Don Tishman's Real Estate Development and Investing Solutions

It is either impossible or very difficult to obtain a bank loan to build a new commercial real estate development. Banks fear collapse of the commercial real estate market. Many banks remember that they  collapsed or nearly collapsed from the disintegration of the residential real estate market.

In addition, commercial real estate rents have fallen. Vacancies in commercial real estate have increased.

Is there any type commercial real estate in demand? Several! First, there are existing commercial real estate that have loans that are expiring. The owners of these developments are finding it equally difficult to refinance these existing developments.  The same is true of potential buyers of these developments not being able to finance the purchase, thus making it very difficult to sell these existing developments.  Many of these buildings need work- with no funding of loans available- no needed work being done. Secondly, there is a demand for new mixed use developments that include residential, commercial, and entertainment.

Many banks that were large construction lenders for real estate, are not making any loans. They are saying that the earliest they will even look at new loans is the second quarter of 2010.

Meanwhile governments and other groups, are demanding  all new or rehab construction  meet L.E.E.D. standards.

I think in the next few years commercial real estate loans will be 75% or less of cost. In the last building boom loans were at 80% to 85% of cost. Despite the Fed keeping down interest rates, commercial loan interest rates will be higher. So if a building cost $1 million, the developer could loan $850,000. Now with the lower loan to value and the increase in interest rates- the developer will probably be lucky to get a $700,000 loan.

This doubles the equity required to be raised from $150,000 to $300,000. If the building was projected to have a cash flow of $20,000 per year for the first five years, and the investors received 70% of the cash flow.  With the lower equity requirement- the investors would receive a 9.3% annual return. With the higher equity requirements, the investor’s return is only 4.6%- hardly a rate that will attract capital. One of the solutions is to cut the development budget.  This means that we will not be able to add anything to the building specifications. UNLESS, we can substantially lower the operating costs enough to substantially increase the cash flow.  Do not forget the 30% tax credit for alternate energy systems.

This what architects, engineers, and contractors should be working on in their now spare time. Next year,  clients will come into your offices wanting to develop commercial properties faced with problems similar to the foregoing example. They have a budget and are having difficulty meeting the local  L.E.E.D. requirements. Their bigger problem is raising equity capital.

You wave your hands – abra cadabra – you may have the answers to their problems. You will  have to work on the design of their building to see if your solution is feasible for their project.  You can not do this on a contingency. They have to invest in your work. What are their alternatives? This is your ticket to the contract.

Most designers, regardless of how well known they are, are hurting for work. For quite a while, public and non-profit work filled the gap created by no private work. Today, the budget crunch felt by public and non-profit organizations is severely limiting this work.

First, this has nothing to do with the designer’s abilities.  Many  architects, planners, engineers, and all other designers are blaming themselves. Their rainmakers are just as capable as when they were bringing lots of business. Why is this drought hitting these professions?

The population keeps growing.The demand for various uses and products continues! Therefore- why are you not executing design contract where you agree to design X for Y dollars? Simple, there are no Y dollars for development available. Banks have previously made development happen. These banks accomplished this by being in the business of making construction loans for new developments. These loans included funds for the acquisition and development of the development sites.  After the housing debacle, there were huge inventories of available new housing. Finally, inventories are being reduced. Today inventory of lower priced housing (under $350,000) are back to normal. This apparent housing demand should start development of this type housing. However, most banks are not making construction loans this year. Most do not expect to start making construction loans until mid 2010. If the media’s prediction of the collapse of commercial and retail real estate is adopted by the banks, there will not be construction loans in 2010.

We have developed in most of the major metropolitan  areas in the U.S.- each metropolitan area claims to be different and each is different. Think of San Francisco vs. New York City, or Madison, Wisc. vs. Albuquerque.  Today I was checking the unemployment rates in several metropolitan  areas: San Francisco, San Jose, Albuquerque, Santa Fe, and Madison Wisc. All the attention is to a national rate of close to ten percent. The unemployment rate in the foregoing metropolitan areas are 6% or less. Surprising, these are similar to these area’s unemployment rates to when development was booming. Talking about vacancy rates in the U.S. is useless. There are 250 U.S. real estate markets where the National Association of Realtors keeps a mass of statistics for. All these markets are different.

Real estate is local. Albuquerque and Santa Fe are about 50 miles apart. There is not much difference in the Area Median Income for each. Yet, the average home price in Santa Fe is almost  double of the average home selling price in Albuquerque.  The building cost is about 20% higher in Santa Fe.

These strange differences are true throughout the U.S. real estate markets. In Dallas and many areas of the country, , a mansion will cost under $500,000. In New York City, $500,000 will buy a 300 square foot efficiency.  Much media is located in or near New York City. Many writers for these media may believe NYC real estate statistics as what happens throughout the U.S.

Professional organizations in each area must start having programs that show the demographics for their area as compared to national statistics. Showing that your area is indeed different. Only by making your community aware of these figures will you help to create a lending environment for development. These organizations must do market studies to show what type real estate developments fill unmet needs and are feasible in your area. You can not wait for bankers to do this. Their last experiences still has their CEO’s, directors, and stockholders shaking violently. The only way to calm them down is to conservatively show them great opportunities for their bank. Like it or not _”Money makes the world go around.”

Nothing for private markets has been built for several years. These opportunities are there – your professional organizations can advocate these opportunities – these organizations do not have an ax to grind- your community will be the winner by solving the locals unmet needs and stimulating the local economy.

In China the two largest banks are owned by the Chinese government. When China’s economy was going south, the Chinese solution was to order the two principal banks to increase their loans significantly. This lending led to investments that created many jobs. China’s economy has since made tremendous improvements due to these loans.

In Germany, where the economy has been worse than the U.S., the Deutches Bank, partly government owned, has had a record third quarter in 2009 due to greatly increased lending.

Today, many ” U.S. experts” are predicting a disaster in commercial real estate. Offices have a five year high is vacancies. Retail vacancies are even higher. In the third quarter of 2009, there was an impressive increase in retail sales.  After hearing this yesterday, the Dow went up 200 points . Today upon hearing that consumer confidence was down slightly, 6/10 of 1%, the Dow lost more than it gained today. This is a good example of the fickle actions on Wall Street.

Problems are that many office buildings and shopping centers have short term loans that are expiring. One of the largest shopping center companies recently went bankrupt because there was no financing available to take out their expiring real estate loans. This company has a great financial statement.

The same applies to office buildings. Many office buildings with at least 90% occupancy can not obtain financing for expiring loans.

What is a solution for U.S. commercial real estate? Many large banks that make commercial real estate loans are not making any loans in 2009. Some of these banks expect to start making a few loans in the second quarter of 2010.

Although the Federal government put almost a triillion dollars spread among almost all large banks, most of these these banks are not making commercial real estate loans. The U.S. method of recovery was to add to the capital of every large bank. The basis of this capital enhancement was that this would increase the bank’s ability to raise their lending limits- lend more money!. Bank’s have a capital requirement to maintain reserves of at least 10% of their loans. So when the U.S. added a billion dollars to a bank they could make $10 billion of new loans. So with a trillion dollars- the banks could totally add ten trillion in new loans. This did not happen. There was no express condition of these federal capital enhancements for the banks to make more loans.

It is this failure to have capital available that is contributing to this disaster in commercial real estate. The banks are lobbying Congress hard to prevent any passage of laws that would add lending requirements to these Federal loans to banks. But all is not lost. On many of the Bank’s Board of Directors our Government has named Directors. Now it is time for these Directors to stand up and demand the increased commercial real estate lending- before this market collapses like the home market collapsed.

The present U.S population is about 305,000,000. By 2040, the U.S. Census Bureau projects a U.S. population of 405,000,000. An increase of 100,000,000. The projection shows this gain will be 51% female and 49% male. Of these 67% will be a natural increase ( births-deaths) and 33% will be immigrants. Today the Total Fertility Rate(TFR) is about 2 per female and this is what the population projections are based on.  The highest recent TFR was in 1957 at 3.6.  At the height of the depression the TFR had dropped to 2.1. The households per person today is 2.59 person per household.  Any change in the TFR would significantly alter these projections.

As you will note from the table below, based on this household size, the Census Bureau expects about 1,250,000 new households per year. The present total households in the U.S is about 111,000,000. The increase annually is about 1%. Not gigantic. A study the of other Census tables in the population projections shows that the only age group whose % of the total population increases each year is the age 65 and older group.  This group is 12% of the population in  2010 and is 20.17% in 2040.  Today, there is almost a year’s housing inventory available.

These projections do not apply to areas that have significant changes in employment.

One of the few ways I see an increased housing demand is if much of our present housing is considered functionally obsolete. An old example of functional obsolescence is when I first started in apartments, most apartment complexes did not have central air conditioning. Soon residents demanded air conditioning.  These non-air conditioned apartment complexes became dogs on the market that had few occupants and no buyers.

If new households demand green residences, a home that is not green would soon radically lose value because the house becomes functionally obsolete. How serious is the demand for green houses in the next thirty years? Could the demand for green homes have a similar result as the demand for air conditioning had many years ago?  Could your home suddenly become obsolete?  Beware- Only the shadow knows!!

Some thirty years ago, Roman Polanski was charged with having sexual relations with an underage girl. Polanski was a celebrity motion picture director.This accusation was fodder for the media for many months. The authorities assured the mother of the girl that their names would not be revealed. Nevertheless, the girl and her family were besieged by reporters and photographers. The mother of the child was furious and told the same authorities that her daughter would not appear in Court.

The District Attorney was under threat of not having their essential star witness testifying. They  met with the defense attorneys to negotiate a solution to the prosecution’s problem.  Finally, both parties agreed to accept a guilty plea from Polanski to a reduced charge. Polanski would then be sent to he State Hospital for the Criminally Insane for a 60 day evaluation.  If he was evaluated as sane,probation would be  recommended. The Los Angeles County Parole Dpt. considered Polanski and recommended probation. The D.A. recommended probation and the trial judge agreed.   Polanski  was then promised he would be given probation when he entered a guilty plea.  Some years ago, HBO did a special on the Polanski and established these facts.  No one from the D.A.’s office disagreed with the facts in the HBO special.

Meanwhile the trial judge who had agreed to the various recommendations, was running for a higher offices. In some of his campaign talks, he was saying that Polanski would get the  stiff sentence he deserved. Hearing this, Polanski fled the country and has never been back since. He has been living in France and Poland. Despite both countries having extradition treaties with the U.S., both France and Poland have refused to extradite Polanski. When Polanski went to Switzerland to receive a honor for his motion pictures, he was arrested pursuant to Switzerland’s extradition treaty with the U.S.

What is the legal position of POLANSKI?  He plead guilty to a lesser charge, the DA, the Hospital, and the L.A. Parole office all recommended probation.. The trial judge  agreed to the recommendations. Then after the judge  may have changed his mind. Polanski fled the jurisdiction.

The DA told Polanski’s attorney the State would agree to the defendant pleading to a lesser charge and that the defendant  would get no jail time. This IS what happens in criminal cases. It is called plea BARGAINING.  It is widely used by police, prosecutors, and defense attorneys. If plea bargaining does not bind anyone, this would eliminate plea bargaining. Today, with plea bargaining,  only about 6% of cases go to trial. If all cases would have to be tried, this would completely bog down our criminal justice system. With present number of judges, prosecutors, and courts, a criminal case might take 10 years to come to trial. The U.S. Constitution guarantees a speedy trial for persons accused  of a crime. Witnesses may die, move  or disappear.  Justice delayed is justice lost. Many say imprison Polanski and throw the key away with the key.

Polanski’s acts were particularly heinous. The DA agreed reduce the charge to much milder act. What is at stake is the way criminal cases are subject to plea bargaining in this country. Regardless of how bad Polanski’s conduct was, we do not want to”throw out the baby with the bath water”. We must preserve our criminal justice system. The State must be bound by their promises. Without a responsible criminal justice system, there is no justice.

Amidst all of the uproar over extending health care, a principal objection to this program is because federal government may be involved in managing health care. These objectors insist on private management of health care.  When you look at 45,000,000 Americans without any medical coverage, it makes me wonder why so many Americans do not want to extend medical care because of their government may manage a portion of this program.   The New Yorker magazine recently had a story of the results of some private management in 2008  most banks thought TO BE the pinnacles of superior management  were near collapsing in the fall of of last year.  Some of the  largest insurance companies had to be bailed out by the federal government.  The record of some of the  largest privately American manufacturers is frightening.  GE was near collapsing. GM and Chrysler went bankrupt. All the wizards of Wall Street had to be bailed out by their federal government.

Contrast this failed private management to recent developments by the U.S. Department of Energy. These recent developments of public management are startling. The Lawrence-Livermore National Laboratory recently announced the development of their program to  use  gigantic lasers to convert nuclear waste into a very inexpensive source of energy- a relatively small amount of nuclear waste can produce enough electricity for the all the electric users in California. The Las Alamos National Laboratory is competitive with the Lawrence-Livermore National Laboratory. Both are publicly funded institutions. Not to be out done by the Lawrence-Livermore, the Las Alamos National Laboratory recently announced a public- private partnership to produce low cost alternative energy for transportation from algae. The release from the Las Alamos National Laboratory states:

“An award-winning Los Alamos National Laboratory (LANL) sound-wave technology is helping Solix Biofuels, Inc. optimize production of algae-based fuel in a cost-effective, scalable, and environmentally benign fashion—paving the way to lowering the carbon footprint of biofuel production.

The world population is 6.7 billion. Of these folks, approximately 4.5 billion have some sort of electricity. The population of Germany is 82 million. This represents less than 2% of total world population that have electricity. Nevertheless, Germany is the world leader in alternative energy including wind production, solar voltaics (solar panels), and passive solar buildings. Passive solar buildings require little energy for heating and cooling without using solar panels. The first passive solar house was built in Germany in 1990. In 1996 the Passive House Institute (Passvihaus) was formed to promote solar houses and establish standards for passive buildings in Germany. Since then passive houses in Germany have reduced energy costs by as much as 90% compared to “normal” house of the same size.

Passive solar housing design uses windows, doors, and walls to collect, store and distribute solar energy to heat in the winter and reject solar heat in the summer. The key to designing a passive solar home is take advantage of your local climate.

How is a passive house designed ? Through the use of conduction,convection and radiation.

First, these homes must face south. The east/west dimensions  may be twice as long as the north/south dimensions.  The exterior building materials store heat. Best are masonary materials like concrete, brick, stucco, etc.  The design’s features include window location, window size and glazing, insulation and air sealing.

The angle of the sun is higher in the summer than the winter. The solar heat in summer must be blocked. Shutters,awnings and overhangs are used for this.  The design of the overhang depends on how far the home is from the equator.

The passive building design does not use pumps, fans, or electric controls to move solar heat.

On December 27, 2008, the New York Times in describing a passive solar home in Germany wrote:

“In prior years attempts at creating sealed solar housing failed because of stagnant air and mold. But now passive solar houses use an ingenious central ventilation system. The warm air going out passes side by side with clean,cold air coming in, exchanging heat with a 90% efficiency.”  www.newyorktimes.com/2008/12/27/europe/27/house.html

Here are web sites for more details:The Department of Energy has a site for Passive Solar Design, the Green Building Institute, and the Passive House Institute, U.S

These are a few I found on Google under passive houses and passive house design.

Recently I put solar panels on my roof which are terrific, but passive home design may be the future of home design.