TrendWatch: Real Estate Development

Transcript

Scott Rosenthal
Partner, Real Estate

My name is Scott Rosenthal. I'm a partner here in our Portland office in our real estate transactions practice, and I focus mostly on real estate development.

Can developers keep up with rising costs?

Well, there are a few trends shaping development today. For our market rate developers, one of the real issues is cost pressures, both, of course, with interest rates going up over the last few years which has impacted development work across the board, and also more recently with the discussion around tariffs, which are going to impact the cost of building things, no matter whether it's in Portland or in a rural community, on the west coast or in the southwest or in the mountain rocky states, all markets where we're quite active right now.

How can you beat inflation and interest rate hikes?

So addressing these cost escalation concerns really depends on our client and on the project. But one of the trends we're certainly seeing, which we really didn't see a few years ago, are clients that are actually going out and buying materials and storing them before the project is ready to be built as a way of controlling what they expect to be significant escalation in the cost of materials.

In terms of interest rates, there's not a lot you can do. The interest rates are what they are. But for some projects, what we're seeing more and more are clients who are actually not going out and getting debt to get the projects done. They're finding partners that are willing to fund the cost of construction or rehab, depending on the project, simply with equity with the plan of waiting until interest rates come down, until the lending markets are a bit more favorable to developers. And then they'll finance the project at that point and have proceeds to distribute to their partner.

Is affordable housing at a breaking point?

For affordable housing developers, we're seeing more and more sensitivity to thinking about exit options, which is typically well over a decade, often 14 or 15 or 16 years after our developers close a transaction. What's called a year 15 exit is an important issue because that's where our clients expect if they're going to sell a project or refinance a project to pull a lot of proceeds out of the project that they've built and they've managed for well over a decade. And there often are disputes or there are disagreements or there's friction between our clients which are developing and managing these projects and the capital partner who's provided equity to get the projects built. And we're really advising our clients even as early as the term sheet stage when they're looking at a new project and they're starting to talk with their equity partners, about being detailed about the requirements that they're going to expect in their partnership agreement, in their operating agreement with their equity partner about what are the parameters for determining 15 years down the road how the sale proceeds will be distributed. And we're certainly seeing much more client interest early on, on really understanding the projections: 15, 16, 17 years from when the project's built to really understand how the sale proceeds will be distributed, whether they'll follow the waterfall, or whether there'll be capital account issues which will impact, for example, tax obligations of the parties that could really skew how the proceeds are ultimately going to be split between the developer, the sponsor of the project, and their equity partner.

What should you lock in before breaking ground?

One of the current topics we're talking a lot with our clients about are really in the pre-development stage, particularly if they're looking at building a housing project, creating apartments for a community, to really talk with the city about deferring or finding other ways to lower the cost of system development fees, water fees, and other fees that can really impact whether a project can be built.

Cities are very engaged with developers. They need housing in all of the markets where we're operating. And we're seeing more willingness to engage on strategies to try to mitigate the costs of these upfront fees while providing some comfort to a city that they'll eventually get paid the fees that they need to operate their, for example, their sewer and water system and to deal with the impact of development in the community.