Doctor Merritt,
I am President of a Beverly-Hills based company. Our company owns ocean-front property in Central America that is zoned for a resort hotel, condominiums, and light commercial. What are your thoughts about financing and development?
-Walter F.
Beverly Hills
Walter,
I am not current on financing sources, as that is not my area of focus. As you may remember, my primary consulting practice involves three areas in development and management: leadership, strategy, and opinion surveying.
I remember that your company is a specialty automotive parts manufacturer, so venturing into international real estate development will be extremely risky. When we last spoke you told me that your sources in Central America were telling you that the market there is heating up once again. Assuming that is the case, my advice would be for you to sell the property.
Here are some guidelines as to what is going on: The financing market has changed tremendously over the past five years or so. Most of the traditional sources – banks, insurance companies, large pension plans (like CalPERS), and GE Capital and Textron are all re-assessing their involvement in new ventures while they sort through assets they have currently.
Venture capital is perhaps the most active source of funding. However, the major drawbacks are, as always, control (they will demand a lot), very high requirements for equity positions (to help compensate for the risk), and impatience (they typically earn more ownership in their ventures when timing does not work as planned for the general partner). Depending on size, any of the large brokerage houses may be interested in doing an offering for limited partnerships across phases. This is typically how we did development of resorts with clubs and real estate. Another way, may be to find a willing partner representing one of the major international flags that wants a presence where your friend owns property, such as Hilton, Marriott, Four Seasons, or Ritz-Carlton.
The timing issues for pure, initial developers, are subject to extreme effects of external variables, primarily interest rates, economic downturns, governmental planning and processing, and consumer optimism. Because these events are largely uncontrollable by the developer, initial development, while satisfying ego needs, is extremely risky unless the initial developer is well-seasoned and has the financial capabilities to make it through the downturns. A good example of a very successful real estate developer during the 1980s and ‘90s was Chevron (they have since exited the business). Their financial wherewithal (at the time the largest public company in California), cash flow from retail operations, maturity, and patience made them almost ideal to work with. After many years of working with pure developers, my years with Chevron were a delight.
Last week while in Chicago I spoke with a successful developer who has changed his strategy from ‘initial mover’ for 25 years to ‘bottom feeder.’ He said that the economic ups and downs of the development life cycle (primarily external variables) of a project make it almost impossible to successfully take a project from planning and processing through to maturity. Instead, over the past four years he has focused his efforts on acquiring distressed projects at hugely discounted prices after three or four previous developers and their financial partners have taken baths. He just completed the acquisition of a $50 million project from a lender for $12 million. Aside from the enormously discounted purchase, the planning, processing, and horizontal infrastructure are all in place, which greatly eliminated the time lag (almost four years) between cash outflow (planning) and cash inflow (sales).
So initial movers should be aware of the adage: The fastest way to make $10 million in real estate development is to begin with $50 million.
I hope that those thoughts help.
All the best,
-Ed Merritt
eamerritt@csupomona.edu
