Property Development 101
Quality, Consequences and the Construction Industrial Complex (part 216).
I am always surprised by the architects and engineers I meet that do not understand the basics of property development i.e. the key assumptions that drive the development process.
To understand developers decision making it is important to understand the economics. Spoiler alert; it is all about the $’s.
- When an Architect or Engineer submits the glossy “options” report, spoiler alert; it is all about the $’s and not the environment.
- If developers decisions are based on first costs, which they typically are, then the local supply chain and not the design team dictate design decisions and the options report becomes a “grooming ritual”.
Property development is always very high risk and capital intensive, due to long time spans prior to generating revenues. It is for those with deep pockets and a high risk tolerance or those using other peoples money.
Each building has a “monopoly” on the land it occupies plus it has a multi generational life span. This truth requires land valuation to be based on the “Highest and Best Use” principal i.e. land valuation is based on best possible use and potential income generation.
Generally there are three drivers of property development:
- Private Sector Demand – Driven by financial returns.
- Public Sector Demand – Driven by demographics (census data) and government requirements e.g. civic and defence.
- Vanity Projects – This ignores 1 & 2 above and is driven by people and governments with resources i.e. other peoples money, and crucially, no real accountability.
This is a competitive market and trends towards rewarding high performance and crushes poor performers i.e. the strong survive and the weak perish.
Investment decisions are subject to the business cycle, ROI and sometimes total cost of ownership for developers that build and lease long term.
Basic metrics for a project are:
- 15% to 20% development gain.
- Leasing ROI at say 3% to 4% above the 10 year bond yield and / or cost of capital.
Should these ROI metrics not be met during investment appraisal, it is unlikely the project will proceed.
If you work on these projects, budget is a big factor but so is prestige, “green credentials” for marketing, if within budget, and for high end developers, a wish to “lead the market”. Prestige buildings attract high rents.
This trends towards the political rather than business cycle. In my experience there is a focus on first costs rather than total cost of ownership. This seems counter intuitive as public sector buildings are not sold on and their total cost of ownership is a key factor.
However, buildings are long term and the political cycle is short term. Politics seems to trump long term thinking.
If you work on these projects budget drives everything along with some “Soviet level, politburo politics” plus a general avoidance of ownership and accountability from clients. Building design solutions tend to be formulaic with little innovation.
Completely driven by people and governments with resources and no real accountability. Victorian Britons called them “follies”. Things in this world can be surreal and they are more prolific than you may think.
For some examples Google the” sky scrapper curse” or check out some of the command economies where no body can say no and there is a “build it and they will come approach” or “they have the tallest or largest etc. so we will have something bigger and better”. Build it and they will come is as risky as it gets in property development.
Property development without a business case and ROI is a miss-allocation of capital and resources, it is essentially a crime against the citizenry.
So what is the take away?
- Know what game you are playing and act accordingly. Pitching for say DOAS plus radiant heating & cooling on a stock civic building in North America will not fly.
- Pushing the innovation envelop against the wishes of a budget or client representative that is worried for their job will get you nowhere.
- Know your place in the game and do your job. If you do not like the game you are in, then move!
Related posts & links:
#76 – London Vs New York – Office Development
Edifice Complex Podcast