As mentioned in Part 2, it took about two years to complete the redevelopment of McDowell Studios. If we had hired a faster sandblaster, and had the City approved our drawings in one month instead of six, we would have taken the project to market as half year sooner. Those six or seven months made all the difference.
If you know anything about development, your first question might be, why weren’t you marketing during construction? Don’t all condo projects do presales? In hindsight this may have been a “mistake” but here was our thinking at the time: Yes developers most always begin pre-leasing or pre-sales before or during construction, not only to determine market receptivity but also because the typical project is leveraged up to 80% with borrowed money. That’s a ton of interest to pay so you need closed sales or signed leases quickly. We decided not to leverage but to use our own money to fund this project and calculated that the huge savings in interest would offset any longer marketing period we might incur. And after all, we only had five units to sell, not 55.
The second reason we didn’t pre-market was because we were re-developing a skanky old building and it looked extremely nasty until the final stages of construction. Most people can’t envision through that much nastiness. In a typical pre-marketing situation, the customer walks into a nice sales office onsite with floor plans and renderings, and may actually tour the new construction which is proceeding on site. But we concluded that walking people around a funky old building in an edgy neighborhood was probably too much of a stretch.
We thought it would make a bigger impact to show the completely finished project all at once as a diamond in the rough, the proverbial phoenix rising from the ashes. We thought the best way to do this was throw a big open house and let the wow factor create immediate, spontaneous sales.
The open house evening was a fantastic success. We went with an "art" theme and put a talented local artist in each studio. Partygoers strolled through the studios staged with lots of big, beautiful art. The whole building was an instant gallery. This actually generated $20,000 in art sales for that one evening.
We hired an event planner, caterer, valet parking, with security at the door, due to our urban pioneering neighborhood. We had over 300 in attendance including a few local power players. We put the first unit in escrow that evening and had calls to return for more possible buyers...
...And then the wrathful deity called “Market Cycle” came calling. Our open house was in February 2007. By that time, it was apparent to the wiser market players that the Phoenix residential market was probably overpriced and overbuilt. Less experienced investors were still in total denial, probably because they needed to be. That is, they had just paid $450,000 for a new, empty 4BR/4BA single-family home in Casa Grande or Queen Creek or Surprise (the dreaded perimeter). They just knew they could flip it for $495,000, because just a few months ago it had flipped from $400k to $450k. As the weeks continued unfolding, denial turned to fear and fear turned to panic.
While the connection from the residential decline to the commercial sector was not yet obvious or apparent in 2007, it was still present in a sort of unconscious way. Commercial follows residential. The one escrow we had soon fell out, and other interested parties stopped calling. Keep in mind that our units were small and thus relatively affordable, starting at $199k. And these were very unique, hip spaces—real lofts, 1948 vintage. But we couldn’t sell a one.
Meanwhile our company had other properties that required attention. For example, we had just finished a $400k residential redevelopment that in a continuing “good” market would have easily sold for about $500,000. But buyers started dropping like flies. We were forced to rent that property out and later sold it at a big loss. Fortunately we flipped another commercial building we had purchased on Central Avenue downtown “as is” for a profit because we got it so cheap. We had also sold all of our other residential re-developments during the peak a few years earlier, another lucky break on the timing .
So in the big picture, we were ok. It could have been a lot worse. All we had to do was figure out the best thing to do with the five cool commercial condos we had created at McDowell Studios. Unfortunately, we had decided to borrow heavily against them after construction, so they were no longer free and clear. And we had mostly used those proceeds to live on for a few years. And just for spite, the county assessor kicked the real estate taxes up from $5000 up to $30,000 in one year! We got them back down to $17,000 and are still fighting...
We tried to sell the studios through the summer of 2007...Nada. On the bright side, we still controlled the whole building, which seemed better than selling just one unit. Though we were brokers ourselves, we decided to change strategies, and hired a commercial leasing agent who specialized in urban properties like ours. We were quite surprised when he could not lease a single unit in six months. We knew the leasing market was not that bad, so we fired him. I rented my own residence out and moved into the building to lease it up myself. That was the right choice—simply being there 24/7. For some reason, seeing the owner live-working in the building made it easier for potential tenants say yes. I had a couple of studios leased at nice rates within a few months.
A year later the building is now 85% leased and we are cash flowing in a very tough market. Our best strategy now is to hold it until the next up-cycle. Then we'll consider selling it, maybe as a single building, or maybe as individual condos. The market will certainly determine that, and it could be five years until the next up-cycle begins...no one really knows.
This little three-part story is yet another example of how the real estate game never plays out as you intend. There are too many factors involved, including that most unpredictable one called time. But it is always exciting and I love the game. It requires all of your faculties--emotional, intellectual, physical, and intuitive. It forces you to take risks, builds your confidence, and teaches you how to adeptly deal with surprises, which always happen. In this particular case my partner and I never planned to be landlords, but now we are quite thankful for our tenants and the rent. I'll talk more about landlording in a future blog.
At the time of this writing (2009), the American economy is a lot different than it used to be. I'm not sure about other industries but in real estate all you can say is, “Build it, and something might happen.”
If you know anything about development, your first question might be, why weren’t you marketing during construction? Don’t all condo projects do presales? In hindsight this may have been a “mistake” but here was our thinking at the time: Yes developers most always begin pre-leasing or pre-sales before or during construction, not only to determine market receptivity but also because the typical project is leveraged up to 80% with borrowed money. That’s a ton of interest to pay so you need closed sales or signed leases quickly. We decided not to leverage but to use our own money to fund this project and calculated that the huge savings in interest would offset any longer marketing period we might incur. And after all, we only had five units to sell, not 55.
The second reason we didn’t pre-market was because we were re-developing a skanky old building and it looked extremely nasty until the final stages of construction. Most people can’t envision through that much nastiness. In a typical pre-marketing situation, the customer walks into a nice sales office onsite with floor plans and renderings, and may actually tour the new construction which is proceeding on site. But we concluded that walking people around a funky old building in an edgy neighborhood was probably too much of a stretch.
We thought it would make a bigger impact to show the completely finished project all at once as a diamond in the rough, the proverbial phoenix rising from the ashes. We thought the best way to do this was throw a big open house and let the wow factor create immediate, spontaneous sales.
So that’s exactly what we did. Of course, we had been accumulating a potential buyer list during development and all those folks were obviously invited. And we worked the press ahead of time: a feature article in the Business Journal, a favorable review by big-time local architect Will Bruder, and a feature TV segment on Desert Lifestyles, an offshoot of the very popular local glossy magazine Desert Living, in which we also were featured. We also did lots of web broadcasting, emailing, you-tubing, etc.
The open house evening was a fantastic success. We went with an "art" theme and put a talented local artist in each studio. Partygoers strolled through the studios staged with lots of big, beautiful art. The whole building was an instant gallery. This actually generated $20,000 in art sales for that one evening.
We hired an event planner, caterer, valet parking, with security at the door, due to our urban pioneering neighborhood. We had over 300 in attendance including a few local power players. We put the first unit in escrow that evening and had calls to return for more possible buyers...
...And then the wrathful deity called “Market Cycle” came calling. Our open house was in February 2007. By that time, it was apparent to the wiser market players that the Phoenix residential market was probably overpriced and overbuilt. Less experienced investors were still in total denial, probably because they needed to be. That is, they had just paid $450,000 for a new, empty 4BR/4BA single-family home in Casa Grande or Queen Creek or Surprise (the dreaded perimeter). They just knew they could flip it for $495,000, because just a few months ago it had flipped from $400k to $450k. As the weeks continued unfolding, denial turned to fear and fear turned to panic.
While the connection from the residential decline to the commercial sector was not yet obvious or apparent in 2007, it was still present in a sort of unconscious way. Commercial follows residential. The one escrow we had soon fell out, and other interested parties stopped calling. Keep in mind that our units were small and thus relatively affordable, starting at $199k. And these were very unique, hip spaces—real lofts, 1948 vintage. But we couldn’t sell a one.
Meanwhile our company had other properties that required attention. For example, we had just finished a $400k residential redevelopment that in a continuing “good” market would have easily sold for about $500,000. But buyers started dropping like flies. We were forced to rent that property out and later sold it at a big loss. Fortunately we flipped another commercial building we had purchased on Central Avenue downtown “as is” for a profit because we got it so cheap. We had also sold all of our other residential re-developments during the peak a few years earlier, another lucky break on the timing .
So in the big picture, we were ok. It could have been a lot worse. All we had to do was figure out the best thing to do with the five cool commercial condos we had created at McDowell Studios. Unfortunately, we had decided to borrow heavily against them after construction, so they were no longer free and clear. And we had mostly used those proceeds to live on for a few years. And just for spite, the county assessor kicked the real estate taxes up from $5000 up to $30,000 in one year! We got them back down to $17,000 and are still fighting...
We tried to sell the studios through the summer of 2007...Nada. On the bright side, we still controlled the whole building, which seemed better than selling just one unit. Though we were brokers ourselves, we decided to change strategies, and hired a commercial leasing agent who specialized in urban properties like ours. We were quite surprised when he could not lease a single unit in six months. We knew the leasing market was not that bad, so we fired him. I rented my own residence out and moved into the building to lease it up myself. That was the right choice—simply being there 24/7. For some reason, seeing the owner live-working in the building made it easier for potential tenants say yes. I had a couple of studios leased at nice rates within a few months.
A year later the building is now 85% leased and we are cash flowing in a very tough market. Our best strategy now is to hold it until the next up-cycle. Then we'll consider selling it, maybe as a single building, or maybe as individual condos. The market will certainly determine that, and it could be five years until the next up-cycle begins...no one really knows.
This little three-part story is yet another example of how the real estate game never plays out as you intend. There are too many factors involved, including that most unpredictable one called time. But it is always exciting and I love the game. It requires all of your faculties--emotional, intellectual, physical, and intuitive. It forces you to take risks, builds your confidence, and teaches you how to adeptly deal with surprises, which always happen. In this particular case my partner and I never planned to be landlords, but now we are quite thankful for our tenants and the rent. I'll talk more about landlording in a future blog.
At the time of this writing (2009), the American economy is a lot different than it used to be. I'm not sure about other industries but in real estate all you can say is, “Build it, and something might happen.”
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