It seems like every week brings new information or new numbers reinforcing what so many have been saying for some time now: The national real estate market is not just softening up – it is experiencing a significant downturn.
One national research firm tracked home prices in April as being down 2.1% from a year ago, after an 11.2% increase over a corresponding period from 2005 to 2006. Far from the heady days in 2001 at the height of the real estate boom, 2007 finds everyone involved in the financing, construction and operation of residential, commercial and mixed-use development needing to recalibrate their expectations and refocus on sound, prudent decision-making if they hope to avoid difficulties.
Because the economy has slowed to a crawl in many markets, some developers are running low on cash, and lending institutions are being forced to take back properties. Residential developers, who often serve as the symbolic canary in the marketplace coal mine, have been some of the first and hardest hit by recent developments.
In a national real estate climate that is fraught with uncertainty and financial woes for so many, the question for many frustrated banks and developers becomes "What now?"
While the national real estate market is most definitely going through a readjustment period, many of the resulting financial struggles are less the result of unavoidable trend lines and more due to ingrained processes and perspectives.
Industry trends tend to accumulate a certain amount of momentum, and it is not always easy to abandon the bold, aggressive strategies that were so successful during the "everyone's a winner" real estate markets of a few years ago. Lenders and developers alike are finding that to survive in the downturn, they have to make significant adjustments in their decision-making and operations.
By controlling costs and repositioning assets that were misaligned due to either overly saturated markets, loans granted without a full contemplation of the market trends or players involved, or mistakes in the development process, development professionals can still experience some success, even in today's challenging marketplace.
Perhaps most importantly, there are a number of ways in which banks and developers can strategically reduce the risk of having property foreclosed upon.
Working alongside an experienced professional developer, banks are finding ways to revise management and marketing strategies, review and evaluate all documentation, strategically evaluate their current holdings, minimize or eliminate financial losses by repositioning developments to better reflect the changing marketplace, and ultimately reduce write-offs, as well as potentially preserve some upside.
For lenders and developers engaged in the everyday minutiae of residential and commercial development, it is easy to sometimes become so mired in the details that it is difficult to take a step back and re-evaluate the bigger picture. One of the primary advantages of working with an experienced development partner that specializes in workout situations is the developer's ability to approach a project with a fresh outlook.
No matter what market segment and what type of development, the primary goal of any workout analysis should be to focus on the fundamentals and address four basic steps: evaluate the project, develop project alternatives, determine the best alternative to meet your objective and determine who is best suited to execute your chosen alternative.
Project assessment
A comprehensive assessment begins with what may seem to be overly obvious – but is actually one of the most vital and most often glossed-over steps: understanding the current marketplace.
In today's national real estate environment, the condition of local markets varies dramatically, even within a state or region. This variability makes determining the current status of a particular market a difficult chore that requires more than just a glance at a demographics spreadsheet. Understanding the nuance and complexity of market trends and direction demands insight, experience and a detailed understanding of how national and regional influences can affect local markets.
But while the information that goes into the market assessment equation is detailed and complex, a skilled development partner will be able to express the resulting conclusions in a familiar format – as a basic expression of supply and demand.
Whether a market is providing strong, relatively vibrant conditions or is performing poorly, that current marketplace demand must be evaluated alongside the corresponding supply, the available land and the lots or units in the same market segment. Determining the state of the competition by looking at new projects, vacancies, occupancy rates and other indicators provides the other piece of the marketplace puzzle and helps clarify available options.
Once the competitive climate is understood, it is crucial to dig deep into the details of the project itself. By understanding the various types of information that make up the project, you can avoid pitfalls when potentially repositioning the project.
The amount of information contained in project documentation – and the great value of that information to anyone trying to make a comprehensive assessment of a property – can best be appreciated by reviewing just a few of the laundry list of critical issues contained within.
Project documents can reveal key details about everything from environmental assessments to geotechnical and soil evaluations; title issues such as easements, liens or second mortgages; site-plan agreements and other arrangements with municipalities; civil engineering issues like water, storm water and sewer facilities; existing architectural controls and agreements; and marketing issues and limitations related to signage and other local factors.
The volume of information is staggering, but each of the above-mentioned items, if not understood, could significantly impair the ability of making the project successful.
Repositioning alternatives
A comprehensive project and market review is a vital prerequisite. But what next? What are the implications of this information for a project, and what are the best options going forward? It is not necessary to always foreclose on a project, especially when there are other options available that are, all too often, not considered. Lenders and developers must evaluate all of the alternatives before making a final decision.
Generally speaking, the ultimate goal for developers and lenders is to avoid costly reclamations whenever possible. Different corporate strategies and different types of funding, however, may result in different priorities.
While some national or out-of-state lenders and developers might be more inclined to pursue a course of action that cuts their losses and provides the maximum short-term return, some developers are taking advantage of local knowledge and long-term experience to transform distressed, vacant, half-built or developed residential real estate projects into successful developments.
These developers, some of whom are investing in properties in distressed areas that are either in default or about to be in default, are working directly with other developers to purchase the developments at a discounted price. The developers are therefore starting with a reduced basis or working directly with the lender to buy out a loan, taking on the significant risk of a project and removing the loan from the lender's bottom line.
Such actions provide a valuable model for lenders and developers trying to transform a faltering property into a successful project. You must be able to think outside of the box and consider various options and potential opportunities.
In many cases, repositioning a project within the local or regional marketplace can generate significant long-term financial benefits for a relatively small investment. A quality repositioning initiative does more than just "stop the bleeding." It uses information gathered through the assessment process to make informed decisions about how the project needs to evolve to better satisfy the needs of area residents and consumers.
There are two general strategies employed to reposition a project. The first, to change the price structure and bring in a less expensive product, can be an effective strategy in markets that have experienced a slight financial downturn.
The second strategy is to be responsive to changing conditions and provide a different type of product. This strategy provides an opportunity to modify either the site or concept plan for a more relevant usage profile.
Decisions
Once a project and all of the alternatives have been evaluated, involved parties can make an informed decision on how to proceed. Whether it is best for a lender to foreclose on a property and remove it from the outstanding debt as quickly as possible, sell the project to another developer at a loss or reclaim a project and consult an experienced professional to assist with repositioning the asset, every deal is different.
Determine who is best suited to execute your chosen alternative. If repositioning is impractical or if market forces and financial realities present overwhelming obstacles and make reclamation or some other kind of resolution unavoidable, the services of a outside developer make it possible not only to facilitate the process, but to do so in a manner that minimizes exposure and maximizes financial returns.
Whether it is through networking or through procedural expertise, an experienced development partner can make determining the next step a logical and intuitive process.
Experienced developers can help expedite the sale and disposition of the project in the most efficient and financially sound manner possible, assist in the entitlement process and transition to a new development team or investor, or simply secure the asset until the market improves.
The information and evaluations assembled by a consultant team or experienced development partner via site visits, surveys, research and documentation reviews, and then presented in cost estimates, projections and strategic recommendations ensures accurate and timely situational analysis. These strategies ultimately help to fund, design, build, operate and maintain thriving, vibrant and profitable projects.
Most importantly, in today's era of foreclosures and reduced property values, experienced developers can assist in evaluating all of the options available to prevent losses and identify opportunities whenever possible.
Howard Fingeroot is managing partner of Farmington Hills, Mich.-based Pinnacle Homes, a residential building and development firm specializing in high-quality homes and communities. He can be reached at howard@pinnaclebuilt.com or (248) 539-9333.
