The First Year of Small Developer Activity

duncanville boot camp
Attendees; First Small Developer Boot Camp in Duncanville, TX August, 2015


I tend to let too many files accumulate on my computer desktop.  As I was clearing out files today I came across the photo above and the text below.  As you can see from the photo, we did manage to put on the first boot camp in Duncanville.  By the end of 2015 we had done six bootcamps and workshops and launched non-profit to coordinate the effort to cultivate Small Developers around the US, the Incremental Development Alliance (IDA).  Next Tuesday, June 7th in Hamtramck, Michigan we will running the 7th event of 2016 the day before the 24th gathering of the Congress of the New Urbanism starts up on June 8th.

In addition to running the one day and three day training events, IDA along with Midtown, Inc has been awarded a Knight Foundation grant to do a deeper diver into the Midtown neighborhoods of Columbus Georgia, providing 18 months of extended training and mentoring for local small developers.

None of this would have been possible without the hustle and hard work of local sponsors and volunteers in each of the cities that hosted us and the ongoing efforts of the IDA staff and board.  Strong Towns helped us get started, hosting the boot camp registration for the first couple events on their website.  Lynn Richards and the staff at CNU have been tremendously supportive as we continue to figure out how to scale up the Small/Incremental Development Effort.  The CNU’s Project for Lean Urbanism was the genesis of this entire effort.  The time we spent with the Lean Urbanism Working Group exploring what it would take to Make Small Possible made it very clear that we need a new business model for development, That shifting the scale of the development enterprise was going to be critical to building better places.   Thank you everyone.


June 5, 2015

Things are moving FAST with the rapidly expanding Small Developer/Builders Facebook group that we set up last April prior to CNU 23 in Dallas.

I have heard from a number of group members via email and phone calls that they would be interested in a hands-on workshop on basic skills needed as a small developer builder. There is an effort percolating to hold a one day workshop for Small Builders in Atlanta the day before the National Town Builders Association (NTBA) Fall Roundtable October 16-18.

But that’s all the way into late October and folks are pressing for something much sooner.

I think we can put this together in the Dallas area rather inexpensively. If the folks attending cover their own travel, lodging and meals, if we can find a venue at modest cost. It could be a very Lean affair.  A meet-up with other folks considering or practicing as Small Developer/Builders. Connect with some mentors, roll up our sleeves and get some skills.

Here’s what we are thinking for content:


What other content should we cover?

We are thinking folks would arrive in time for food and drink on Friday evening, leave after lunch on Sunday.  We are doing this on August 14-16,  Who’s in?


What the heck is a “Quadrant Foul?

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If a picture is worth a thousand words, then the right diagram is worth at least ten thousand.  I am very grateful  Jim Heid of Urban Green has boiled down the difference between Large and Master Planned Development and Small and Incremental Development into the series of excellent diagrams above.

I recently had a conversation with a bright guy in a Masters in Real Estate Development program at a serious university.  He was wondering if a Real Estate Investment Trust (REIT) would be a good vehicle for people in a local community to be able to invest in small projects in their neighborhood.  Just to set things straight, a REIT would not be a good vehicle for this as a REIT has to have a lot of property under management to justify their existence and overhead, so the structure would be way beyond the scale of small projects in a specific neighborhood.  Investors would own shares in an outfit that owns a large portfolio of a specific type of real estate.

-But the conversation reminded me of Jim Heid’s diagram.  The kind of  local in the neighborhood projects my grad student friend was describing belong in the lower left quadrant of Jim’s diagram, the Small and Incremental/Entrepreneurial and Bootstrapped territory.  Ownership of real estate by a REIT belongs up in the Corporate and Institutional/Large and Master Planned upper right quadrant.  We might want to bring established tried and true tools scaled for the upper right quadrant to bear on projects in the lower left, but often the scale is just…off.  I think we can call that a Quadrant Foul.

Rethinking the development business model for Small Developers will continues to uncover habits that may serve folks doing large project well that need to be substantially retooled to work in small projects, or they may just need to be set aside as because they are not fit to the purpose.


Balconies? Nah.

Bay Window, Back Bay Boston


One of these things adds serious value to an otherwise basic apartment making the unit much more pleasant.  The other is a balcony.

I am not a fan of balconies on apartment buildings and mixed use buildings.  They can present a raft of construction and liability issues.  They also tend to accumulate stuff.  Storage for tenants can be better delivered without the cost and hassle of hanging a balcony on the outside of the building.

I asked Fayetteville, Arkansas Architect Robert Sharp what he thought about all this.  Don’t tenants all want some sort of private outdoor space? Rob suggested that If you ask prospective tenants in a focus group “Would like some private outdoor space like a patio or balcony?”,   The answer would probably be yes -asking about private outdoor space in the abstract is kind of like asking if they would like a free pony.  Rob’s view is that people want access to quality outdoor space, that could be a courtyard, a well supervised trail system, or a public square.  A balcony is a pretty poor substitute for any of those things.

Rob would rather build some units with a good bay window, and then charge a little more for those units.  I think he’s right.

How do you know there is a demand for decent renovated or new apartments close to food, drink and day care?


The Blenheim Apartments in Denver.

In most places the demand is large and the supply is pretty damned small.  So just how large is the demand?  If we were able to wave a wand and redirect the entire US housing industry to deliver only new rental housing in walkable urban places tomorrow, we would not catch up with the demand until 2050

If you understand urban places and have the ability to produce modest buildings for a living, I encourage you to figure out how to build apartment buildings and mixed use buildings, rent them out and and hold onto them. You should look for opportunities to do this in walkable or even marginally walkable places.  Avoid completely car dependent locations so you don’t have to build swimming pools nobody uses.
If you are a contractor, I think this might work out better than building for other people.  If you are an Architect or urban designer I think this will work out better than performing fee for service design or consulting work.
If this seems like a crazy idea, please read Arthur C. Nelson’s book Reshaping Metropolitan America and give it a a little more consideration.
Here is a link to Dr. Nelson’s entire data set (in excel file format).
Go ahead and download it and poke around.  At a minimum, cruising through the spreadsheet will make you want to read the book , where Dr. Nelson very helpfully explains what all these data mean. I suspect that if you are half as geeky about this stuff as I am, you will hone in on the place where you live to see what the housing future holds for a place you care about.
 You can look up your Metropolitan Statistical Area (MSA) and find out the annual demand for new rental apartments is going to be in your place.  Then hop over to the US Census website to look at how many multifamily building permits were issued in your county in 2014 and 2015.
For example, I live in Albuquerque.  In the Albuquerque/Bernalillo County MSA, the annual demand for new rental units, according to Dr. Nelson is 4,000 units.  Imagine that a quarter of those units get delivered by the apartment fairy in the form of converted single family houses and the demand number comes down to 3,000 units.
In 2014 there were 400 units built in Bernalillo County, so the short fall of 2,600 would roll over into 2015.  add the conservative number of 3,000 units for 2015 and that comes to a demand for 5,600 new rental units.  I check in on the permit activity for the City of Albuquerque and the number for the city (admittedly not the entire MSA) for 2015 was 570.  So now the demand for 2016 is something over 8,000.    Vacancy for apartments in Albuquerque over the last couple years has been less than 2% (–about what you would see when apartments need to be repainted and re-carpeted between tenants)  Rents have gone up 5-10% a year in this market with the higher rents in the walkable parts of town.
Is your area any different?  Do you see an opportunity?

An Email Reply to a Prospective Small Developer

You raise a lot of good points and express concerns which I have also heard from other folks looking to get started in incremental development.  We should probably talk about this by phone or video chat when you have an opportunity.  Some responses;
The most satisfying projects deliver on several levels
  • They post good financial returns that justify the risk of construction and leasing.
  • The process of getting the the building built or renovated builds relationships of trust among your team making it possible to take on another effort with greater confidence.  I think that working with people you genuinely like and respect, seeing them grow and develop new capabilities is very rewarding.
  • A good project contributes to the social and economic flywheel of the neighborhood.  The best projects have lots of synergy that benefits other people.  A restaurant opening across the street from a coffee place strengthens both enterprises and makes that block a good place for someone to want to open their new office.  Building projects that create local wealth and local jobs within a neighborhood protects the long term value of your own buildings in that setting.
I think it is critical to have a geographic focus for incremental development.  Monte and I talk a lot about “farming”–identifying specific areas and getting to know them well.  That investment of focused time and attention reduces your risk, because you can know the place well enough to understand where catalytic efforts will have the impact needed.  Have you picked an area or neighborhood where you would want to concentrate your efforts?
New Construction vs. Renovation for a first project
I started out in the trades as a carpenter and later, an electrician.  So, I tend to think it is always better for folks who want to understand the nuts and bolts of development and property management to start with a piece of new construction, rather than an ambitious renovation.  That first construction project should also be of modest scale.  Small scale helps you limit your risk and focus your learning. You are not looking for economies of scale on your first building experience, you are looking for an opportunity to learn the basics and connect the pieces so that you can communicate effectively with your team.  Once you get a handle on the  fundamentals and mechanics, you move to more subtle stuff like refining the design to make construction and maintenance easier, or to making the units more pleasant for your tenants.  Renovation and new construction both have risks, and tradeoffs that you need to identify from the start and manage through the process.  (I just think the risks and tradeoffs  of new construction are more straightforward).
Affecting people’s lives
If we think about the resources we have; capital, skills, determination, and vision as things that we have stewardship over, understanding how  we manage them in ways that affect the lives of people in the neighborhood should guide what we do and how we do it.  Building a culture within the team that looks outward is really important in my view.  Conventional development practices applied to existing neighborhoods tend to displace people who have limited choices and opportunities, so we need to have different strategies grounded in the principle of increasing choices and opportunities for local folks.  I really appreciate the way that Monte Anderson finds the local entrepreneur tenants and puts them on a track to eventually buy their own building, so they are not displaced by Starbucks or some national tenant down the line.  The local entrepreneur gets to build local wealth which stays in the community.  That’s  better for everybody.  The current shortage of skilled construction labor presents a problem and an opportunity for an incremental developer working in an underprivileged neighborhood.  A small developer can generate steady work  for the trades.  That steady work can become the platform for training local folks in the trades, with the goal of helping them sort out the logistics of having their own contracting enterprises and eventually owning their own buildings.  There are more opportunities in these neighborhoods than there is capacity to meet them, so the wise strategy would be to build a local trade base to add to that capacity.
Acquiring and sharpening tools
I understand that you have capital you want to put to work soon.  Rather than look for deals right now, I encourage you to sharpen your tools and build your skill set for a while. Maybe set a target of getting into a project by the end of 2016.  One potential way for you to get up to speed on the tools and techniques that will help you as you look at opportunities for incremental development is to come to a boot camp.  The concentrated format of two and a half days gives you a lot of information in a short period of time and getting to know other folks at various stages of doing this kind of work will help you build a network of people you can reach out to for counsel when things get tough.  You will find the the network of small developers has a culture where nobody wants to see their colleagues repeat their learning curve.  There is a lot of lateral support among the crew.  They are generally looking for a chance to pay it forward.  We are scheduling at least one event a month through most of 2016.  Keep an eye on the Incremental Development Alliance website for new dates as events get confirmed.

Answering some basic questions on forming an LLC and getting a construction loan for a small project


Today I got an email from someone who attended a Small Developer Boot Camp that asked the following questions:

  • How do I structure my project for an outside investor or for my own investment of capital?
  • How do the investors get paid for that investment?
  • How do I set up an LLC?
  • How do I get a construction loan?
  • How do I structure my finances and credit?
  • Should I use of my house and the land as collateral?

I figured posting the questions and my response here on the blog would be helpful to others.

Forming an LLC
You will need to find a local attorney familiar with real estate development and have them draft the Operating Agreement for your LLC.  If you are going to have another person or persons investing in your project you should hold off on actually filing your LLC paperwork at the State until you have sorted your deal with your investors.
The first step you need to take is to outline (on paper) what you want to do in your project and who will do what before you sit down with your lawyer.  The lawyer probably has a boilerplate LLC Operating Agreement that they will start with and they will modify it to suit your goals and requirements.  The Operating agreement is your opportunity to set up your the structure of your deal, answering questions like the following:
  • Who will manage the LLC?  This can be a designated manager or a managing member of the LLC.
  • Who will the other members of the LLC be?
  • Do you have more than one class of LLC member?
  • Are there milestones in the project or performance metrics that will require members to surrender their interest for a stipulated sum?
  • How are the proceeds of the project going to be distributed?
  • What happens if more capital is needed?
The reason why you hold off on filing your LLC documents until you have a deal with your investors, is to save the time and expense of modifying a recorded LLC to reflect the particulars of the deal you stuck with your investor after the LLC was formed.
Your negotiations with an investor should culminate in a (non-binding) Letter of Intent which is where you put down on paper who is going to do what.  Your lawyer will use the Letter of Intent as a guide to draft the LLC documents.
Links to general information about LLC:
(Legal Zoom is an online resource, but I strongly recommend that you find a flesh and blood local lawyer ).
Roles of the parties in a development project
In a basic deal the Operating Partner gets paid a fee to do the work of coordinating the design, entitlement, financing, construction and leasing of the project.  This can range from 5% to 15% depending upon the scale, complexity and duration of the project.  The Operating Partner is the active member of the development and typically serves as the Manager  or the Managing Member of the LLC.
The Investor or Capital Partner has a passive role.  They provide capital which they could lose if the project fails and they received a return in consideration for the risk they have taken in making that investment.  They also may be  guarantying the repayment of the construction loan.
If you are putting up cash you are a capital partner.  If you are running the project for a fee, or for a piece of the deal, you are the operating partner.  An operating partner can also be a capital partner if they are investing cash or contributing their land to the deal, but outside capital partners typically get their investment principal back ahead of an operating partner who has contributed cash or land.
Paying the Investor back their principal and a return
You construct your plan for how your project will make money in the form of a pro forma.  Based upon what the likely hard and soft construction costs and the cost of the land and the needed improvements to bring the land to the level of a finished lot or lots you look at what the likely revenue will be in rent after operating costs and debt service.  Cash flow after operating expenses and debt service is the money you use to pay back the investor their initial principal (the cash they invested) and the return you committed to provide them for taking the risk of investing in your project.  You can also refinance the project after it is built and fully leased up with demonstrated operating expenses.  This new loan will be used to pay off the construction loan and the cash left over can be used to pay the investor their remaining principal and the return you promised them.  For example if they invested $100,000 and you committed to pay them a 12% return, you pay them $112,000.  $100,000 in principal and $12,000 as their return.
Getting a Construction Loan
You get a construction loan by first talking with several banks to gauge their interest in the project and the likely terms of the loan.  Then you submit  a loan application or “bank package” to the lenders you think are the best fit for your project.  The bank will lend you a specific percentage of the total project cost, referred to as the Loan to Cost or LTC percentage or ratio.  If the total cost of your project is $1,000,000 and a bank commits to lending you 75% of the cost, you need to come up with $250,000  (25%) in equity  in essence, your down payment.  The deal with your lender is that if you default on the loan and they foreclose on the project, you lose your equity (or down payment).  If after they foreclose, they sell the project for less than the amount of the outstanding loan, they will look to recover the shortfall from the person who guaranteed the loan, either through a pledge of specific collateral or a personal guaranty.  If the property you have purchased is appraised at $350,000 and you bought it with cash, the land will be sufficient to cover the equity requirement.  If you bought the land for $350,000 with a loan and only put down $150,000 in cash, then the bank will want you and your investor to put in another $100,000 to meet the required 25% of the total project cost.
If you have good credit and enough equity, but you do not have enough assets to guaranty the loan in case of default, you will need to find a capital partner who can cover the guaranty.

How do you handle all the risky stuff that goes into development?

Courtyard between apartments in New Town St. Charles Tim Busse - Architect.
Courtyard between apartments in New Town St. Charles Tim Busse – Architect.
Ahead of the Small Developer Boot Camp this weekend in Duncanville, TX, I have been thinking a lot about how folks outside the field perceive what it takes to be a developer, and how that perception departs from the reality.
People that are not developers often talk about the developer’s amazing and unreasonable tolerance for risk as a defining characteristic.  This is not correct.  Seriously.  The key thing to understand is that Developers typically see the risk of a project parsed into hunks, not as one big scary ball of risk and adversity.
A developer’s job is to identify risks in the stages along the arc of the entire project and then manage or mitigate those risks with the appropriate know how, relationships, time & attention, and setting up the right deal structure to align the interests of the parties.
Market and Site Selection Risk is managed by doing lots of homework before committing to a specific site or sites.
Entitlement Risk is reduced or mitigated by building as-of-right projects or by not closing on the subject property until entitlements are secured, and by thoroughly understanding the technical steps in the process, the politics of the place and the culture of the staff and neighborhood.
Construction Risks (including cost overruns and delays in completion) can be reduced or mitigated by not taking on projects with building types outside of the developer’s experience.  Podium Buildings are a different animal than wood frame walk-ups, Mixed use building are different from one story commercial building or walk up apartment buildings.  If you are making a move to a more complex building type, get a partner who has been there before.
Leasing Risks are managed by doing your homework on market preferences and competing projects recently built or in the pipeline.
Financing Risk can be reduced or mitigated by cultivating multiple sources for equity or debt and not being tied to one investor or just one bank.  Rookie financing risk can be reduced by getting mentors and advisors to review and critique your deal on paper several times before you put it in front of an investor or construction lender.  Structuring multiple exits for investors and for the developer reduces financing risks following construction and lease up.
The mechanics of managing risk can start with assembling checklists and standardized deal structures and agreements with consultants and trades.  With practice comes more mature perspective and a more intuitive grasp of what activity and risks should demand the developer’s attention at a given time within the project arc.