What Will Development Look Like When It Returns?
By Suzann D. Silverman, Editorial Director
One of commercial real estate’s saving graces in the recent recession was the fact that even during the preceding boom time development remained fairly controlled. Throughout the past few years, construction growth has been kept in continued check, and this year’s volatile economy has further delayed any full-scale return of real estate’s official bird: the crane. Redevelopment has thus far constituted the lion’s share of what has been taking place, but a variety of projects spanning property types and ranging from single assets to master-planned campuses are starting to crop up. This time around, new technologies, greater cost consciousness, improved efficiencies and a more coordinated collaboration among team members promise to produce some beneficial changes. CPE gathered development, design and engineering perspectives on what to expect in commercial and multi-family development.
CPE: How do you see the design and development process changing?
Mark Yakren, Senior Vice, President, Syska Hennessy Group: I think development today probably goes under more scrutiny from financing and from design objectives. Before people invest in and finance these projects, there are a lot more studies and assessments and evaluations to really prove that these are valuable, important projects.
I think in the public sector we’re going to see a lot more finance-design-build-operate projects. We’re starting to see these, and I think we’re going to see more and more in the U.S. and abroad. … All municipalities today are strapped for finances, and that’s one of the ways to bring private money to the project. Then they let the developers operate the facility for a number of years and then turn it back to the public sector. Very specific performance criteria is put into these projects, so when these facilities do get turned back to the government, they are functional, well-designed and well-thought-out facilities. …
(And) even mixed-use projects are picking up speed, because people are investing a lot of money and investors are expecting some returns relatively fast. You don’t have a lot of time to sit and think. That’s why things need to be done in a very collaborative way, very fast. I think the pace of development probably will accelerate with time, and that’s why I believe that BIM tools, which will continue their development, will become very helpful in, hopefully, reducing the design schedules and also the construction schedules.
Kevin Batchelor, Managing Director & Leader of the Southwest Region Multi-Family Platform, Hines: (Multi-family) developers have had to become more sophisticated in their design and development process rather than pulling something out of a drawer and it being cookie-cutter, which is what multi-family might have been credited with 10 years ago. It’s become much more sophisticated, site specific, 24/7-oriented and much more dynamic in terms of product type, variety of unit types and quality of units and amenities, with an emphasis on what I’d call public amenities and how they relate not only to the product type but to the physical environment. … There’s a current trend toward smaller units, where in the last cycle the units started growing. … We’re seeing much larger demand from the Baby Boomer, empty nester, older renter pool. They have more disposable income, and they’re looking for 24/7 lock-and-leave urban lifestyles. Highly amenitized properties … with an emphasis on efficiency and on nominal rent.
John Mooz, Senior Managing Director, Houston, Hines: These are common themes on the commercial side, too. … We’re also enhancing existing assets by adding elements like fitness centers and conference centers.
Richard Gatto, Executive Vice President, The Alter Group: What we’re seeing in terms of workplace strategy or design changes starts really, No. 1, with the location. In Chicago, for example, the New Economy and the new Internet or technology-related companies—Google, Salesforce.com, Groupon, others—have chosen not to go into traditional office locations. … They’re looking for a location that is designed more for all-around entertainment and a more integrated work/social setting. … Then, as you move inside the building, you have a more open workplace environment. Less walls, less structured areas. There’s a lot stronger grouping mentality, whether it be in lunchrooms or meeting areas rather than traditional conference rooms. And then there’s the pushdown toward the amount of rentable square feet dedicated to each employee. …
The newer office buildings and the retrofit office buildings (also) are doing rooftop decks. The idea 10 years ago of a guy in a suit and tie sitting out on a deck sweating would not even come into play. But now, because of the nature of casual dress and less structured working hours, rooftop decks are something that is a viable and a sought-after thing by a tenant, which is a reflection of the cultural change.
John Gering, Managing Partner, HLW: One of the things I’m seeing is a lot of stop-and-go processes these days. Where a couple years ago a lot of owners would go full speed ahead, we’re finding clients doing everything in sound bites because the approval process is more in sound bites. … It’s rare these days that clients are looking to build on spec, whether it be a corporate client or a developer; they haven’t had an interest or an appetite to build on spec. And because of that, they’re not going to spend any more money or spend more energy than they need to, and they’re always looking for an escape valve in case things go wrong.…
Now what we’re seeing is a lot of developers realizing that they need some added value on the front end, because it’s not purely about aesthetics, it’s about working with a development team to look at all the various options that could potentially be out there (because) it’s all about the ratios and how the numbers work. … They need to dot all the i’s because if they don’t the banks will, and they don’t want the banks to stop the process. …
And then we’re seeing change in technology, with BIM modeling. It didn’t exist at many levels four to five years ago with many developers and design firms, and now a lot of the bigger firms are using BIM to document. … From the developer or end-user standpoint, it gives them an enormous opportunity in terms of documentation that they can go out and price. … The technology that’s available now has significantly impacted how people think about starting up jobs.
CPE: In what ways is demand for sustainable design influencing the planning process?
Gatto: Where we’ve witnessed it more is in our corporate development, where the corporation is designing their own headquarters, their own campus. When the corporation is more involved in the development and the planning, they’re willing to pay the price for sustainability. But in the commercial leasing market it just doesn’t seem to have taken on the traction that it maybe could have. Seven years ago, a lot of regard was paid to LEED certifications.
Yakren: Sustainability I think today is a norm, not an exception. I don’t think anybody would even think not to consider sustainability. It’s really a question of how far a particular development will take sustainability ideas and goals and objectives. … Sustainable design is a very integrated process, so it requires not only the designers but also the builders and owners to work together as a team to achieve goals. You can’t design a very energy-efficient, very effective building and then have the owner not willing to operate it in a certain way. You need the buy-in from everybody. As for the people looking to lease space, I think more and more corporate clients are looking to have very sustainable spaces.
Baker: In this tight market, you need something to distinguish yourself. … At the same time, we were hearing a lot of reports (from architects) about an effort to really keep costs as low as they could be, to really take as many costs out of the design process as possible. And that often meant not getting the same level of sustainability scores. It was pushing both ways during the downturn. I think we’re going to get a better reading for how much momentum there is behind sustainability as we head back into the next upturn. I think, frankly, that’s going to be dictated a lot by tax policy and energy costs and things like that.
Mooz: On the commercial side, there’s definitely a trend—a very definable trend—toward a sustainable and LEED strategy for commercial office buildings. It is top of mind, particularly among our energy-sector clients. … If you are developing in this cycle and you do not have a strong LEED strategy, I don’t think you’ll be taken very seriously. And tenant representatives and tenants are way too sophisticated to simply say, “What’s your certificate say?” It’s, “Show me where the LEED strategies are. Show me what you’re doing on the air side. Show me what you’re doing for natural light.” They really don’t want just to see the piece of paper. They want visibility into the process and the asset that backs up the certificate. In the end, it’s not really just that their mission is consistent with sustainability, although that is clearly important. the push to sustainability is also about recruiting and retention for the companies we deal with. They know that for the under-35-year-old current and prospective employee, what is very important to them is not only the type of building they work in but also the type of space they work in. They want to understand their employer’s attitude and corporate policy toward sustainability. Employers are having to pay attention to that.
Gering: Sustainability has become … second nature. If a client says they do not want to deal with LEED, we’re still giving it to them at a certain level. It doesn’t have to cost them more money. The reality is, if we’re smart about how we capture light, if we’re smart about how we reduce energy by the mix of the mechanical systems and the glazing systems and how we place finistration so it doesn’t become a heat sink, or how we look at exposure to light from the inside … it doesn’t cost money to do that and it doesn’t cost a lot more time to do that. So everything we do is sustainable. … To me it’s all about the generational complexion. … When I look at buildings, I look at it as, How do we design for the future? Because the future is the next generation.
CPE: What are the biggest challenges you’re encountering, and how are you surmounting them?
Batchelor: Land pricing is becoming more expensive, and so from a multi-family perspective there is upward pressure on land pricing that’s causing our costs to increase as a whole. That’s putting us up into tighter economic conditions, where everything’s becoming thinner. And from that perspective you’re starting to see some pushback on the financing side from equity guys that are forcing us to be more disciplined in site selection and overall financial modeling, making sure that we’ve got the best sites.
Mooz: Financing is in an interesting place. There is a healthy debt market out there. It is well priced but it is also perhaps a little more disciplined in this cycle than the last, at least on the commercial side. Lenders are going to look for very strong pre-leasing requirements for any build-to-suit or speculative office project.
Kermit Baker, Chief Economist, The American Institute of Architects: We started hearing from our members about a year and a half ago, (when) projects were starting to come in house. (Architects) were very frequently getting calls: “Could you hold off? We have issues to resolve with financing.” … I think that’s changing. Credit is unfreezing and there’s more available now. But there’s still a lot more scrutiny about lending in the real estate sector than there is lending in other sectors, and that’s holding back—at least from what architects are telling us—what are otherwise very viable projects. …
Gering: From a land-use standpoint, a lot of municipalities are getting very smart. They’re relying on developers to develop properties that may need a different use or may be contaminated or whatever. The challenge is, because the communities are getting smarter, it’s a lot more difficult to get things through a system quickly because there’s always someone who will say, “Did you think about this?” or “Did you think about that?” It prolongs the process.
CPE: What are corporations’ top priorities for new space, and how have those priorities changed?
Gering: They’re trying to mix the changing work styles, the multigenerational workforce, with the impact of information technology on that and the impact of sustainability and energy consumption on top of that—it’s those three major things all combined together. … Two or three years ago, everyone was downsizing significantly, and the buzzword was, “How do I shrink my space?” What they should have been saying and what they’re saying now is, “How do I make my space more collaborative? How do I make my space more flexible for change? How do I make my space allow for more social and community environments?”
Gatto: I’m starting to see a trend—and maybe it’s led more by the New Economy companies—to bring back multiple disciplines of employees under one roof. And maybe going back to more of a regional geographic focus, but a focus where you have the different types of employees. Some of the New Economy companies that traditionally kept all their software engineering and R&D in California and then utilized sales/service operations around the country are starting to add, in those satellite locations, the software engineering, the research and development. They’re finding that the segmentation has not given them the creative process and the interaction that they want, so they’re making a very concerted strategic effort to emulate the multiple functions at the corporate level rather than differentiate them in their different office locations. It goes with the cultural, the interaction, the method of productivity—the software engineer bouncing an idea off of the salesperson, who responds with, “Yeah, I was just on a sales call …”
Yakren: Recessions make people think better and smarter, and the lessons learned become a new norm. I would think that flexibility of spaces is a big priority. Sustainability in my mind is a given. … I guess telecommuting is a very important component for many clients because most of the corporations today are global companies, so they need the flexibility for people to work remotely, come into spaces where they may not be residing normally but work for periods of time and then move on.
CPE: How are communities influencing what gets built?
Gatto: The communities are pretty much across the board under such fiscal duress that there’s a combination of cutbacks at the manpower level that make permitting and approvals more difficult, (and) there’s a very pro-development attitude. There’s a real awakening that these communities need to compete for incoming corporate relocations like never before. So that economic development I see as only stronger and alive. Maybe back to the days of the ’80s, when it was pretty strong and rampant, when many of the states competed for manufacturing.
Mooz: Municipalities are stretched on their budgets and obviously realize that the most sustainable way to either get out of a budget mess or try to stay away from one is to grow the tax base. How do you do that? You try to recruit strong corporate citizens, but also you want to recruit people who are going to live in those environments.
Batchelor: And because the cities are wanting and have embraced higher-density development, in order to encourage that pattern of development they might not write you a check for an incentive but what they are doing is saying, “We’ll waive our permit fees, we will waive certain impact fees” that they have control over. They’ve also given us bonuses in density. … So there are various ways the cities can offer incentives, particularly when you can demonstrate that you’re embracing the sustainability that comes along with high-density urban development and embracing the desire to meet the terms of their development and design process directives and particularly transit-oriented development.
Gering: A lot of the larger communities are getting smarter about zoning laws and master planning and establishing guidelines, learning from the ills of the past. So when a development team comes in, they have to comply with a wider, more broadened sense of design guidelines. Right down to: Here’s the character of the lightposts and here’s the width of the sidewalks and here’s the width of the roads and here’s the ratio of hardscape to source-scape and landscape, and setbacks and things of that nature.
CPE: What were the biggest mistakes in the last development cycle?
Gatto: Office as an asset class needs to somehow fix the amount of tenant improvement cost that goes into the turnover from lease term to lease term, whether it’s a renewal of the same tenant or a relocation. Especially in today’s market, where the valuation of office properties has become compressed, the tenant improvements have if anything increased a little bit, and as a result, the tenant improvements, the cost to make a transaction now as a percentage of your total value are at unsustainable levels.
Mooz: Anyone involved in the capital stack is wanting to have a little more all-weather underwriting relative to prospective development. People are absolutely more focused on downside analysis: If the development can achieve these types of returns, that’s great, but what happens in the event of a downturn? How well are you protected?
Batchelor: First, we’ve learned in the multi-family industry that when times get tough and rents are dropping and vacancies are increasing, what you don’t want to do is to have units that are too big. Developers were growing their units in anticipation that condo converters would be buying them to convert from apartments to condominiums. They lost sight of their apartment metrics to chase condo converters. That was a huge mistake. You won’t see that in this cycle. There’s discipline in the product.
And second, where we used to be driven to build it down to the cheapest decision, we now are putting an emphasis on quality. It doesn’t mean spend money frivolously—you still have to meet your budget—but in a down cycle a renter will move out of a unit where the nominal rent’s too big, but they’ll move down to a higher-quality product. So there’s flight to quality.
Kermit: I’m not sure there were a lot of mistakes last time. … If you look at standard metrics like office vacancy rates and retail rents and things like that, there’s very little evidence that the market was overextended in 2008. The market exercised discretion over the last cycle. In retrospect, it doesn’t appear it was overbuilt. The vacancy rate never dropped lower than in the last recession.
Gering: In the last recession, people looked at development as something that would always be a significant opportunity … and now a lot of those projects are boarded up. I think what people learned from that is, Don’t overleverage yourself. … Now there’s more of a movement toward, “Let me develop a project by going through the process on the front end, with the marketing tools, and get the building approved, through the planning board process and get everything right, and I’ll take it through a schematic design level and then go out and find a tenant, and once I have a tenant, the tenant then becomes a partner in the development of that process.”