Jul 26, 2007

23rd & Union development: some expert advice

Many thanks to all of you who commented on Jim Mueller's proposal to upzone and develop the Coleman site at 23rd & Union. Please Click Here to review the previous comments or add your own.

Most of the comments were very supportive of the project, but a couple questioned whether Mueller really needed the upzone to 65'. I took the question to Joe Nabbefeld, who has lived in the neighborhood for many years, and used to write on real estate for the Daily Journal of Commerce (see these articles as examples of his work) and now has his own company. He's agreed to let me share his very informative answers.

Please feel free to comment further.

My blog post about Jim Mueller's 23rd/Union project has generated some interesting feedback, including this comment:

"I'm not willing to take Jim at his word when he says that he needs 65'. This is because I'm largely ignorant of financing matters and because I see so many other new retail/residential buildings that are below 65'. Why can these projects "pencil out" but not Jim's?"

Do you know how we could get estimates on costs etc to answer that question?


Andrew Taylor

Joe's first response:

First, land prices (aka costs) play a role in what height will "pencil."

Land prices adjust, through market forces, to what height the zoning allows.

So, for example, when there is land that is zoned for 30 feet (such as L-3 zoning, which these days is almost entirely having townhomes built on it), the land quickly becomes priced at the maximum that a builder can pay for 30-foot land.

The next zoning tranche up is 40 feet. More can be built on that land (another story), so the market will price at a bit more per sf of land than for the 30-foot land.

The next up is 65-foot land. You can build roughly twice as much than on 30-foot land (it's more complex than that, based on different setback requirements and such. So, as you can see, the land price adjusts up to the essentially the maximum that a builder can pay for that land based on still penciling at what can be built on it.

So if someone sees a project that is built to only 40 feet, they can't just say well why can't the guy over there just keep his at 40 feet ...
Since the "guy over there" may have paid more per sf, and more per residential unit that can be built, for his site, and therefore has to build to the higher capacity to "make it pencil."

"Making it pencil" is a term that can be misunderstood, or abused, meanwhile.

These projects involve massive amounts of money that someone has to put at risk. So "making it pencil" does not just mean break even or make a slight profit. "Making it pencil" means I have to go out in the marketplace for capital and convince investors to bring put down these massive amounts of money on my project. I have to compete against every other opportunity that these capital sources have, so I have to promise them a competitive return, or profit, on their investment. It has to reflect, or compensate them, for the level of risk that they are taking, too -- which is rather high in development.

So the market will say how much these investors have to receive, and once they put their money into my project, I have to deliver them the return that they were promised. Delivering that return is "making it pencil." If there's not a clear path to delivering that return, then the developer has to opt not to attempt the project -- but instead take those investors and themselves to a different site that will pencil with more certainty.

What we don't want to get to on any project, particularly ones that are bringing housing into the city, getting people off the freeways, and particularly ones that are attempting to build out greenfield sites that have been sitting fallow and also formerly red-lined sites and red-lined areas ... What we don't want to do is worry about how much profit the risk-taker might make. That's a bad formula. What we want is just the opposite -- we want to encourage the risk-takers to take the risk and build, and the way to do that is to say "we hope you do so well that you want to come back and do the next one." We particularly want to say that to classy, well-meaning, smart risk-takers like Jim Mueller.

Being "in scale" with what is currently in a neighborhood, while sometimes well-meaning, is often a red herring. It's often the wrong perspective (or an attempt to hide the NIMBYism that is at play). "Scale" is always changing, and will always be changing. Every new advancement steps out of the scale of what was there. The first teepee wasn't in scale with the meadow. The log cabin wasn't in scale with the teepee. The 3-story fort wasn't in scale with the cabin. Then an office building came in, then a taller one. The first 240-foot tower wasn't in scale with the 85 foot ones around it, but then came another 240-footer and it was in scale.

The city has rightly set a course of bringing growth into the city, where the infrastructure is already built and paid for, and where people thrive by sharing so many facilities and resources and the energy that courses thru a good city. To do that, each neighborhood has to build up where it can, such as where the earthquake long ago took out a brick building and nothing is there now. It would be a travesty to not build as much good, well-designed housing as we could on that site.

To: Joe Nabbefeld
Subject: RE: Question about Mueller project

Quick follow-up question, having read your letter more closely.

Mueller's site is zoned 40'. Was it priced as 40' by the seller, and hence allow a 40' building, or did the seller also assume that it will be upzoned to 65', and price it as a 65' property (and hence preclude 40' buildings)?

Presumably the purchase price is public information, so we could compare it to similar recent 40' or 65' NC property sales and make a judgement?

Sorry to be a bit slow on the uptake, but I don't think about this stuff all day?

I personally like Mueller and favor his plans, but then I don't have to live right next to it!

Joe's answer:

I don't know what the price was. (And have no knowledge whether Jim has closed on buying it.)

And it gets complicated real quickly.

For one, there's the cost of the environmental clean-up. (And does the neighborhood want that to remain not-cleaned up?)

For another, almost nothing gets built in 40-foot zones these days (just because we see a building in a 40-foot zone, doesn't mean that building could be built today. Market conditions right now preclude building to 40 feet ... Generally, an exception being if the property owner is the builder themselves and have owned it so long that they own it free and clear ... Hence can make something "pencil" that somebody buying the land today couldn't make "pencil.")

What does get built in some 40-foot zones is townhomes, under-utilizing the site, which is not good for the city and region.

One reason so little is done in 40-foot zones is what you would do is small wooden condo structures, and liability insurance costs preclude that. The apartment market is coming back, and so some small wooden apartment buildings might possibly begin to pencil again, but not yet.


dave said...

very informative - thanks

Anonymous said...

Consider 3 distinct questions:
* What makes a project pencil?
* Is a 40' project desirable?
* Could Jim's project work at 40'?

Joe's post addressed largely the first two. Andrew wanted to know where to find the data to answer the third.

Perhaps the way to gain insight into question 3, is to look for ongoing 40' res/retail projects: i.e., those with comparable land and construction costs that have been able to attract investment.

Jim's estimated construction costs are in the meeting notes. Land costs are public record. (BTW: Is the cost of clean-up really close to the difference between land priced at 40' and land priced at 65'?)