Local developers are the best buyers in the market

BY SEAN R. KELLY, ESQ.

Sean R. Kelly, Esq. is Managing Director of CPEX’s Development & Conversion Investment Sales Team.

A client recently asked me, “Who is the best buyer for my property?” My first response was the obvious one: “The all cash, non-contingent, sit-down, sign and close buyer.”

The client owned a mid-size development site – a great infill project in an established neighborhood with a lot of upside, ideal for five 3-family townhouses or a small condo/rental building. Before returning to my office, I already knew the first round of offering calls. Based on my team’s list of developers, tracked in our database by their preferred neighborhoods and project scale, this would be an assignment that would probably end up in a bidding war. Our target would be the small to mid-size local developer, the same ones who continued to build through the economic downturn.

Toward the end of the last real estate cycle, “developers” were coming out of the woodwork, or the doctor’s office, or from behind the trading desk. Everyone became a “developer” to be a part of the New York real estate boom during the mid-2000s. Unfortunately, most of the newcomers were inexperienced, didn’t rely on market fundamentals, and never understood the risk.

But who could blame them? Their friends, family and eventual partners were raving about the state of the market and their “foolproof plan.” Banks were lending to anyone and everyone with zero regard for track record. Community banks from Iowa were giving construction loans without any recourse and little skin in the game for “developers.” They were over-levered and playing with house money!

In 2008, however, that came to a screeching halt. The banks shut off the lending spigot and started selling bad loans at steep discounts. Development sites sat dormant for years. Interestingly, most of the local development continued, albeit slowly. Why?  Because local developers are a different breed.

Local developers operate in a space that is too small for the capital market firms and focus on projects that range in size from one-, two- and three-family homes to projects less than 40,000 square feet. They are entrenched in the neighborhoods that they build in. Typically, they either live or have lived there, and know the market better than any detailed demographic report that you could download. They may not be familiar with a ten-year discounted cash flow model, but they know within $5 per square foot what their hard and soft costs will be, how long the project will take to build and sell or rent apartments, and which bank or mortgage broker will be their best option for financing the project.

Additionally, local developers already have all of the necessary underwriting tools because they’ve done it over and over in the same market, or a clearly similar one. They don’t need to call every residential and retail broker to find comparable sales or leases, because their last project is the “comp.” It doesn’t take two weeks to get an offer.

Nonetheless, their capabilities often times go overlooked by lenders purely as a result of a lack of dollar volume. It takes the same amount of man power to originate a $50 million loan as it does for $5 million. But these are the bread and butter deals for sales brokers and mortgage brokers alike. As big as New York City is, the neighborhoods, particularly in the outer boroughs, are largely self-contained, as local as the markets and players in them.

At CPEX, we pride ourselves on being outer borough experts who specialize in a specific product type. In the commercial property sales arena, particularly in the outer boroughs, volume comes in the middle market where pricing ranges from $500,000 to $10 million. For example, of the 300 plus development sites that sold in Brooklyn last year, only 15 exceeded $10 million. Meanwhile, there were 200 sales for development projects priced between $50,000 and $2 million.

The moral here is that bigger is not always better when it comes to creating a sustainable real estate market. Most of our clients at CPEX own properties priced in the middle market, while our customers are small development companies or “local developers” that are involved in the day-to-day operation of their businesses. Even if they pass on a site, they are generally forthcoming in their reasoning and eager to discuss the economics of a deal. I generally find that their capabilities and commitment are unrivaled. The key is that they answer to themselves and that often times they are comfortable hitting doubles instead of always swinging for the fences.

Ultimately, these smaller-scale, middle market transactions that occur on the local level are the consistent, driving forces behind the real estate market and overall economy. And local developers, embedded in the neighborhood and committed to the community, are the captains steering the ship.