On the flip side, building a development project that doesn’t just look good on paper, but actually has the ability to be flexible in case of the development “curve balls” that will be thrown your way, will allow for a successful project, bringing solid returns to your investors and provide the foundation for long-term peace of mind.
Over the past few years, it hasn’t been hard to find cases of developments gone bad: just look around at half-built projects or check out the latest list of foreclosures and bank-owned properties. Fortunately, there are developments that may provide for long-term success based on flexibility and a willingness to accept a solid double, rather than be pigeon holed into having to deliver a grand slam.
One specific project is a current Block Real Estate Services Healthcare development project, Wyco Medical, being led by myself with Steve Block as the managing member of the syndication. In this particular project, the challenge we faced was a long-term, committed tenant, which comprised of approximately 30% of the footprint, decided that they were no longer interested in new space late in the planning stages. And while that is not an uncommon occurrence in developments, how you adjust to that change is critical.
Option A is to keep plugging away with the current footprint and work hard to find a tenant to fit in to the space that is currently available.
- The plus: projected higher initial return, a greater development fee on the project and more economies of scale on the building costs.
- The downside (and more realistic scenario): you are exposed at 30% vacancy, the tenant may never come and if they do, the developer/ownership group loses any leverage on negotiating to the rate that is set in their proforma. Any rate that is agreed to that is $.01 lower than that in the proforma, adversely affects your returns, which potentially sours the mood of long-term, loyal investors. Unfortunately, many developers fall in to the trap of “if you build it, they will come”, and compound that problem by either spending or leveraging any fees anticipated coming in the door on the larger project.
- The plus: the project becomes much more stable without the risk of the projected vacancy. Given the more conservative, flexible approach to the curve-balls thrown our way, we are now in a position to provide our ownership with close to a 9% initial cash return on a smaller, single-tenant development, with a long-term, non-recourse debt commitment.
- The downside: such a move could increase the $/SF of construction, lower our development fee and lower the projected rate of return to the investors. However, the benefits and stability offered by this option far outweighed the downside.
VP of Healthcare Development
Block Real Estate Services