Return On Brain Damage -the small developer’s key metric

anguish

There’s an old joke.  Where does wisdom come from?  Experience.  Where does experience come from?  Lack of wisdom.

Real Estate Finance has a lot of technical terms and acronyms.  Return on Investment (ROI).  Return on Equity (ROE).  Internal Rate of Return (IRR).  These are all worth understanding for a small developer working on incremental projects to make their neighborhood a better place to live.  They are ways to look at the numbers.  But how do you look at more intangible things like know-how, reputation,  and relationships?

More important to the small operator than any of these is the Return On Brain Damage (ROBD).  I am talking about figurative not actual “brain damage”.  Figurative Brain Damage for a small developer is the the accumulated effect of going through an a painfully confusing and ill-defined process to get your project approved and built.  You could call it painful learning gained in an informal ass-backward process.  This kind of learning is painful because while you are proceeding through the effort there is a voice in your head saying “This can’t be right…Are you sure you know what you are doing?  This makes no sense…”

For example, I was looking in a local zoning code to understand if it would be possible to build a four-plex on a 40′ x 125′ infill lot.  I sort through the setbacks, the hight limit, the maximum lot coverage, the minimum lot size, the minimum lot area required per unit, the minimum off-street parking required, and the minimum landscaping standard.  By my reckoning, a four-plex could be built on the lot as of right.  So I took my site plan to the front counter of the building department and met with a helpful staffer.  She showed me the Definitions section in the zoning code and pointed to the bit titled “Multifamily”.  Along with describing any building with three or more dwelling units as multifamily, the definition went on to explain how multifamily buildings were required to be at least 25′ away from any property line.  This would certainly be hard to do on a 40′ wide infill lot.  The fact that the city’s Comprehensive Plan specifically calls for more Missing Middle Housing in the neighborhood where the lots are typically 40′ wide never made it into a rewrite of the zoning code.

So I go through all that on the front end of a promising deal, only to learn that I should not buy the 40′ infill lot.  I had been invited to the town. Reading the Comprehensive Plan got my hopes up.  Reading all about the specific zoning classification applied to the infill lot was pretty encouraging.  I drew a site plan and had a 20 minute meeting with a seasoned staffer before I found out that there were 76 words buried in the Definitions Section of the zoning code that killed the potential four-plex (or anything bigger than a duplex.  So what was my return on brain damage?  What did I learn from that frustrating experience.  Always read the Definitions Sections of the Code.  -Something that I can use in any place I work or help others with their projects.  All in all a pretty good return on the frustrating experience of getting caught between the good intentions Comprehensive Plan and a black letter definition in the back of the zoning code.

If you are weighing one prospective project against 5 or 6 others in the same neighborhood, consider what your return on brain damage is likely to be for each of them.  If you learn the specifics of building on a particularly lousy local soil type, would that new know-how help you understand how to build other projects on that side of town?  If you can build trust with local activists and neighbors would that trust help with your next planning commission application?  If you can get through the communications issues you seem to be having with your architect or your framer, will that make things go more smoothly for the rest of the project?  Is it worth the frustration your historic tax credit consultant to draw a clear diagram of the process using small words (and no jargon).

If you facepalm and ask yourself “What am I getting myself into here?  The next question should be “What’s my likely return on what looks to be a fair amount of brain damage?”

My experience in 20+ years of trying to help large scale developers retool their operations to fit into urban places produced an extremely low return on the brain damage, given the effort required.  That’s why I figured it would be better to invest the effort needed to train a new cohort of developers committed to building incrementally at the neighborhood scale.  Over the last 3 years we have seen an excellent ROBD on that effort.

Video: Introduction to Incremental Development

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The Infill Group’s Prairie Street Mixed Use Building, Fayetteville AR

 

Matthew Petty is an impressive and capable guy.  The three story mixed use building above is his first project as a small developer.  (Full disclosure; my able partner David Kim designed this building).

Follow this Link and check out a video of Matthew explaining how Incremental Development works in an introduction lecture in Conway, Arkansas.  I think this is the best video of an IncDev intro presentation to date.

Three Story Urbanism? No Problem.

 

I think it is important and valuable to build Accessible/Adaptable apartments as  currently required under HUD’s Fair Housing Design Manual .  Here’s how to do that in a straightforward three story walk-up building you could build with ordinary residential construction trades in your local market:

The requirement for apartment building or mixed use buildings containing four or more units, and built without an elevator is that all of the ground floor units must be Accessible/Adaptable.  If the 1st floor has no residential units on it, (say because the ground floor is occupied by commercial space or parking garages), then the next floor (the 2nd floor) becomes the “Ground Floor” for the purposes of compliance with the federal Fair Housing Act and you would have to install an elevator for access to that floor unless the building was adjacent to a steep enough grade to provide access to the 2nd floor without an elevator or lift.  As I explained in an earlier post that seems to be getting a fair amount of play, The International Building Code (IBC) allows you to build a three story TYPE V (wood frame) structure with fire sprinklers with a single exit stair, as long as the upper floors do not have more than 4 units on each of them and that the travel distance from the farthest location within each unit is less than 125 feet from the exit stair enclosure.  Follow the link for the specific IBC code citations:

Another Look at how to build a 3 story building without an elevator

The photos above show some capably designed 3 story buildings.  It is possible to do this.  If you have doubts and you need some help,  I suggest that you contact the good folks at Union Studio in Providence, RI They designed the two 6-plex buildings on the lower left or Eric Brown at Brown Design Studio in Savannah Eric designed the white 6-plex walk-up in the larger image on the right.  My able partner David T. Kim designed the 22 unit Hutchinson Green Apartments in the upper left as our first major project after the Great Recession.

So 3 Story Urbanism is no problem?  Okay, admittedly that title does cross the line into Click Bait, because while these hard working modest buildings are very useful in creating 3 story urbanism, your local zoning code with it’s needlessly deep building setbacks, or bloated off-street parking requirements may make it quite difficult to build good #3StoryUrbanism.  But as you can see, but the International Building Code should not be an issue for you.

Bloated parking requirements will mess up your site plan so that you cannot build the same way as the venerable 1920’s 3 story apartment building across the street.  Municipalities are famously bad at guessing how much parking you should be required to build on your private parcel.  Many cites will not even give you credit for the parking spaces at the curb in front of your potential building -as if they do not physically exist.  Unnecessary parking takes up space, creates additional impervious surface that you have to address for the storm water requirements, and those additional spaces cost money to build and maintain.  Bloated parking screws up perfectly good projects every day.  The development math for parking you don’t need never works in your favor.

 

Sharing a Cottage Court Pro Forma (A Live Excel File)

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Repurposed MEMA Cottage, Ocean Springs, MS

 

Here is a link to a live Excel File you can download for a modest rental cottage court:

 

Cottage Court Excel File

You may recognize the Static Pro Forma tab as the template used in the IncDev Small Developer Workshops.

Please post comments and critiques here or email me with questions.  The sooner folks understand the small developer business model the sooner building/rebuilding will get better.

Walk Before You Attempt to Run (or Fly)

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The sequence is really important

 

I do a lot of teaching and coaching of small developers through the Incremental Development Alliance (IncDev).  In the course of that effort I meet folks who are really interested in Alternative community based models for owning buildings.  These include  Benefit Corporations ,  Co-operatives (Co-ops) , Low-profit Limited Liability Companies (L3C’s), or Cohousing.  I think I understand and appreciate the reasons why these arrangements are attractive to people looking to build community, but I want to offer some advice on the mechanics of using these structures in a development project.
These are all structures for owning real estate that have alternative methods for governance and distribution of profits that are alternatives to the more typical tools for owning income producing real estate, the partnership or Limited Liability Company (LLC) .  Before you get fancy with alternative ownership structures, focus upon the basics by standing up an enterprise that will be doing the work of the developer; finding the site, testing various designs and financing approaches, building . leasing and operating the building or buildings.  The Operating Company can be the operating partner, operating co-op member, managing LLC or L3C member, or Benefit Corp. manager. All of these various ownership structures are set up to do the job of describing how capital will be raised for the project and how profits will be distributed. It is the role of the Operating Partner to raise the capital, build/rebuild and operate the buildings profitability so that there is cash flow to distribute among the owners regardless of what ownership model is used, or the mission of the enterprise.
Before you get fancy with alternative ownership structures build a straightforward simple project with straightforward and simple ownership structure, an operating partner and a capital partner under a typical LLC that is limited to just one project as the owner. (a Project-Specific LLC).  You build this structure with an ordinary LLC Operating Agreement.  Under the Operating Agreement, the Operating Partner and the Capital Partner both know who is supposed to do the work (the Operating Partner), who is supposed to put in the capital needed (the Capital Partner), how important decisions will be made, how and when the capital partner will get their original investment back, and how revenue beyond the repayment of principal will be distributed between the capital partner and the operating partner.
The basic deal structure is a good starting point for folks that want to eventually set up other more elaborate alternative forms of ownership. It will help the small developer to  become good at doing the work of the operating partner -an essential role that is required in every one of the alternative ownership structures mentioned above.
In any of these structures people putting up the money in large or small amounts are going to ask a very legitimate series of questions:
  • Who is in charge of this thing?
  • Do they know what they are doing?
  • How do decisions get made?
  • How does the project make money?
  • When do we get our initial investment back?
The horse that goes before the cart is knowing how to do the work of the operating partner. Do that on a small project. It’s like learning how to drive in an empty parking lot before you attempt to drive on local streets or on a freeway. Once you have some of those basic operating skills, then you can look at alternative ownership structures consistent with your mission. The operating partner is the crucial resource, not the money.
Raising money from a couple of individuals and operating under a straightforward project-specific LLC is easier and less complicated than Crowd Funding, REIT formation, starting a co-op, L3C, or Benefit Corporation. Walk before you try to run (attempt to fly).

Arrrgh! How do we start a productive conversation about Inclusionary Zoning? (Part I)

anguish

I live in Portland Oregon.  Moved here last December.

Last year Oregon’s legislature removed a prohibition on Inclusionary Zoning (IZ) which now allows cities to require a percentage of Affordable Housing units in new buildings of 20 units or more.  The Portland City Council unanimously voted to put an IZ ordinance in place.  Recently I have had a number of folks from around the country and from Portland ask me what I think about IZ.  I have had a hard time coming up with a response that does not shut down the conversation. I get really exorcised over this topic.  To be blunt, IZ makes me nuts and I tend to go off on the people who innocently ask me about it.  Clearly, I need to craft a more grownup response.

I respect the motivation behind wanting to see more affordable housing get delivered. I am appalled by the naive methods being employed toward that very positive goal.  I get frustrated with smart and sincere people who are serious about the delivery of housing if I think they have not made a serious effort to understand the basics of how housing gets delivered.  Maybe that information has not been available to them if they are not in the business.  It’s not reasonable to hold people accountable for information they don’t have, so let’s start by laying out the basics of how a building makes money and how people decide if they want to construct a building in a given location.

If you can’t get the rent, you shouldn’t build the building.  The rental income for a building needs to cover the Total Project Cost.  This includes cost of buying the site, , paying the impact fees, designing, bidding, financing, building and leasing the building.  The rental income also needs to allow for some of the units not paying rent from time to time because nobody is living in them (Vacancy).  Finally, the rental income needs to be able to cover the building’s Operating Expenses which include property taxes, insurance, property management, maintenance, water, sewer and trash, and replacements reserves of $300-$500 per unit set aside each year.

In addition to covering these costs, a building need to make a profit to justify why someone is going to put up 20% – 40% of the cash need to make the building happen.  Whoever puts that money up (and signs a guaranty to repay the construction loan that will provide the rest)  has other things they can do with that money and they can reasonably expect to get paid something for the risk they are taking in undertaking a construction project.  A construction project has more risk than a savings account, treasury bond or mutual fund, so money put into a real estate project has to pay a higher return than alternative investments with lower risk.  A workable rule of thumb is that $1 in monthly rent can typically support $100 in Total Project Costs and yield a reasonable return of 10-12% on the cash you put in the building.

What happens if 20% of the units in a building don’t pay their way because the rent you can charge has been limited by the IZ Ordinance?  The assumption is that you will have to convince the potential tenants for the other 80% of the market rate units to pay higher rent, or find a way to  reduce the Total Project Cost.  Reducing Total Project Costs will come down to convincing the person selling you the site that you need to pay less for it.

In Part II we can walk through the math on how this works on a example building.

 

 

The Best Cottage Court Guy I know

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Front row left to right; Bruce Tolar, Steve Mouzon, Jason Spellings, and Jene Ray Barranco.

Last weekend I was working on a charrette crew that included my colleague and partner, Bruce B. Tolar.  Searching through my hard drive today I came across my (improvised) remarks from when the New Urban Guild gave the 2015 Barranco Award to Bruce, the Developer/Builder of Cottage Square in Ocean Springs Mississippi.

“For those of us who knew Michael Barranco and were there for the Katrina charrettes, this is a person who really made a mark on our lives, not just because we showed up and did work together, but because his character was such that it was like playing in a pro-am: You really upped your game when playing around Michael. Very genuine. No artifice. No phoniness. He was genuinely concerned about every person he ever met, and wanted everyone’s life to be better. He decided that architecture was his way to do that.

With his passing, there is a hole in the CNU, but the New Urban Guild offers the Barranco Award to practitioners who are that kind of stand-up guy. It’s about the character with which you comport yourself. It’s about how hungry you are to learn. It’s about how much you care about your community. It’s about how much you love and encourage your fellow-citizens. With that said, I’d like to introduce you to this year’s award-winner, Bruce Tolar, through some of his work. <begin slides of Bruce’s projects>

The original Katrina Cottage which by itself was great, but Bruce took it out of the total chaos and mayhem and bad financial circumstances that were pretty much an everyday deal in Ocean Springs at that time, and all along the coast. And from nothing, he created the peaceful excellence of Cottage Square, where he put the pieces together into something amazing which that community cherishes. It has even become a tourist destination. Imagine that: an interim housing solution after a hurricane has become a tourist destination!

So Bruce pulled together all the Katrina Cottages that were built as prototypes for demonstration purposes and brought them to Cottage Square. And he made something out of the pieces, just as we all try to do, which is to aggregate a great place from small incremental parts. It is a modest place, with gravel sidewalks; a place where you can operate a tiny business out of those tiny buildings. And the community that has formed there has become a real anchor to Ocean Springs. From there, Bruce launched an expansion, which was an incredibly ambitious project in a place governed by FEMA… <cough> <laughs and applause> … a terrible environment to work under, but he is doing amazing, excellent work with modest little pieces.

He reached out to nonprofits in the area; he connects with so many people; he’s been in that town forever, serving on many boards; and the idea that there was something to be done after a hurricane, and fixing civilization in general, was a natural thing for Bruce. The people love this neighborhood. The nonprofits he’s been working with have been tremendously empowered by seeing one guy’s ability to put people together and make things work. Bruce is the best design caulking gun you can imagine, pulling everything together on modest means and making things happen. So with that, I’d like to present this year’s Barranco Award to Bruce Tolar.”

If you are traveling along the Gulf of Mexico between New Orleans and Mobile you should give yourself a treat and stop to walk around Cottage Square.  It is a special place built in tough circumstances by a remarkable guy.