​Consultancy Encourages Taking 'One Step' Toward Transforming Neighborhoods

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585 Niagara Street, a project done by Inc Dev alumni Bernice Radle. (Buffalove Development)

​Monolithic capital stacks are quaking; REITs are reshuffling; an economic downturn is looming. But amid a flurry of harbingers in the commercial real estate industry, one grassroots consultancy says it’s time for you — yes, you — to step up.

Or not even necessarily “up.”

“Take one small step off the curb” is the message from Incremental Development Alliance (Inc Dev), a national not-for-profit group of developers that wants to help anyone getting started in real estate.

STEP, among the group, is an acronym for buildings that are small-scale, time-enhanced, entrepreneurial and purposeful. In a November workshop hosted by The Hopewell Downtown Partnership (HDP) in Virginia, mentors Ryan Terry and Richard Price championed the idea that everyday citizens who care about their communities are best suited to creating wealth and transforming their own neighborhoods one project (and one step) at a time.

The First Step

The key to this method is to first identify what’s missing in your local community. If you notice gaps in housing, retail, workplaces or services in your daily life, consider them opportunities. A corner store here, a duplex there; “these are the puzzle pieces that investors neglect,” Price said.

Large developers nowadays are seeking returns from large single-family home developments and massive, high-end multifamily complexes, Price said. “But guess what? Most people don’t want to see a lot more of either.” Your advantage over large-scale developers is that you know what types of places actually enhance daily life in your community, he said. “You have skin in the game.”

After spotting some opportunities to add value in a market, try to confirm your observations. Economic groups like HDP conduct studies on a given area’s fundamentals and should be sourced for data, Price said. “You really start by trying to understand the basic stuff about your market … like the existing rents and sale prices, and what buyers and renters are looking for.”

A rudimentary grasp on the market will help crystalize what type of project makes sense for a given location. But more importantly, Price stressed, is to ask what makes sense for you. To do this, consider a couple of factors.

“Do you own or have access to property of any size or kind?” Terry asked. “I don't care if it's 10 square feet on a street corner in the middle of nowhere, or if it's your own house. Is it worth considering it as a potential project?”
Alternatively, do you own a business? “If you rent a commercial space, the next logical step is to consider a project that would also allow you to own the real estate that your business sits in.”

Knowing someone who owns property can go a long way, too. “A lot of times they inherited it, but don't really know what to do with it, so it just sort of sits there,” Terry continued. “You show up with some cool ideas and figures and all of the sudden, you’ve got a partner.”

Having property available is key. If you don’t own the land or have it under contract, “you’re at a high risk of wasting your time,” Price stressed. “I would strongly encourage you to focus first on getting a piece of land under contract and then figuring out what makes sense for that project — not the other way around.”

Price started with his own house. “Renovating the basement [into a rental unit] gave me the confidence and a certain amount of savvy to start to understand what the residential real estate market was about in Charlottesville, and how to be a landlord,” he said.

The Money Part

By this point you’ll have discovered your “why,” Terry pointed out. “You have to understand what you want out of this. You may want to do one purposeful project, maintain a side-hustle or you may want development to be your new full-time job.”

From there, an entrepreneurial real estate developer just needs a few more ingredients, according to the mentors: some people to help reinforce goals, whether that’s through investment, promotion or moral support; enough hustle and willingness to not quit when it inevitably gets hard; and, of course, some money — whether that’s yours or someone else’s.

“The second step to becoming a developer is the money part,” Price said. “But don’t be scared,” he urged. “I really need to emphasize that real estate finance does not need to be complicated.”

"Basically, if you can add and subtract, you can do a pro forma. And if you can do a pro forma, you can be a developer." - Richard Price

Start with a pro forma, he said. “If you haven’t heard that term before, it’s basically just a score sheet for real estate development where you keep track of expenses and potential revenue. It answers the fundamental question of ‘how am I going to make money on a project like this?’”

Get figures on “soft costs” in your area — things like how much designers charge, how much it costs to get a project approved by the municipality, and what to expect in legal fees. For “hard costs,” gather data on the price of materials and how much builders charge for similar projects.

The pro forma will be a living document, Price continued. “You never get it right the first time; it's something to keep going back to and working on.” Luckily, he said, there are plenty of resources available to help create a pro forma for any type of project.

But more important than how to get money from a project, is how to get money for a project. Both Terry and Price said they began developing with modest resources. “I had to borrow money from a bank,” Price said. “Then I went and raised a little bit of money here and there from people we knew.”

Personal connections in the financial services industry can certainly help, Price said, but even without that, presenting solid fundamentals supported by a plan and passion should make it possible to land a loan. A community development financial institution (CDFI) in your area is also a good starting point, Inc Dev executive director Sherry Early chimed in. “CDFIs have less rigorous underwriting restrictions and they also have patient capital.”

“It’s very difficult to do things in this business with bad credit and no cash,” Terry said. “But I’m here to tell you that all sorts of people have done it.” Early said she started with personal savings for her first project in Gary, Indiana, then found it increasingly easier to go through due diligence processes with banks and get loans on subsequent projects.

​Entrepreneur Bernice Radle's 585 Niagara Street project. (Buffalove Development)

​The concept of “other people’s money” is crucial for real estate entrepreneurism, Terry said. Small projects — especially first projects, almost always start with one or two types of partners.

Friends and family are a common source of seed money, but it all depends on who you know. Some people may be willing to contribute, but expect too high of returns, Terry said. “But if it’s someone who is otherwise getting 6% from a mutual fund and you can promise them 8%, you’re looking pretty good.”
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Most professional investors are looking for evidence of stable cash flow or a high return that reflects the risk they’re taking. “But on a first project, you have neither,” Terry said. “You’re high risk and not very potentially high reward,” and you have no long-term cash flow to show. “That’s why friends and family are your best bet.”

The other type of partner is someone who can contribute property or “sweat equity," Price said; maybe they are willing to put in labor on renovations or even a contractor who contributes their skills and expertise.

The developers recommended steering away from owner-financing for a first project, though. When the owner of a property sells you their property on interest, “typically it’s going to be more risky and more expensive to you as a borrower,” Terry explained. “The rates can be double or triple over prime. If you miss a payment and you’re late, they take that property right back and you’ve lost a lot of money.”

Instead, seek out the “most vanilla form of financing possible” for your first project, he continued. “You’re going to make so many mistakes on your first project anyway. Don’t put yourself in a position where that mistake might be fatal.”

Size Matters

After observing the market, making sense of simple finances and seeking out some capital from friends, family, partners or a bank, Price said, it’s important to “right-size” your project. By that he means that “bigger isn't necessarily better.”
The smaller the project, the more straightforward it is to develop, Price said. As you add space, the seesaw between costs and profits becomes harder to balance.

“If you’re building a one-story building, it’s basically a simple box,” he continued. “No stairs, no elevator and minimal amounts of mechanical space. Just about every foot you build is rentable.” As you add size, you add complexity, he said. Costs per square foot go up, which means that the rents or sale prices required to achieve returns also go up.

“If you start to get into really large-scale development, code requirements change,” Price elaborated. Fire protection requirements, for example, get more stringent. “You start to devote space to nonproductive uses. If you're building stairs, elevators, hallways, mechanical spaces and structured parking, that’s square footage you can’t get revenue from.”

Your very first project is likely going to be really modest in scale, Terry said. “It’s likely going to be a renovation — and I’m not talking gutting a building, I’m talking about things like fixing a roof and painting. Maybe you rent it out, but maybe you have to sell it to establish a nest egg for your next project. If you’re starting with $0, like a lot of us do, you’ve got to start small.”

Real Estate Development Is Like Farming

But this isn’t about flipping buildings and making a quick buck, Price cautioned. “You're focusing on the long-term rewards of the project. You're helping build rich soil to nurture a place that can grow and help you with your endeavors as you're going forward. We call this ‘finding your farm.’”
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One successful project tends to lead to the next, Price continued. “As you start to do more projects, it starts to improve your neighborhood. The neighborhood starts to offer more opportunities, and suddenly you’re on a roll and instead of asking the questions, you're the person who’s answering questions for other people.

Small-scale development tends to build stronger, more sustainable neighborhoods because the projects are typically flexible, Price said. “They're time-enhanced, meaning the buildings are designed to grow and adapt,” he continued. “What made sense 10 years ago may not make sense now, but with small, flexible buildings, it’s easy to convert them into something new.”

​'Middle housing' example Eleven: 30 condominiums in Charlottesville, Virginia. (Courtesy of Richard Price)

​Price’s “farm,” the automobile-centric east side of Charlottesville, Virginia, “had been beaten up by many years of disinvestment,” he said. “It was not a vibrant neighborhood, but I saw a lot of potential; I looked around and said ‘wow, these are nice old buildings.’ There's some great natural features and it’s walking distance to downtown. I was one of those people who said, ‘what can I do here?’ And I started doing.”
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First it was a six-unit residential infill project that included mixed-use income, Price said. Then an old factory building converted to offices, restaurants and a bakery. Next some townhouses built on an old railroad yard. “Now I’m one of several developers working in this neighborhood and our collective efforts over time have started to transform this forgotten neighborhood into a place that's now in demand.”

Ideas for First Commercial Real Estate ProjectsBuildings aren’t even necessary for incremental real estate development, though. The basic building block of urbanism is about bringing people together, Price said. Businesses like farmers’ markets, street fairs and food truck courts are ones you can start partnering with, possibly by hosting them on vacant land, before helping them graduate to brick-and-mortar spaces.

Pop-ups and short-term rentals are also good first steps. “Bring someone from a tent into a more permanent solution,” Price said. “One of my colleagues bought an old industrial building and filled it with a bunch of desks, which he rents out as a coworking studio.”

“Liner buildings” are another good option. This is a term for very small shops positioned on a street front to mask parking or other unsightly structures behind them, with facades that meet a city’s design approvals.

Live-work housing, with a retail component on the first floor and apartments on the second, can also be a great first project that provides two sources of income.

Examples of first projects from Inc Dev mentors and mentees run the gamut. Monte Anderson, for instance, bought a long-vacant property on the “wrong side of the tracks” of South Dallas and converted it into an incubator space for young entrepreneurs called Grow DeSoto Marketplace, Terry said. “He chopped a grocery store up into a bunch of 300- to 500-square-foot spaces and the rest is shared facilities and common space.”
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Part of Anderson’s model includes business mentorship, or basically the “Lord’s work,” Terry joked. “But what he has found is that because these spaces are so small, they are both profitable for him on a per square foot basis, at say $400 per month, but they’re also affordable to the tenants — the youngest of whom is a twelve-year-old who was since able to get a loan from the bank to operate his snow cone business.”

Going-in costs can be low with old buildings, he continued, but end up being cash-flow positive with careful management, Terry continued. Alissa Shelton bought an old bank in a Detroit suburb and turned it into a community incubator space called Bank Suey.

​Bank Suey, a community space in Hamtramck, Michigan. (Bank Suey)

​Others have renovated commercial spaces into middle housing, a term used for duplexes, fourplexes, cottage courts and small multiplexes that sometimes have a commercial component integrated or nearby. It’s a type of project Terry often finds himself gravitating toward.

Jenifer Acosta bought an old building with “terrible 1950s cladding that had beautiful brick underneath,” Terry said. “She renovated it and turned it into a commercial use downstairs and loft apartments upstairs.”
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Look at every building’s potential, he continued. Bernice Radle saw a “really plain commercial building — just a big, brick box, really — and rehabbed it into apartments on the upper floor with commercial uses downstairs. She put a cool mural on it [with the help of an established artist as well as volunteers] and got some cool tenants in there, and it’s a great cash-flow project.”

In This Economy?

With interest rates and inflation rising, even the biggest institutional players are currently balking on real estate projects, the developers concluded. “This model is not going to save you from all the other stuff that's going on in your economy, okay?” Terry said. “This is not a panacea.”

But you, as an individual, “likely have a burning reason why you want to do this,” Terry continued. “You have to have your heart in it, because if you don’t, you’ll quit.”
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Wealth creation is likely a big reason, but one that won’t set you apart from large-scale developers. “It’s not that we’re out here doing this for charity,” Price said. “We all need to earn a living and hopefully build wealth over the long term. But for me, there’s nothing more gratifying than having the people in this neighborhood walk up to me and say, ‘that's a great project. We’d love to see more of that kind of project here in town.’”

Navigating interest rate disruption in CRE, bank and hospitality execs on the state of lending, Trepp’s April CMBS report, and office buildings are ripe for multifamily conversion

Navigating Interest Rate Disruption in Commercial Real Estate

The inflation rate has cooled some as mid-2023 approaches, allowing the Fed to slow the pace of its rate hikes. But for many, the damage is done, with the fallout still reverberating, especially in commercial real estate (CRE).

An ebook from PwC—“Navigating interest rate disruption: How real-time data can facilitate better CRE decisions amid volatility”—provides an overview of the CRE market and some advice on how to manage through.
The report looks into a combination of factors, including economic and geopolitical forces, the ripple effects of Covid, increased construction costs, inflation, and more. Sections of the 9-page report (with excerpts) include:
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• Workforce trends and logistics push companies to curb spending—“Remote work, inventory logistics, and labor shortages are forcing businesses to tighten their budgets and reevaluate their real estate footprints. In fact, 45% of businesses are planning real estate reductions.”
• Managing inflation-related challenges—“Higher capital costs—rising interest rates—are widening the bid-ask pricing gap for buyers and sellers, signaling a weakening economy.”
• Weathering an uncertain cash flow storm—“Soaring costs have led to a slowdown in the pace of construction since cost instability combined with rising labor costs make it challenging for businesses to bid on projects.”
• A proactive path forward—“To remain adaptable and competitive, commercial real estate professionals need access to relevant, tech-enabled, real-time data.”

Six Bank and Hospitality Executives Discuss the State of Lending Amid Bank Failures

Lenders and hospitality executives at the 2023 Meet the Money national hotel finance and investment conference commented on the current state of the banking crisis. Six of their comments were published in Hotel News Now: Ash Patel, president and CEO, Commercial Bank of California; Alan Reay, president, Atlas Hospitality Group; Matt Mitchell, vice president, Hall Structured Finance; Bruce Lowrey, managing director of investments, CIM Group; Matt Bailly, vice president of real estate, Prospera Hotels; and Keegan Bisch, vice president of originations, Stonehill.

Read their comments here.

For more from the conference, see this article from CoStar: “Five Key Takeaways on Hotel Investment from Meet the Money Conference.”

For more on how bank failures could make hotel financing harder to find, click here.

CMBS Delinquency Rate Holds Steady in April, But Office Rate Continues to Rise

This is an excerpt from Trepp’s Delinquency Report (May 3).

To access the full report, click here.

“The Trepp CMBS Delinquency Rate held steady, but the segment that everyone continues to watch closely saw its rate move higher again in April 2023.

The Trepp delinquency rate was unchanged in April at 3.09%.

​Declines in the retail, lodging, and multifamily rates offset a small increase in industrial loans and a bigger increase for offices.

“Office remains the most heavily watched part of the market as firms look to aggressively reduce space. Sublease space is at or near record highs in many markets as demand from big tech firms has eroded sharply. In addition, many companies are letting leases expire or are renewing for smaller footprints.

“Last week, Microsoft announced it would offer up several hundred thousand square feet in Seattle. The tech bellwether has already announced plans to relinquish more than two million square feet in that city.

One in Three Office Buildings in Major North American Cities Could Be Ripe for Multifamily Conversion

The combination of 1) companies (especially tech firms) continuing to lay off people by the tens of thousands, 2) the ongoing shift to working from home, and 3) the current U.S. housing shortage has caused landlords across the country to seek innovative ways to fill their millions of square feet of empty space.

“Up to 34% of office buildings in 14 major North American markets could be potential candidates for adaptive reuse. Looking at more than 26,000 buildings, office to residential conversions could open the door to potential housing for thousands of families in as many as 8,996 properties,” according to global commercial real estate advisor firm Avison Young.

“Adaptive reuse is an important conversation we are having around the art of the possible, to demonstrate how this potential solution contributes to placemaking and to the revitalization and vibrancy of our neighborhoods—particularly our downtown cores,” said Sheila Botting, Principal and President, Professional Services, Americas at Avison Young. “We must reimagine how we want to live, work and play. Adaptive reuse is one of the key components of how we do that as a community.”

For more, click here.