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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Behind the Veil

I work in the real estate development business, but my perspective has always been from the accounting and finance group.  I was a ski bum in Vail after college.  I waited tables at a fancy hotel like so many other ski bums, and it wasn’t my plan to stay in the mountains.  But, the lifestyle was great, I felt healthy and stimulated, and I saw there were real opportunities to work hard and have a career.

A relatively easy entry into accounting in many resort towns is as revenue auditor.  Plus, it usually means you work at night and can ski all day.

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The following is a list of accounting jobs from the lowest level to the highest.  I’ve done all of them.

The Revenue Auditor makes sure the front-line staff recorded all their sales transactions correctly.  The auditor makes sure the point-of-sale system tells the same story as the actual cash and electronic payments received.  Once the revenue auditor signs off and corrects any errors, the daily sales can get recorded in the books.

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The Accounts Payable Clerk is the person you want to know if you rely on a company to pay you.  The A/P clerk enters all the invoices into the accounting system for payment and cuts the checks and disburses them when it’s time to pay.  An organized A/P clerk is essential to a reliable accounting department, for both ensuring expenses are recorded accurately and in a timely manner and for managing cash flow.  In a big company the flow of invoices through the A/P clerk can be overwhelming but good A/P clerks develop procedures and schedules to keep everyone happy.  This is the person most likely to have the famous (in accounting departments at least) sign above their desk that reads “Lack of planning on your part does not constitute an emergency on my part”.

The GL/Staff Accountant doesn’t enter invoices for payment but makes all the journal entries for a company.  Cash deposits and transfers, interest payable and receivable, depreciation and amortization, month-end adjustments and write-offs and maybe even payroll get entered into the system by the staff accountant.  They have the power to keep the books clean and accurate or to really screw them up.

The Financial Analyst is not really an accountant but works closely with the department to harvest financial data and create accurate, relevant, and useful reports for management to use in decision-making.  They often have access to the accounting software so they can write reports directly in the system for easy output. 

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The Assistant Controller is the catch-all once you’ve moved beyond A/P Clerk and G/L Accountant.  Every CFO has been an assistant controller somewhere along the way, and if a company has only one or two accountants, someone is the assistant controller.  The role is responsible for making sure the activity recorded on the books is accurate, that you’re not bouncing checks, that your source documents are organized and auditable, and everyone higher up is getting what they need. 

The Controller usually isn’t in the software except for review.   The controller is managing cash flows in and out, signing checks, and closely following sales.  The controller is reviewing and finalizing financial reports, preparing cash forecasts, dealing with auditors, and overseeing tax work.  The controller may often have some responsibility over the human resources/payroll department and the technology services group.

The VP of Finance is the person in charge of business plans and budgets and matching up the actual work of the accounting department versus budgets while looking into the future.   The VP of Finance needs reliable information from the Controller but also works closely with heads of sales, project management, capital improvements, and other departments to make sure overall company performance is on the right track.  You’ll often find an Ivy League MBA in this role.

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The Chief Financial Officer is the boss.  He or she talks to lenders, investors, Wall Street, the CEO and anyone else who is important to the finances of the business.  The CFO is where the buck stops on the finance side of the business.  You’ll usually find someone here with great technical skills and excellent personal and communication skills.  It takes both to get to the top.

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More on Green Building

Our Director of Environmental Initiatives had a favorite saying.  “There’s no such place as away.”  I get it.  We’re all drowning in plastic.  We poison our water and air.  The Planet Earth documentaries make it clear humans leave a path of destruction wherever we roam.  But we all need a place to live and there are less impactful ways to build homes, along with almost everything else we do as people and businesses and governments in 21st century America.

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We put the “no such thing as away” into practice when we de-constructed part of the old Northstar-at-Tahoe base village.  I have a plaque somewhere showing the ceremonial removal of the hands from the clock on the clocktower building.  We didn’t use a wrecking ball.  I don’t remember anything being demolished.  We literally took the building apart piece by piece and there was a company in the Bay Area who was willing to buy all the raw materials and re-sell them.  I was under the impression they had a massive junkyard somewhere in Oakland where small builders could come shop for secondhand supplies at a discount.

It’s cool to think you can re-use many of the parts and materials from an old building.  I’ve certainly seen the high-end homes using century old recycled barn planks as trophy flooring.  And I’ve also read the stories of thieves looting new construction sites for raw materials like copper.  On the other hand, I have also seen many on-line of videos of old hospitals and hotels being blasted and destroyed and crumbling to earth in a cloud of dust.

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I’m not sure where the breaking point is.  I know one of the measurement criteria in obtaining green status for new construction is to eliminate waste created by recycling and to incorporate recycled materials.

The US Green Building Council awards buildings LEED certification based on levels of green.  LEED is Leadership in Energy and Environmental Design.  There are different levels ranging from LEED certified to LEED platinum.  The more elements you can incorporate into new buildings the higher up you can climb on the scale.  It is a point of pride to achieve these standards and they’re not easy.

The problem with residential development though is I don’t think consumers will pay more to buy a LEED home even though it costs more to build, and costs to go through the certification process.  We thought it was a compelling story for the Bay Area market in the early 2000s but while you might feature the story in the sales gallery it didn’t exactly translate into higher sales prices.  It might have been a feel- good factor and a story that got people interested, but certainly not a negotiating point.

With a commercial building the scale of utility savings over the years in a green building can really add up but it doesn’t translate in a compelling way to smaller unit.  In California at least it seems the government is already stepping in to accelerate requirements for green building on a smaller scale.

We did make one green build decision that back-fired big time.  It was a classic example of “no good deed goes unpunished.”  We used recycled rail ties that had been conserved at the bottom of the Great Salt Lake from the time of the transcontinental railroad as siding.  Obviously, the ties were recovered and cut up to make a decorative and supposedly weather proof siding.  It was green.  It was a cool story.  It was new.

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But the siding didn’t perform exactly as the architects and builders planned and that created a field day for the construction defect attorneys that hijacked the HOA and created a massive lawsuit for the developer and insurance companies to defend.  More on defect attorneys in a future blog.  This fight got ugly.

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Green Building

Green building is a thing.  It’s a worthy cause and there are some wonderful examples of green building around the world, but I believe it’s still struggling to find footing, especially in the residential sector.

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When I began in the real estate business in the late 90’s as a low-level staff accountant I never heard discussion of green building nor paid any invoices to consultants who were helping companies achieve results in that realm.   By the time we were rolling on California developments in the mid-2000s everyone was talking about green building.

It helped that the owner and leader of our company had gone off to serve a term as President of the Urban Land Institute and green building was something he championed in that role.  We tried, but it never quite stuck.

We hired a Director of Environmental Initiatives.  As far as I could tell that was progressive to create a role in a development company for someone whose job it was to bring sustainable initiatives, training, and education to everything we did.  He drove a hybrid company car long before they were common.  Of course, after a couple of winters in Tahoe snow he realized he got a raw deal.  The other team members with company vehicles were driving SUVs and Audis with all-wheel drive.  He was chaining up his Honda Civic with every new snowfall in a time when there weren’t many electrics or hybrids to choose from.

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His car story kind of parallels my overall impression of green building.  It’s a great idea, a great story, makes everyone feel good, but it might be a little forced in a way that’s not really paying off for those trying to make a difference.

We were into green building with our new California projects because we thought it was the right thing, thought it would help win project approvals in the town and county, thought it was a good marketing story for the Bay Area consumer, and were genuinely excited to be on the cutting edge of design and construction.

I think green building’s problems are similar to the growing pains we saw in organic produce.  I bought and buy organic but saw the battle over who gets to certify something as organic play out on the grocery store shelves.   It was obvious that some organic claims were pure marketing, and some were real, but hard to pay the organic price when you can’t trust it.  I think the state of Oregon standards were the best, but I can’t remember.   That battle seems to have been solved, or at least removed from the headlines.

Likewise, green building was a free for all, though the United States Green Building Council seems to have emerged as the arbiter of green.  I remember however they didn’t make anything easy.  It’s fine that to get certified green means meeting high standards but based on what I witnessed with our team it seems the USGBC was only slightly easier to work with than the IRS.  They sound governmental, but I hope they’re not.  Frankly, I’m still not sure.  They do produce a nice magazine for you if you’re a member.

Plenty more to cover on green building but will leave that to a future blog.  If you like (or hate) my writing, please follow my blog.  Also, please connect with me on Twitter of LinkedIn.  Thanks.