• Evaluation of Various Operations and Programs
  • Identification of Business Opportunities
  • Support in Business Affairs
  • Advice and Consultation in Real Estate Development
  • Deal Structuring and Development Strategies
  • Project Development and Strategic Planning Solutions
  • Visioning for the New Normal

    An Executive Summary:
    “Visioning the Future – Relevant Issues and Concerns
    For Investor and Developers of Real Estate”

    The purpose of this executive summary is to provide a framework for consideration of the key economic, demographic and feasibility issues and concerns affecting real estate development   and investing over the next five (5) year business cycle and beyond.  This executive summary is simply a launching point – it is limited to the identification of many of the issues and concerns that should be evaluated before risking a real estate development and/or investment.  The issues here will not only highlight a preponderance of factors that might discourage development and investment, but at the same time will serve to illustrate the significant opportunities that will emerge once thorough due diligence, as suggested below, is performed. Not all are of the same importance but each must be considered for its relevance to the specifics of the real estate opportunity under consideration.  Prior to undertaking any future  risk, further in-depth analysis and discussion of each of each of these factors should be performed with the assistance of appropriate consulting and advisory expertise such as this report’s author, Anthony J. Trella,  and other qualified professionals.

    The world-wide recession of the last several years has had a profound and permanent effect on the real estate industry and all other industries that are engaged within it.  Many developing and investing principles that have guided the industry for the last twenty (20) years or so have been eradicated and are very unlikely to be re-instated.  New real estate paradigms will be required – for planning, entitling, developing, product, marketing and financing.  Yesterday’s visioning and strategies will be of little value to tomorrow’s successful developers and investors.  Those utilizing such practice will significantly increase risk and failure.  Developers and investors must realize that the world is well on its way to establishing a “New Normal”, an economic reset requiring the re-education of human resources and the re-positioning of business structures and strategies.  The American fabric of life will undergo a generational shift the likes of which have not been seen in over fifty (50) years.  These far reaching changes will not come easily to many as change is very difficult even for the most intelligent and energized people.  Despite overwhelming evidence that such changes are inevitable and already underway, many people remain in denial, disbelief or are simply too entrenched in outmoded strategies and operational systems.  Success in adapting to the New Normal will require persistent dedication and resolve and a commitment to embracing different consumer perceptions, capital structures and real estate product solutions.

    For those developers and investors ready to seek and embrace theNew Normal, this overview provides a high level outline of a number of the most relevant issues and concerns that must be assessed, and possibly intergraded, prior to establishing new development strategies and underwriting new investments.  Conversely, among all these sobering concerns and issues, lie numerous opportunities for those with the talent and resources to turn others’ failures into tomorrow’s successes.  Emphasis must be placed on the fact that the organizations and operators that will be at the forefront of the real estate industry’s recovery must possess superior human talent, based on years of experiences and successes.  Also, equity and debt investors must have the ability to price and underwrite risk utilizing sound marketing and financial fundamentals as discussed below.

    The real estate development industry and the investment capital that supports it have always been and will continue to be a high risk – high reward businesses.  In the mist of this severe economic recession, one would be wise to consider that “a crisis is a terrible thing to waste”!

    I. Financial:

    How much longer will the Federal Government be able to serve as the primary (and nearly exclusive) buyer of home mortgages?  The recent rise in housing sales has been almost entirely driven by the Federal Government’s positive intervention in the mortgage industry.
    When (and how) will mortgages again be securitized by the private sectors?  Until there is stabilization in the private mortgage-backed securities industry, uncertainty remains. One need only to consider (and to appreciate the magnitude of the risk) what would happen if the Fed’s support of mortgage underwriting were to suddenly terminate.
    Homebuilders and developers will require new sources of equity and debt financing. What (and when) will be the sources of such funds?  There are now hundreds of Billions $$$ available for real estate development and investments from private/public equity and opportunity funds and recovering central banks.  How (and when) will such funds’ managers invest such capital?  When will commercial banks again provide construction loans to homebuilders and land developers?
    Increases to the residual values of land may be burdened by slow to no increases in home selling prices, thus resulting in less available returns for equity and debt investments.  Will such investors accept lower yields from investments in land banking and development (perhaps yields as low as economic cycles prior to 1990)?
    Interest rates will rise.  When and to what level?  What will be the impact on sales absorptions, financing costs and mortgages from such rate increases?
    How and when will impaired Community Development Districts be stabilized?  Currently there are a significant number of District bond programs nation-wide in default or heading into bankruptcy.  For decades this method of financing has been a major source of capital (leverage debt) for homebuilders and developers.  When will investors again be willing to purchase Community Development District bonds?  Will banks and commercial debt providers possibly make up the slack given their other constraints?
    Throughout the United States, various forms of governments require homebuilders and developers to post letters of credit or completion/performance bonds to warrant the quality of development and infrastructure work.  Bonds were normally the favorite choice.  Such bonds were usually provided by the insurance industry (with AIG a leading provider).  At this time there is no evidence that bonds can be obtained in sufficient numbers to satisfy governmental  requirements.  When will the availability of such bonds resume?
    Commercial, industrial and retail real estate appear destined for another leg down as their values slip below their underlying debt.  What will be the ultimate disposition of toxic commercial debt instruments currently held by banks and other investors?  Will billions $$$ of commercial debt be reset or will such debt be sold at deep discounts resulting in long term disruptions in the commercial real estate markets?

    II. Marketplace Conditions:

    The coming resurgence of the real estate industry will require its operators and investors to reaffirm the universal maxim:  Identify real estate needs in the marketplace and then successfully fill those needs.  This will require a level of attention to market data not practiced since prior to the 1990’s.
    Foremost is the basic – yet critical — need to identify who (and why, how and when) will buy, lease or occupy the real estate under consideration.   Most know this as identifying the successful “exit plan” for the development and investment strategies.  The consumer remains king and as such will determine the behavior, actions and performance of the marketplace.  The accuracy and thoroughness of the search for the successful exit plan must take precedence over all other considerations.  For example, a financial projection driven primarily by desired investment yields and profits and not primarily by marketplace reality is similar to the cart attempting to pull the horse.  Failure will be inevitable.
    There are numerous tiers of data that make up the collective understanding of the marketplace.  Some are global in nature while others are very specific to local sub-markets.
    The following are some (but definitely not all) relevant global marketplace issues that deserve understanding and consideration in strategic planning, risk assessment and decision-making:
    Gen(eration) Y– comprised of about 73 million people.  (Known as “Echo Boomers” or “Millennials”.)  All born 1980 and after but only 10 to 29 years old are counted.  Extensive market research indicates that this group has many different beliefs and expectations than their parents and grandparents that will significantly impact real estate structure and use.  This impact is already being felt and it will likely grow geometrically.  Their economic standing will rise quickly.  It is safe to assume that the needs and desires of this generation, as in the case of their parents (the Baby Boomers) before them, will be the primary driver of housing and real estate usage for years to come.
    Gen(eration) X– comprised of about 45 million people.  All born between 1964 and 1980 or 29 to 45 years old.  Most affected by recent severe recession.  Their previous behaviors and beliefs could change dramatically going forward. Their economic standing is steady and will remain so for at least another decade.  However, despite its small number this consumer group will   have   a significant impact on the coming evolutionary changes to real estate products and uses.
    Baby Boomers– comprised of about 78 million people.  All born between 1946 and 1964 or 45 to 63 years old.  Also affected by recent recession, primarily in dilution of household wealth and promised retirement benefits.  This is likely to impact previous plans of life style in pre-retirement and retirement.  Their economic standing is steady but will begin to decline in the foreseeable future.
    The population of the United States is projected to grow by approximately three (3) million people per year for at least the next thirty (30) years.  That’s about eighteen (18) million more people in the USA by the end of 2015 (equivalent to the current population of the state of Florida).  However, this will not be evenly distributed across all marketplaces.  The exact locations of these additional people will vary across cities’ and counties’ submarkets.
    About one third (1/3) of the population growth (one (1) million people) will be traceable to immigrants from outside the United States.  This group will arrive with many different cultural and social attitudes.  Such differences will impact the planning, design and build out of real estate structures.  Many of these differences will run counter to historical trends and the growing expectations of the Gen Y’s.

    The above paragraphs – a) through )e —  are just a few of numerous significant demographic categories that will require thorough understanding in strategic planning.  There are others to consider, such as the continuing growth of households without children and the impact on rental housing as the percentage of home ownership continues to decline.

    Perhaps of most importance is that all real estate, whether already built or future developments, will be directly affected by the creation of new jobs and new job skills. The locations and types of job expansion (along with simultaneously continuing contraction of other job types) will have the single, most dynamic, ongoing impact on real estate.  Where the jobs are located, how far the commute and the amount of relative wages will serve to shape a development or investment.

    III. Development Industry:

    The recession has played havoc on the organizational and financial structures of land developers, homebuilders and commercial & industrial developers.  Similarly affected are the financial institutions and private/public equity and opportunity funds whose businesses are aligned with all aspects of the real estate industry.  One must also consider the tremendous reductions in: the number of those available in the construction labor pool; the supply pipeline of building materials; and the number of professional support firms such as architects, land planners, engineers, etc.  Many such organizations have been stripped bare of physical and human resources.  Therefore the size and timing of the industry’s recovery will be tempered by the ability and commitment of such firms to regenerate and grow.  Many markets will simply not recover as quickly as the dynamics on the ground will allow due to this lack of developing and building capacity.  What if there is land to be developed and homes and buildings to be built, and there are not a sufficient number of capable homebuilders and developers?
    History has demonstrated that real estate cyclic recoveries from recessions usually witness the emergence of new homebuilding and developing firms.  This pattern is expected to repeat itself in the coming recovery.  This may partly mitigate the loss of so much building and developing capacity but this will take time, will not necessarily be uniform across all markets and will likely be impeded by constraints on debt capital.
    The preceding two (2) paragraphs should be of particular concern to developers and investors.  For example, what if an investor acquires land based on an exit plan to sell lots to land developers and/or homebuilders and then finds that there are not enough developers and homebuilders with the financial and human resources to buy land in a matter required by such exit plan?  A failure scenario.  However, such a scenario also presents an opportunity for those ready to step in with adequate human and financial resources to make such an otherwise viable exit plan successful.  Of course, the   financial risk must be kept in proportions to the depth of one’s market knowledge and development skills.   Such opportunities are not for those unable to see the value of risk mitigated by a well documented exit plan and a superior human resource organization.

    IV. Conclusion:

    This executive summary should serve as a catalyst, a call to action, for a real estate industry in desperate need of change.  This will require new thinking, new process models, new risk/reward models, new financing models, and new collaborations to succeed.  These challenges and shifts in thoughts and actions will be very significant and so the rewards for new approaches and innovations will also be significant.  A paradigm shift in which all participants including investors, developers, urban planners, government regulators, architects, and especially the emerging repositioned consumer groups will hold a handsome reward for all stakeholders.  All participants can no longer afford to stand still believing that the “return to the old normal” is around the corner.  The good old days are gone and the future is waiting for those who can embrace and profit from change.

    CONFIDENTIALITY NOTICE:This report was prepared by The Meranth Company, Inc., under the authorship of its president, Anthony J. Trella, based on the extensive real estate knowledge and experiences of Meranth/Trella.  This may contain information that is confidential and subject to legal restrictions and penalties regarding its unauthorized disclosure or use. You are prohibited from copying, distributing or otherwise using this information without the written permission of Meranth/Trella.

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