success are

often defined in different terms


Contact information

Owen Beitsch or Tom Kohler

Real Estate and Economic Advisory Services

GAI’s Community Solutions Group

618 East South St

Orlando, FL 32801

(407)843-5635

real estate financial analysis for planners: a very short ... · two bedroom, fully-furnished...

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