Why Build New Buildings in Distressed Neighborhoods?

(--From an email exchange today about transition strategies that will work for new rental apartments and workspace in distressed neighborhoods).

"Lean development should make marginal neighborhoods more complete and complete neighborhoods more affordable". ---Rob Sharp, Architect & Urbanist

For example, let's take a scenario where current apartment rents in the distressed neighborhood (in older buildings with deferred maintenance) are at $0.85 to $0.90 per SF per month for 2 and 3 bedroom units, and rents for dumb garden/carport apartments out by the highway are at $0.90 to $1.00 per SF per month. In that setting newly constructed, better designed, smaller units (studios, 1 and 2 bedroom units) in the distressed neighborhood can probably see a 20% to 35% bump in likely rents over the current $0.85 - $0.90 paid for the older units, bring them to the $1.00 to the $1.20 per SF per month level.

That rent level will put single stair walk-up into a reasonable range of return on risk and capital at 7% to 8%. This would be just clear of the 2 point spread you should see when you compare a new construction project with a 5% Cap rate on the purchase of an existing building with limited deferred maintenance in the same distressed neighborhood. The project needs to have a good enough return to justify the construction and leasing risk when compared to just buying an existing building with tenants.

If what you build contributes to the neighborhood getting better, that neighborhood amenity will show up in increased rents and reduced vacancy in your new buildings. If you are building apartments in that distressed area, it is in your interest to invest your time , attention, and learning curve in pressing the city to correct the lousy street design, improve services, transit, and policing. It is also in your interest to support local businesses and local institutions; community center, parks, schools, and churches.

If your residential apartments have decent cash flow, you can take a risk on a local food and drink operator on a % of sales lease to help them get up and running in one of your work spaces (in lieu of a straight dollar amount on the rent). The reason why it is possible for you to take these next steps in helping the distressed neighborhood is because you are making the same money on your in-town urban walk up apartments as you would if you had built units in a dumb garden/carport apartment complex out by the highway. One of the reasons why you are motivated to take on that additional effort is that it will translate directly into stable or rising rents.

An OK building at $1.25 a SF per month rents becomes a wonderful building at $1.50 per SF per month rents. When the $1.50 likely rent number is established as a comparable in a single stair walk up building this allows for more expensive building types such as Walk-up Buildings with two stairs + corridors or Elevator Buildings with two stairs + corridors. What is important in this strategy is that the leaner Lean Building Type of the Single Stair Walk-up opens the way for a succession of more expensive Lean Building Types, while keeping the scale of the individual project small enough for a small developer/builder to make a living without having to get any subsidy for their projects.

That is the baseline business model I am focus on working through with small operators. The building types and site configurations can still be aggregated into larger scale projects and can still be used by CDC's and private builders who choose to pursue projects with subsidies. The intent is to encourage folks to use better tools for making small possible. The tools can be deployed by enterprises in a range of sizes, although this approach is likely to be beyond the grasp of larger conventional operators.