Real Estate Value Creation in a Down Market

What started with a pretty simple question has spurred other further questions. Many of our property development clients have seen both sides of the capital equation slow. Obviously, the debt market is not what it used to be. Unfortunately, neither is the equity side. Therein, some real estate developers are asking the fundamental question--what do we do if the capital spigot that feeds our business has slowed to a drip?

I'm a firm believer in the viewpoint that "you can only control what you can control". What this means is the debt and equity markets are going to be what they are--a little bit unpalatable for a while. What property developers can (and should) be focused on in this market is twofold: property operations, investor relations, and external influencing.

On Property Operations:

The favorable financial fundamentals that created all of the real estate wealth perhaps skated over some operational inefficiencies. If you built a high rise in one the west coast urban centers thirty years ago, you more than likely did very well on that property--just based on the product/market fit. Every market has had a boom or a bust and if you've timed the boom well, you probably did not need to worry about squeezing every inch of value out of the property itself. Now, however, the office market is on unstable footing--and some would say that the whole of urbanity is on unstable footing. It is therefore, essential that property developers are making sure that every unit they have is marked to market. They need to make sure that they are spending every penny of operational marketing on the strategy that fills up the building with the highest long-term value renters. On the construction side, they can and should be looking across their entire portfolio to find the subcontractors that are the most-effective and leaning into deeper relationships with those sub-k's. From an asset management perspective, a thorough review of the leverage stack of each building is critical--if there are better terms to be had anywhere, it's time to go get them. The fundamental question to ask is... "do we know EXACTLY what works for us at scale or have we been guessing?" If a company knows exactly what they do well--there is still room for growth in the face of financial pressures.

On Investor Relations:

I cannot stress this part enough. If you do not know exactly how much capital you have returned to every investor at any point and time AND be able to match that with the initial investment assumptions, your investor relations team will constantly be on the back foot with your investors. Further, if your investor relations team does not have a detailed action plan to improve each investor's financial performance in line with THEIR investment thesis, these investors will be looking for other suitors. If a company has real-time distribution data to each individual investor, can show that it is in line (or better than) initial estimates, and it aligns with the investments future investment thesis they will start to win more investors. Those companies that cannot provide that level of financial certainty and service may face more pressures going forward.

On External Influencing:

Lastly, it is important to know that the Commercial Real Estate Market is a closed system. And since this closed system does not have a lot of financial firepower breathing into it right now, it might be time to look holistically at the system. For this, I am referring to the hundreds of thousands of distinct municipalities in the United States that all have their own building codes and standards. Most property developers choose only a handful of municipalities to develop--and the reason is because they have invested their team's time and energy to understand the approval process in that municipality. That process is likely to be completely different in the next municipality (which could be next door). This federated ecosystem is difficult and expensive to manage. Moreover, it slows economic development in each individual municipality by limiting the supply of investment. In many ways the Covid lockdown was a watershed moment for the real estate industry (and perhaps for urbanity). Many Americans have historically "lived near where they work", this fundamental assumption is up in the air. More Americans than ever have permission to "live where I want to live". Therein, there will likely be some sort of land rush within municipalities to lure in more residents by offering a higher quality of life. The municipalities that are able to understand this dynamic, build the infrastructure to support a modern workforce efficiently, and simplify their planning process to lure in developers to make this happen will see a rather sizable spike in property values and likely a significant increase in quality of life. If a company with a storied reputation as a quality builder wanted to help turn a municipality into an engine of economic growth, they would have to be willing to be partners with that municipality to build a better quality of life for the residents.

In Summary:

The world has changed...and the rate of change is changing faster and faster. Individuals have more choice than ever. It is critical as a property developer that you understand all of the vested interests of all of the stakeholders in the value chain. What do our investors truly want? How can we provide that? Which subcontractors are adding the most value to our portfolio? How do we scale with them? What do our residents desire most in their home? How do we provide that most effectively?