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"Shark Tank" at ULI Los Angeles

Posted on October 31, 2011 by David Leazenby

I had the opportunity last week in Los Angeles to lead off the first ever "Shark Tank" session at a ULI Fall Meeting. While planning it over the last few weeks, we were not sure what to expect. Would we have enough content? Would anyone show up? Would the sharks really be interested in these deals? What will it be like to present real deals to different people with different criteria all while sharing all of our strengths and weaknesses? Well, if the immediate response is a good indicator, it was a wildly successful session in front of about 500 people. The concept (the brainchild of Lynn Carlton at Sasaki) was modeled after the popular TV show where entrepreneurs present their product or service to a group of investors. ULI is not typically a large format "deal-making" sort of meeting, but rather an educational and networking organization focused on developing leaders in the real estate industry. However, for 105 minutes in LA, four real estate investment pros poked and prodded their way through two different real estate opportunities while the presenters (and the audience) were educated on what these ladies and gentlemen are looking for in a deal today. Moderating the session was Steve Furnary, CEO of Clarion Partners. The sharks included Cia Buckley, Partner at Dune Real Estate Partners; Arthur Fefferman, President of AFC Realty Holdings; Trish Healy, Principal of Hyde Street Holdings; and Charles Burd, CIO of Bentall Kennedy. The result: I pitched a 380-unit redevelopment project in Indianapolis and asked the sharks for $15M in equity on a $42.6M project; two of them voted to do the deal. Well, actually three if you count Trish Healy's hedge. Thanks to them all and to Lynn and my co-presenter Craig Cherney of American Land Fund for helping to make a great idea come to life.

This entry was posted in Finance, News

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Making Mixed Use Work Financially (Part Three)

Posted on August 26, 2011 by Milhaus Development

For the last few weeks we have been exploring the financial differences between two different buildings – a four-story building consisting of all apartments vs. a four-story building with commercial space on the first floor. Of course, the differences are found in many variables, including construction costs, market rental rates, parking availability, financing terms, etc. The biggest factor affecting the ability to do mixed-use in predominately residential neighborhoods is the rental rate on the retail. Most small market, small business owners operating café spaces cannot pay typical $20NNN-plus and run a successful business. Developers that have forced more commercial space onto a site know that it can compromise the feasibility of the overall project. Further, if for some reason it is included and then underperforms, it presents a negative image of the project and undermines the leasing of the residences. It’s our job to bridge this gap through design and construction in order to deliver space that works for both developer and tenant, yet provides a desirable use for the neighborhood.

Download the full proforma here:
Milhaus Mixed-Use Proforma Compare Full.pdf

In last week’s post, we demonstrated what happens to the proforma during the permanent financing in each of these two building types. Let’s look at the overall value of the project and how much is created in the investment. Notice the apartment building actually receives more loan dollars at refinance since it will have a lower cap rate at its sale than the building with commercial in it (7% v. 7.25%). Appraisers simply do not value the space the same. So, looking at stabilized NOI, the projects are yielding very similar amounts at around $500,000. However, in the mixed-use example, it cost $850,000 more to get that same return. After the different exit cap rates are applied, you can see the value created is $543,734 more if you develop the apartment building on the left. So, which building would you develop?

Today’s economy is characterized by high commercial vacancy rates, low residential cap rates, investors flocking to safety, and high demand for urban apartments in walkable environments. However, without free parking, TIF, tax abatement, or some other subsidy; it is nearly impossible to develop apartments on top of all-commercial space in a mid-market city today. This combination of factors is causing us to pursue buildings with very limited commercial space (all wood construction) and in only the most outstanding locations. If designed and built correctly, these buildings can still add a lot of value to both investors and neighborhoods. Let us know if we can help you with your next project.

This entry was posted in Finance

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Does Mixed Use Really Work? (Part Two)

Posted on August 19, 2011 by Milhaus Development

Today, we are following up with Part Two of our pro forma analysis of two different building types with a focus on operating income and permanent financing. See Part One here for an introduction and a look at the construction costs of both buildings. Download the pro forma for today’s discussion here:

Milhaus Mixed-Use Proforma Compare Part 2.pdf

We are assuming retail rents to be a conservative $14NNN at a neighborhood commercial type location. The residential rents average $1.42 per square foot. The “apartments-only” building yields an 8.71% unleveraged return versus 7.70% for the “apartments over retail” building. To arrive at the revenue numbers for each type, we have assumed a typical vacancy amount and some additional income such as parking and premiums. The NOI is fairly similar in each type at about $500,000. However, as you can see, that difference of about $850,000 between the two project costs as mentioned last week has significantly affected the return by 101 basis points.

Now, this is where it gets even more difficult. Upon permanent financing there is a major difference in how much of the invested dollars can be taken out of the project (about $1,000,000 difference). This dramatically lowers the cash-on-cash return, not to mention the fact that you can’t pull your money out and use it for the next project. Since the mixed use building had about $644,000 higher construction loan, there is that much more to pay back. So, the NOI and Cash Flow are similar on the two buildings; but the coverage ratio, expensive construction, lack of sufficient retail rent create a busted pro forma on the mixed-use side. We don’t have to ask our investors which building they want to have their money in: 8.6% versus 26.3% cash returns.

Next Friday we'll summarize the analysis and present the value of each building type after a sale with their respective cap rates.

This entry was posted in Finance

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Does Mixed Use Really Work? Part One.

Posted on August 12, 2011 by Milhaus Development

We are often requested to explore projects with entire first floors of retail with two or three levels of apartments on top. There are actually some cities that require some degree of commercial space at the ground level of every new building. While we appreciate the amenity that such a use can provide for residents, there are very few markets that support that amount of commercial space. In fact, there is often no financial reason to do it. It usually requires a dense urban market where barriers to entry are very high (eg. New York, Chicago, San Francisco) or some form of subsidy (eg. free land, free parking, TIF, tax abatement, etc.).

To do it in a mid-market city, it requires shrinking the retail space down to a very limited component of the project (see our project that we filed in Indianapolis yesterday as an example). The solution in most places is to keep it in all wood construction and provide flexibility in the design so that it can also be residential space or office space or whatever the market brings. To illustrate, we’ve created an example that is compiled from two different projects that highlights the financial differences between these two building types. Today, we’ll look at the construction costs. Next week, we’ll examine the operational revenue and expenses and finally the results of permanent financing and financial returns to investors.

Our example today (download below) includes the following assumptions to begin looking at the construction side of the deal: identical sites in a mid-market urban area, 4-story buildings with surface parking. On the left is “apartments-only” and all wood construction. For purposes of our illustration, the "apartments-only" building could have a small amount of retail in place of one or two apartments and it would not materially change the numbers. The right column assumes “apartments over retail” with an entire steel first floor and wood construction sitting on top of it. Our “apartments-only” building has 67 units. Our “apartments over retail” building includes 50 units and 12,260sf of commercial space. You can see the differences in pricing according to type. Customary build-out numbers are assumed for the commercial space. The total project costs are $858,715 greater or 15% more in the mixed-use building. Assuming a loan-to-cost ratio of 75%, this translates into $214,679 more funds required to get the construction loan. While significant, this by itself isn’t a deal breaker; but we’ll see when we look at the operational expenses and revenue of the two different parts of the project how these smaller differences result in big financial hits to the returns and feasibility of the project. Let us know if you have any comments or questions. Check back next week for Part Two as we continue diving into it.

Download proforma sheet here: Milhaus Mixed-Use Proforma Compare Construction.pdf

This entry was posted in Finance, Our Philosophy

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Revolving Loan Funds – Private Sector Concept for Urban Repair

Posted on April 05, 2011 by Tadd Miller

Childrens Museum IndianapolisI was present recently to hear Jeff Patchin, CEO of The Children’s Museum of Indianapolis, talk about how important the surrounding neighborhoods are to the safety, security, and marketability of the museum’s patrons. Crime and blight in an area is of course an issue for safety and security, but even more important is often the marketability of such a venue. So with this issue in mind in 2001, the museum committed $2 million to a revolving loan fund that continues to be used today for neighborhood projects. In 2009 alone, this fund leveraged the construction and sale of six new homes and supported repairs to 13 owner occupied homes. This program is a variant of previous such loan funds, including Citizens Gas, Clarian Hospital, and Conseco’s loan funds that have been used throughout the city for years. The most notable application of this tool locally was in the UNWA neighborhood on the former River Side Amusement Park on the West Side of downtown Indianapolis.

Much like micro-banking, this is a private-market based concept that requires repayment, not an entitlement or a grant. It offers lower interest rates and somewhat looser standards with an expectation of higher default rates, and its repayment approach brings some real advantages over the typical grant. First, it appears to bring responsibility, pride, and stewardship into the recipient’s decision-making process, something often lacking in the grant or entitlement process. It also makes helps in the decision-making process for which projects can have the biggest impact, as only certain projects can make the cut of required repayment. And lastly, it allows the granting agency the ability to recycle the dollars, and reinvest them in multiple projects over and over.

Of course, privatization of government and the market-based theories are often debated, and have created a lot of dissention in politics recently. However, with the success of these programs, there is a good argument that these can make a positive impact. They have demonstrated they are a viable option to help spur neighborhood redevelopment, thus benefitting individuals and sponsoring organizations.

This entry was posted in Finance

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Demographic Need is Fundamental - Mark Zandi

Posted on March 21, 2011 by Tadd Miller

Mark ZandiAt a recent ULI meeting that I attended, economist Mark Zandi painted an optimistic financial future for America based on personal and corporate balance sheets and earnings growth. He stated, “its not if they start investing their cash, its when and how.” Although that gets the developer in me excited, the real takeaway from that discussion was his repetitive point that “demographic need” determines the decision-making in every household. In times of low economic activity, therein lies the opportunity. Figure out how to meet the needs today, not so much the wants.

The often “Field of Dreams” mentality of the development industry should take note of this point, and work toward revamped products to meet these consumer demands. Mark used a personal example: his family’s need for a larger vehicle. It was a recent purchase based on need, and it was inevitable in his mind regardless of economic climate. There are certain needs today that are influencing mixed use and urban infill redevelopments; ie. the need to reduce monthly energy costs, to be closer to employment, to accommodate changing household formation, etc. Combine these needs with a credit spigot that is loosening, and personal balance sheet cleanliness (a drop from 430 million credit cards to 320 million over last 36 months) and it appears momentum toward our industry has some real steam behind it. Now, how do we make sure we capitalize on it for our industry, businesses, and personally?

Photo - Mark Zandi in Time Magazine

This entry was posted in Finance, Housing

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Can Microbanks Spur Redevelopment?

Posted on March 16, 2011 by Tadd Miller

Grammen america milhausUrban redevelopment has to be benefited by the exciting news about Indianapolis getting micro-bank locations through Grameen Bank. Grameen Bank, the Nobel Peace Prize winning financial institution from Bangladesh India has become a partner with Central Indiana Community Foundation (CICF)to create a financial institution that will offer micro loans to entrepreneurs in urban Indianapolis. “Grameen means village in Bangalese, and it isn’t what Americans think of as their typical bank, this is an institution with limited regulation, and a focus on lending the old fashion way; that is, holding people accountable for the loans that they sign up for. Grameen already has US locations in Brooklyn and Omaha, and Indianapolis should be proud to be the next location for expansion of this social changing force.

As user for some time of KIVA, and an interested bystander of the Micro-bank movement, I am not sure what their impact will be in these urban neighborhoods, but it can only be positive. One of the biggest things lacking in many of these urban neighborhoods is often not residents, but services and small businesses. This is exactly where micro banks can provide a service, which is very difficult to be implement without a larger organization such as Grameen Bank or KIVA making a specific neighborhood the focus. For these residents and neighborhoods, this is a potential life changing benefit that will hopefully help drive people to open small businesses and encourage others to follow these footsteps.

This entry was posted in Finance

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Market Observations

Posted on August 17, 2010 by David Leazenby

If you are in real estate development today, you have be very careful to not fall into the thinking that characterized the industry for the past decade. When you are thinking about your business today, you have to consider that there is no job growth, people have more debt than ever before, companies are shrinking, and the government is growing dramatically. This is hardly a signal to developers to add more space to our cities. We all know this wasn’t the case only a short time ago. In 2005, all signs pointed in the opposite direction and we added condos, single-family homes, malls, offices and whatever else we could build as fast as we could build it. It’s in our nature as human beings that when you find success at doing something, you tend to keep doing it. Unfortunately, too many people were still doing it in 2006-2007. Not only did this contribute to the Great Recession, but this thinking is still affecting deals today. We regularly meet land sellers that have expectations of value and terms that were commonplace 5 years ago. Unfortunately, in this environment, land has little value. We used to say that land is local. I am not sure that is the case today. Today, it’s value is affected by a much broader market context. Equity is chasing high quality, very well located, trophy assets. There is still value-add opportunities all over the country. Cap rates have dipped below 6% in parts of the country. If you start thinking that you can go buy 5 or 10 acres for a couple of hundred apartment units in “name your typically strong suburban market here”; then you better be lining up public financing, tax-credits, or a land seller willing to contribute the land to the deal. We’re looking at new angles to every deal today. As we (hopefully) emerge from the Great Recession, it is clear that 2010 and 2011 are shaping up to be the among the most difficult and most creative financing times for multi-family in America. Let us know if we can help you with your project.

This entry was posted in Finance

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Mixed Use Density Capped by Costs

Posted on August 16, 2010 by Milhaus Development

Mixed use projects in the Midwest are traditionally limited to wood frame construction because of market rents/pricing vs. construction costs. Take into account that 3 story, non-elevator, surfaced parked product costs +/- $65 pnrsf (15 – 22 units/acre), a midrise, underground parked, common corridor, elevatored building +/- $125 pnrsf (22 – 100 units/acre), further dwarfed by the previous example in steel/concrete at +/- $155 pnrsf (75+ units/acre).

Basically, any residentially based steel/concrete frame product in Midwest the market is a viability non-starter, as there is absolutely no way to make an increase in density make up for the 30 – 100% construction cost increase! The argument is often made that increasing density increases value, therefore making it make sense, however, this is like trying to make money in volume in a product that has no profit/margin to begin with. See this comparison (milhaus-construction-type-comparison.pdf) of a project that shows the difference between the three construction types on a specific site.

This entry was posted in Design, Finance, Housing

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Mixed Use Per Unit Price Misnomer

Posted on August 10, 2010 by Tadd Miller

Mixed use development professionals should second guess their per unit valuations for residential product. Combining the numerous components of a mixed use project always seems to become a custom fit solution, thereby, introducing multiple valuation factors into a fair analysis. Per unit valuations have been driven by the industry's commoditized approach of repetitive product, specifically the suburban single family lot, or multi-family land, which cannot be replicated in the mixed use category. These construction costs were known quantities, so all you had to do was figure out the rent/sale price and absorption, punch it into a spreadsheet, and you knew what your per lot/unit price was.

So let's do a quick comparison, suburban lot price vs. a price per unit of air from a retail developer? The suburban lot is very simple, you get a defined land parcel with basic restrictions upon which you build within certain lines and that is it, and most likely, you can easily without substantial architectural and documentation define the basic product of what you are going to build. However, take a mixed use unit pad for analysis. You need to basically design the entire product, define exactly where specific lines are going to be drawn, determine at which point what utilities, access, parking are going to be delivered by what party, deal with use restrictions, venting, utilities, what type of platform and what type of weight intensities and spans must be delivered, etc. All this before you can reasonably understand the true valuation of what that air rights lot should be valued at. Most of this would be a deduct to whatever the standard suburban multi-family per unit price would be. One of the most common issues we see with this is the need for structured parking, of which is usually a deduct to whatever the standard suburban multi-family lot would be, which in turn makes most suburban mixed used infeasible without government intervention, as this per unit parking cost exceeds the per unit value of the land.

However, this analysis isn't all negative, as there are value enhancements that arise within a mixed use product as well. Often times there is a premium price paid by end consumers to live within a mixed use projects, although I have yet to see a solid study that shows these real rental premiums that can be achieved. In addition, the savings of shared maintenance and resources within the project are often substantial. Lastly, you can never underestimate the savings that one experiences within the actual project from a construction standpoint, value to the retail shops, as proximity to the other uses as a savings efficiency.

This entry was posted in Finance, Housing

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