Natural Disasters

Real estate development must plan for and around natural disasters.  Over the long duration of planning, construction, and sales, nature will have a say about a project.  Where I work in Northern Nevada and Northern California the three primary types of disasters that are considered and planned for are wildland fire, floods, and earthquakes.

There is nowhere in this country that does not require an accounting for natural disasters and climate change is elevating the amount of discourse, research, and mitigation measures required as we plan.  Thankfully, we have science on our side in way that I don’t think developers did for most of the 20th century.  Drought in Las Vegas, tornadoes in Dallas, flooding in Chicago, hurricanes in Florida, and blizzards in NYC are all regular phenomena and must be part of our learning as we move ahead.

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One great positive about real estate development today is that we have a variety of experts to aid in understanding natural conditions and disaster planning when it comes to land planning and construction.  The California Environmental Quality Act (CEQA) governs the preparation of a very thorough analysis of the environmental impacts of a new development in a region.  CEQA is a bit of a cottage industry in California.  Certain consulting firms can make their living creating the voluminous and detailed reports.  Certain attorneys can make a career out of arguing about the scope and meaning of the requirements.

How many cars will use an intersection at build-out and what does that mean to air quality?  Will new lighting from development negatively impact migratory bird behaviors?  Are there any rare or threatened plant species for which the site is critical?  Will a 100-year flood wash it all away?  CEQA calls for the creation of an Environmental Impact Report (EIR) which answers all these questions for local planning authorities to consider when reviewing a project.

Where I grew up in the suburbs of Chicago it seemed that almost every spring the Des Plaines River would come out of its banks and flood the homes nearby.  There was some good modern planning around leaving flood plain as open space, parks, and playing fields when I lived there but too many homes had previously been built in the river’s path.  One of my key lessons in life is don’t live in a flood plain unless you want to be in a situation where volunteer high school football players filling sandbags will determine the fate of your property.

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In the West flash floods are more the issue vs. the slow-moving behemoths that occur in the Midwest. But even downtown Reno floods when there is simply too much water flowing out of the Sierra Nevada for the creek beds and river beds to hold.  Of course, humans haven’t helped as we converted urban river corridors to concrete chutes that allow little room to flex, but we’re learning.

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We’re in a better place than ever when it comes to studying land uses, but the problem is not going away.  Real estate development will always require some compromises as we move forward, but new projects and housing can’t be expected to fully remediate the sins of the past.

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Affordable Housing

Affordable housing is an extraordinarily complex and sensitive issue.  Due to my many years of being on the front lines of the issue I know to tread lightly.  It has not been solved in the North Lake Tahoe area and seems to be an increasing problem in many places in the country, including Reno.  There are a lot of good ideas and plenty of good people working on the issue, but I don’t know if we’re any closer to a solution.  It’s a hot button campaign issue for politicians but solutions to housing problems are easy to promise and very hard to deliver.

Sawmill Heights at Northstar

The development group I work with provided several land parcels for affordable housing as part of entitlements for projects.  Land was conveyed to regional affordable housing builders who move around the country with this set of expertise.  They know how to build the right product for the market, and they know how to use tax credits to finance their construction.

There are many incentives set up by governments to promote the issue, but my observation is it takes quite a bit of institutional knowledge to know how to use the tools and how to unlock the value.  I think there must be a high barrier to entry in terms of expertise needed and financial risk taken in order to operate profitably in this realm.   Also, I’m sure the different sets of rules put in place by every locale you work in allow for the application of general principles but require addressing specific details in each.

Emma Garrard/Sierra Sun The view from an upstairs unit at Gray’s Crossing. Workforce Housing of Truckee Tahoe is currently taking applications for the affordable housing.

Sometimes affordable housing gets built and doesn’t get used fully, either because it can’t compete in the market when it comes to cheap pricing,  or it’s simply the wrong product and is not attractive.

NIMBYs are a major problem with affordable.  Everyone says they want it, but only if it’s not in their neighborhood.

Environmental opposition groups won’t for allow for exceptions to their attacks to help get things done.  They run by hard and fast rules which don’t allow for compromise.  Their mission is to fight everything.

There’s a theory the prevalence of Airbnb and VRBO allow owners to rent for less total nights and achieve greater financial returns versus locking up their properties in old-fashioned ski or summer leases.  I’m not sure if they’re even still a thing but I remember from my younger days when a group of folks would rent a beach or ski place for the season.  It could be locals, living and working there, or it could be young people who would pool their resources to lock up a place to share.  I don’t hear those terms any more.  It seems so easy to rent what you need when you need on your phone that there’s no reason to make a big commitment.

It seems logical the result is there are less places available for long-term rent and there may in fact be less stable seasonal visitation and more peaks and valleys as allowed by easy short-term availability.

The Zuckerberg purchase of $60 million of real estate only highlights the competition for Tahoe housing.  It’s great to see that the world’s wealthiest value Tahoe so highly when the world is their oyster, but it also reminds us that in order for Tahoe to be a great place we need ski resort operations, restaurants, yoga instructors, and housekeepers, not to mention police, forest rangers, teachers, firefighters and the trash man. 

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I don’t have any answers for this issue, but I am always deeply skeptical when I hear someone say they do.  It’s going to involve broad representation in this problem-solving effort, and it must include developers.

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Bankruptcy, continued

I’ll pick up where I left off in my previous bankruptcy blog.  We were at the front end of a massive development project.   The business owner had been sold to Morgan Stanley in late 2007.  Every project and every community was loaded up with construction debt.   I think by my count we had seven different construction loans outstanding in late 2009 of various sizes.

We had a 4-bank consortium providing the largest loan in company history on the new Ritz-Carlton hotel.  The same bank group also provided funding for the Hyatt Residence Club project.  The Village condominiums had debt, the golf course lots had debt, the Sunset Dream House had a mortgage, the fractional units had debt, and some random townhomes also had mortgages.  We were all in, having taken full advantage of the easy money paired with the skills of a hyper-aggressive CFO. The models showed the debt produced better equity returns and the debt was so cheap and easy you couldn’t not take it.

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The hotel loan was huge, I believe close to $150 million and it was maxed out.  The hotel was due to open in December 2009.  The planning….looking for a site, signing up for high-end operator, finding a contractor, and getting funds committed took almost 10 years and here it was set to open in the teeth of the deepest economic downturn since the Great Depression.

On a side note, I do remember getting my first tour of the hotel site with the project manager.  He had built some scaffolding on the mountain in the middle of the trees to give the team an idea of where to situate the property to get maximum views from the front of the hotel.  RIP Jack Berga, it was his baby.

The hotel loan was supposed to be paid down significantly soon after opening with proceeds from the sale of 23 high-end residences in the property.  If they were roughly 2,000 square feet each and would sell (and do now) for over $1,000 per square foot then you could relieve $50 million of debt quickly and then refinance based on the hotel operations.  It was a reasonable plan, just de-railed by the lack of financial commitment from the new owner and inability to close the units at expected prices when real estate values cratered.

The bigger problem was all the other development assets in the region guaranteed the hotel debt.  The Club that was completely built out ahead of the real estate development was also collateral.  The hotel lenders could take everything in the structure.  Based on the way they mismanaged the hotel over the next two years after they foreclosed it is likely they would have decimated the value of the other assets, too.  No one know which way was up in 2010 and the banks were in total CYA mode.  To make no decision and take no action was better to them than possibly being on the hook for a decision that didn’t work out.  I saw total ineptitude at some of the country’s largest financial institutions during the crisis.   Another side note, but the smaller local banks with local decision makers were the best to work with and could make timely decisions to move towards reasonable resolutions.

So we gave up the hotel to Bank of America and their associates but the rest of the companies that owned assets filed bankruptcy so that we didn’t lose the bigger projects which had so much time and money invested and still so far to go.

image credit to Bank of America

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Construction Defect

Construction defect lawsuits are a huge problem in the development and construction industry.  Most of my experience with this issue has been in California, but I see that Nevada is constantly trying to figure out how to get legislation about the issue right, too.

Here’s what happens.  Developer builds a project…in my case I’ve seen this play out with townhomes, single family residences, and condominiums.  It cuts across all product types.  In California there is something called the ten-year tail.  The developer and/or contractor who builds and sells the units to end users must guarantee their work for ten years after a certificate of occupancy is issued.

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The concept means well.  A house is a big purchase.  Builders should not cut corners and hide shoddy construction.  In my experience I haven’t seen many builders trying to get away with things.  In this business, like any other, most people take pride in their work and show up every day to do their best.  Granted, in the boom times some unqualified people are deployed in the field, and mistakes can be made.  Building homes is complicated.  Building multi-story, multi-family apartments and condominiums is extremely complicated.

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Developers have a “right to repair” in this time frame.  If a defect is discovered, they have an opportunity to fix the problem for the owner.  This can work with a reasonable owner and a reasonable builder.  But ten years is a long time to be on the hook for something and situations change.  A lot of construction companies and developers ceased to exist in much less time than that during the last downturn.

Also, as mentioned previously in my HOA blog, things can get twisted very quickly when defect attorneys can convince an HOA to begin a class action lawsuit on behalf of all the owners of a certain product type.  Insurance has gotten very expense and sometimes cost prohibitive to obtain for this reason in California.  As far as I can tell, defect attorneys solicit HOAs for opportunities to sue builders and developers on behalf of the owners right about  the time a project is seven or eight years old.  Defect attorneys can sell FREE!  FREE! FREE!  They generally agree to work on a contingency with insurance companies and perceived wealthy developers in their bullseye.

Once they can get one unhappy homeowner to convince the HOA it’s a worthy pursuit then it’s off to the races.  Granted, this may often start with real problem.  Water intrusion and mold is a serious issue and that’s often where it starts.  But one problem quickly turns into, “If we’re going to sue, we might as well go for as much as we can.  Let’s find everything!”  The attorneys hire experts who will then de-construct a unit and create a report that shows everything someone might consider was not done perfectly.  The reports I’ve seen show every nail that wasn’t driven all the way in, every piece of flashing that might by ½” short, every place the gutter doesn’t drain as the architect anticipated.

One issue can start it all, but it turns into all-out war over as many issues as the defect attorneys can bring onto the battlefield.  I guess the assumption is that it’s just the insurance company that will pay so it’s OK.  But it drives construction companies out of business having to fight these suits and it makes insurance that much more expensive which ends up in the price of homes.  It’s a very risky part of building and selling homes in California, and I think in many other states as well.

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