Gentrification? Nah. Let’s talk about local jobs and local wealth.

A straightforward three bay building on Wylie Street in Reynoldstown, Atlanta.

I think incremental development, modest projects by Small Developers focused on a specific neighborhood, present an genuine opportunity to get well past the usual arguments about gentrification.  The usual narrative describes how immoral developers come into a neighborhood that is in rough shape and start renovating old buildings and building new ones.  New trendy restaurants appear and before you know it rents are going up and folks who have lived in the neighborhood all their lives can no longer afford to live there.

Here’s where I think Small Developers can flip the script.  If you are committed to working in a specific neighborhood, it may be a place that has a lot of room between what it is now and what it could be.  As a small operator you have limited cash and limited credit, so you can only do so much.  I am impressed with the approach Monte Anderson takes when recruiting tenants for some of the buildings he renovates or builds.  He looks for a local entrepreneur that show promise and works with them to build their business to a point where they can qualify for an SBA 7A loan to buy the building.  It is a win/win.  Monte frees up his capital and credit to build or renovate another building in the neighborhood and the local entrepreneur is building their net worth and creating local jobs.

The next place where small operators can make a difference is in cultivating the local building trades.  Chances are the plumbers, framers, electricians, drywallers and roofers already live in the neighborhood you want to work in and they may be traveling significant distances to find steady work on large projects.  What if you could provide a steady backlog of work for those folks right in their neighborhood?  It is going to be in your interest as a developer or builder to do so, since small outfits are usually impacted more severely than big operations when skilled construction labor is in short supply.  Cultivating a reliable trade base is going to be the cornerstone of your business model as a small developer.  How many tradespeople are close to being able to open up their own shop if they knew they had steady work for their crew?  Maybe you introduce them to Janet the excellent local bookkeeper who knows Quickbooks and how lien releases and trade credit works.  Small business people doing favors for each other can go a long way toward building local wealth and local jobs in the neighborhood.  Maybe you guaranty their first line of credit at the lumberyard for a year to help them get on their feet.  Introduce your framer to your banker.  Before long you may be mentoring them so that they can own a couple buildings in the neighborhood.  Building local wealth and local jobs could start with you in the place you are committed to.  Start by taking the long view in cultivating relationships with your building trades. Keep your eye out for local bookkeeping talent.

Parking Hysteria is the norm -and that ain’t right

I was in Southwestern Michigan recently where I encountered an odd idea about parking on the street.  In many of the residential neighborhoods you cannot park overnight on the public street.  I asked if this was to facilitate snow removal during Winter months.  I was told that the ordinance is in effect all year.  Maybe there was a freak blizzard in July in years long past and that event lead folks to want to err on the side of caution.

Parking is a volatile subject.  Anyone who has ever be frustrated trying to find a place to park is an expert on the subject without applying any effort or legitimate mental rigor to the topic.  Proposals to change parking rules can whip up the kind of hysteria that makes you question the mental capacity of folks you used to hold in some regard.

What does this mean for a small developer looking to get relief from the municipality’s minimum parking requirements?  Don’t assume that common sense will prevail.  Parking can be such a hot button issue that it clouds the minds of otherwise reasonable people.  If you want to challenge or change the local parking rules, you really should not expect grownup behavior from your neighbors, city staff, or elected officials.  Don’t base your project on an assumption that you will get any reduction in parking, particularly if that relief will require a public hearing.  You may be able to get some relief, but don’t count on it to make your project pencil.

Many municipalities are getting rid of minimum off-street parking requirements, recognizing that cities have done a lousy job of guessing how much parking is going to be needed for any given use.  Other cities have figured out what a nifty tool charging the right price for parking is for managing the supply of public parking in desirable areas.  These islands of common sense are still too rare.  Professor Donald Shoup has done excellent work debunking common parking myths.  I recommend reading his book The High Cost of Free Parking (now in paperback) to anyone serious about understanding how to manage parking issues.

If you are not ready to read a 700 page book about parking, I recommend this short paper by Prof. Shoup as an illustration of how warped and hysterical everyday thinking about parking has become: Roughly Right or Precisely Wrong  Parking Bloat is needless and wasteful.  It is born of myth and sloppy thinking.  Providing alternatives will require clear thinking and well-informed local leadership, (so it is going to take a while)…

 

A great place eventually… Downtown South Miami with Victor Dover.

A straightforward little one story commercial building a half block off the main retail street.

Monte Anderson and I are in Miami for the final reviews of student infill projects at the University of Miami on Friday.  This morning we toured some of the infill sites in the Allapatha Neighborhood. We met Victor Dover at the Dover Kohl & Partners office and walked down the street for lunch.  Victor told us the story of how Downtown South Miami came back from $6.00 per SF rents and boarded up storefronts in 1992 to what we were seeing today.

Today there are no vacant stores, new single story and mixed use buildings have been built.  Dover Kohl pushed for eliminating minimum off street parking, but there was a lot of resistance, so the came up with a menu of common sense measures that each reduced the parking requirement.  The 5 lane Main Street with occasional

  on-street parking was reduced to 3 lanes with parking and the sidewalks we widened from 4′ to 15-18′.  Arcades and awnings were permitted to encroach into the public right of way.  The ban on sidewalk dining that had been in place since the Bronze Age was repealed.

The rents are now $60.00 per SF.  They got the basics right and the market is stepping up to pay a serious premium for in-town amenities.  Proper civilization makes money.

Umbrella/awnings for white tablecloth restaurant seating. Tables and chairs come out for seating in the evening.

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.

Farming

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.

Who says you can’t get financing for a small mixed use building???!!

Small Mixed Use Building in Geneva, NY. Photo by Mike Puma

The typical 2 and 3 story main street mixed use building is perfect for a rookie developer to use the FHA 203K purchase rehab loan program to finance their first project.  Understand the Loan program and fill out the forms carefully, design your rehab to fit the rules. Now from the start, understand that this loan program is for owner occupants.  You would have to live in the building for a minimum of one year.

HUD GUIDELINES FOR FHA 203(K)

The program is for 4 units plus some amount of  allowed non-residential space which varies with the number of stories in the building.  Here is the breakdown from the FHA Guidelines:

“A 203(k) mortgage may be originated on a “mixed use” residential property provided that the percentage floor area used for commercial purposes follows these standards:

– One story building 25%

– Two story building 49%

– Three story building 33%

The commercial use will not affect the health and safety of the occupants of the residential property.”

The rehabilitation funds will only be used for the residential functions of the dwelling and areas used to access the residential part of the property.”  So you can stabilize the shell of the entire building including the non-residential portion, but you will need other funds to renovate the non-residential space.

If the building was built after 1991 the Federal Fair Housing Act applies.  In those newer buildings above the  4 units or  threshold for buildings covered by the Fair Housing Act requirement that all ground floor units must be accessible/adaptable, here’s what you do to rehab a small mixed use building using an FHA 203)k) loan:

• ALTERNATIVE 1: KEEP THE NUMBER OF RESIDENTIAL UNITS TO 3 OR LESS AND THE SF OF NON-RESIDENTIAL FLOOR AREA WITHIN THE PERCENTAGES LISTED ABOVE.
• ALTERNATIVE 2: CARVE OUT AN ACCESSIBLE UNIT AT THE REAR OF THE GROUND FLOOR WITH THREE UNITS ON THE UPPER STORIES.

This is not some exotic loan program.  It is a fixer-upper loan on a 1 to 4 unit dwelling that is conveted to a 30 year mortgage once the renovation is completed.  If you pay attention to the particulars of the loan program, you can use it to fix a main street mixed use building and be in a position to live in one of the units rent free.  Four or five local folks doing this within a couple blocks of each other could change the main street.  Seriously worth pursuing for a lot of towns.

A number of colleagues whom I respect have made a point to telling me that the process of getting a 203(k) loan to actually CLOSE can be really tough.  There are enough specific underwriting requirements that are different enough from more typical loans which lenders process that closings get delayed, or the lender withdraws their commitment.  So finding a bank that actually has their act together on this program is important.  Wells Fargo has invested in training their people on this, so start with them.

The extra brain damage involved in the loan is why I think the 203k program is an excellent vehicle for the rookie developer looking to step up their game. It requires that the project scope be well thought out and well documented. It requires the rookie developer to understand the lender’s underwriting way more than the average mortgage borrower would. (-and possibly the more than the loan officer does..) It requires a long due diligence period from the seller. In short, the process is hard wired to require the rookie developer to have an excellent plan and seek help from their colleagues to launch their first significant solo project. It puts the rookie developer squarely in the position of adding value by creating order out of relative chaos. That ‘s the job.

Working with grad students for a week has me thinking about the basics

I spent the last week working with 14 teams of grad students in the University of Miami’s Masters in Real Estate Development + Urbanism program (MRED+U). Each of these teams of 4-5 people have been assigned an infill parcel in the Allapattah Neighborhood of Miami.  Their packet included a purchase price and the basic zoning information under the current Form-Based-Code Miami 21.  The team were typically a mix of  MBA candidates taking the class as an elective and students enrolled in the MRED+U program who are required to take the class.  Many of the MRED+U students come from urban design or Architecture.

Here’s what I found myself explaining in various ways:

• Likely Rent is your first constraint.  Know what your tenants can afford to pay in rent.  If you can’t get the rent needed to support an expensive building, see if you can build a less expensive building.
• If you are building a small project, look at the broad market for the neighborhood, but target staff from local institutions like the hospital and the airport.
• Understand how design impacts construction cost.  Know how the building code, the zoning code and the Fair Housing Act impacts the cost and complexity of basic building types.
• Form follows parking (especially in small infill projects). Figure out the most efficient parking approach early in your design and pro forma process.  The zoning may allow up to 5 stories, but may also require so much off-street parking that you don’t have room to park the number of cars required by the number of units that you would build in the 5 story building.
• If you can’t figure out what to build, try two very different designs to force you to weigh the trade offs in cost and revenue.  Keep them at the same level of detail to help you see the differences.

Watching bright and engaged people trying to figure out how to do something for the first time is very compelling.

Developer in Residence? Exploring three infill scenarios with grad students

The cool building by Leon Krier

The slightly less cool building that houses the MRED+U program…

It might be a strain to imagine me in an academic setting, but here I am at the University of Miami’s Masters program in Real Estate Development + Urbanism (MRED+U).  Dr. Charles Bohl runs the program and has something called the Developer in Residence.  They invite a developer to give a couple lectures and work with the MRED+U students. This year Chuck invited me.

This evening I am scheduled to explain the one page static pro forma we use in the Small Developer Boot Camp to folks taking a graduate level real estate finance class in a building designed by one of my heros; Leon Krier.  I am finding that part of the gig quite wonderful (and a bit intimidating).

Earlier today I was working with small teams of students who are charged with putting together theoretical infill projects on parcels they have been assigned in several Miami neighborhoods.  They all had questions similar to what we hear from Boot Camp participants.  Where do you start? -the buildings? the parking? the zoning?  How can we estimate what construction is going to cost? Should we build the maximum we can under the zoning?  Should we build structured parking?

My advice was to set up three scenarios, the first should be an as-is reality check to use as a baseline.

1. Figure out what the rents would need to be to support the purchase of the existing building and parking lot at the price Dr. Bohl has assigned to the property.
2. Add some buildings to the parking lot and spending some money to improve the existing building.
3. Scrape the site. Demolish the existing buildings and build something close to the maximum the zoning would allow.

Sorting out the first scenario helps you understand how the existing building with existing or similar tenants makes money.  The second is an incremental approach to adding value without creating a really expensive site that needs to be maximized to justify tearing down a building (regardless of how crappy it might appear.  The third shows you what the maximum you could build under the local rules could be.  It also leads you to consider if the market would support that much building program and that much hard and soft construction cost.  Lay out quick site plans for each of the three scenarios.  Annotate them with your assumptions on square footage, residential unit configurations and unit count, and then use your quick and dirty site studies to build three parallel static pro formas.

This promises to be a very interesting week.  I will do my best to capture some of it here.

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:

https://en.wikipedia.org/wiki/Limited_liability_company

https://www.legalzoom.com/articles/forming-an-llc-for-real-estate-investments-pros-cons

(Legal Zoom is an online resource, but I strongly recommend that you find a flesh and blood local lawyer ).

https://www.realtymogul.com/blog/top-10-aspects-of-llc-operating-agreements

http://apps.americanbar.org/buslaw/committees/CL690000pub/newsletter/200807/kean.pdf

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.

Monte Anderson Thinks Your Town Needs a Better Class of Developers

Atlanta Small Developer Boot Camp – October 2015

Who is going to build the finer-grained Missing Middle housing, the small workspaces, the two and three story mixed use buildings that municipalities and neighborhoods are looking for?  Will it be  the large development outfits who see a 10,000 SF single story commercial building or 100 apartment units as a “small deal”?  Doubtful.  Very doubtful, for the simple reason that large scale developers need large scale deals to support their operations.  They can’t execute small deals effectively and they see a lot of opportunity cost in small deals.  “Why would I take on a 4 unit project when I can build 40 units or maybe even 400 units with about the same amount of brain damage?”  Big outfits are constrained by having to achieve economies of scale to get a decent return on their efforts.  Small developers live with the constraint of economy of means.  Small deals, small amounts of capital, small crews, services from small architecture and engineering shops, small sites that make a difference in the neighborhood.

Dallas developer Monte Anderson keeps hearing from folks who want him to move to their town and develop there.  To his credit, Monte is determined to focus on the communities in the Southern Dallas Metro that he knows and cares about.  His advice for the people that want him to come to their town is that they need to find someone who is committed to their town and help that person develop in the place they care about —OR BECOME A DEVELOPER THEMSELVES.

This is actually very pragmatic advice, because the big outfits are NOT COMING to your town or neighborhood to fine-grained projects.  Monte Anderson is a great guy, but he’s not coming to your town either.  Who does that leave?  YOU (or someone a lot like you). Start small.  Learn the business.  Build a reliable team who care about the place like you do.  There is a growing network of support for small developers, some of them are just a few years ahead of you on the learning curve, but they will do whatever it takes to help you avoid repeating their mistakes.

Consider what a small enterprise could accomplish in your town, not just the buildings you might renovate or build, but the local wealth you could create that will stay in your neighborhood.  Think about the jobs that you could create in the trades, and in property management.  Think of the other folks in your neighborhood you could mentor, paying it forward once you have learned the business.  Real capacity for local and lasting economic development is hard to come by, but building the everyday buildings that people need, in a place that you care about will raise up more than walls and a roof.

Last Call for the Atlanta Small Developer Boot Camp October 13-14, 2015

A straightforward three bay building on Wylie Street in Reynoldstown, Atlanta.

Next week Jim Kumon, Bruce Tollar and I will be in Atlanta for another small developer boot camp.  The Georgia Conservancy and the Atlanta Chapter of the Congress for the New Urbanism have put together a great venue and did an excellent job getting the word out. Most of the folks who have signed up are from the Atlanta region, but I saw the names of colleagues from Washington DC and Asheville on the list. Last I heard from Jim, 110 people have registered.  So here is a heads up.  Registration closes on Monday.  People infected with the small developer virus have the nerve necessary to wait until the last minute, so there is usually a bit of a surge in the last couple days of registration.

We get started Tuesday evening with a get together at the nifty converted church offices of Kronberg Wall Architects in Reynoldstown and we will be at the Center for Civic Innovation all day Wednesday. (near the Five Points MARTA station)

If you are still on the fence, give a listen to Eric Kronberg explaining what to expect:

Switchyards Podcast with Eric Kronberg

Then go register on the CNU.org website: Register for the Atlanta Small Developer Boot Camp

The next boot camp on the schedule is an in depth 4 day event in Western Michigan in early December.  Jim Kumon is firming up the dates with the local hosts.