Our interview the Feb/Mar 2012 edition of Bowden's Market Barometer is with Bill Lee, President of Madison Residential Advisors and a specialist in workouts and restarts of distressed properties.
BMB: The term “workout” tends to be painted with a broad brush. Can you define the term more specifically as it relates to residential, resort or mixed-use projects and what it takes to have a successful workout?
Lee: It depends on the nature of the project, who has the reins, and where the project is in the distress cycle. First, all the players – whether the original owner, new owner, or the lender/investor, must be willing to spend the money necessary to turn the project around.
BMB: Are you saying there’s perhaps more than one goal and the strategist must have a working understanding of individual goals?
Lee: Absolutely. There are stakeholders: Developers/owners, lenders, and residents and club members all have a stake in the project’s success. Add to the mix government officials and mandates and it is clear that the restart process is complicated. Does the developer or new owner want to hold the property for long-term investment and continue development? What is the owner’s vision for development and what terms is he subjected to? Will the vision concur with the residents’ and members’ wishes and expectations? If the financial institution has the reins, do they want to resell the entire property? How far are they willing to discount the current value? What affect will that have on the existing residents’ property values? What impact does the surrounding local community property values have on the vision for the community?
But while different motivations may require different strategies, the ultimate goal is the same – reposition the property in a fashion that results in success for the stakeholders and a good rate of return on their respective investments.
BMB: What are some of the considerations affecting the successful workout strategy?
Lee: The process relies on understanding the project’s history and where it is in the cycle of distress. Very often, fundamental errors in master planning and pricing have been made. Developers tend to have a conceptual vision and often do not rely on third-party due diligence – they assume they know better. Consequently, understanding how they got where they are is critical to repairing the damage. It could have been a bad masterplan, or a good plan executed bacly, or the absence of an amenity strategy.
Much of the time, it has to do with product and pricing. This restructuring of a community is not necessarily unique to recession. If developers would keep on top of the market, workouts and restarts would be less of a problem.
Years ago I worked on a large master-planned community in South Florida suffering post-recessionary ills. It had exclusively developed single-family lots around a golf course – a typical development plan back then. But with a single product line all you have is “vanilla” -- unless there are differentials.
BMB: Explain differentials.
Lee: At the very least there should be levels of opportunity: starter/entry-level products, move-up products, and the “ultimate” product – that product that defines the community’s perceived market position. When it’s a single-family custom home community, the levels of opportunity can be simply characterized by varying lot and home sizes and locations or views, but production housing -- built-for-sale products -- can add another dimension to the community and a buying proposition that spurs broader interest.
BMB: How so?
Lee: There are major differences between the various levels. In the primary market, the widest part of the pyramid is at the entry level which is typified by production housing on a small lot with little, if any, upgrade opportunities. This is where lifestyle comes into play and lifestyle at the entry level is represented by access to the amenities. If the amenities are not in place, or have been neglected in some fashion, the entry-level product does not sell well.
Dependent upon location, the community may use a resort product to generate traffic from a broader spectrum of buyer – perhaps a managed product where the prospective buyer can “touch and feel” the community. It can be an entry-level product that owners may use two to four weeks a year, renting it or leasing it back to the developer for the rest of the year. A condo-hotel-like product provides the prospective buyer with the community experience without making a million dollar commitment. Market depth for the $1M-plus product is relatively low and inventory is high. To compete in that environment to a large degree is simply not practical.
After awhile you can stop developing entry-level products as resales take over. The next development level is the move-up product, which is typically a semi-custom production home on a larger lot that provides a sense of privacy. It may be characterized with private pools, garages, bonus rooms, limited floorplans and unlimited finish upgrades. Your audience for this product is the entry-level resident that is now capable of “moving up” -- in other words, a built-in audience.
At the South Florida MPC, we introduced a mix of products including a resort-style entry-level condominium. Upon introduction, the closing ratio for walk-ins went from 10%-20% to 50%-60% for those that stayed on-property.
BMB: So a successful workout strategy is not all about the best price but increased traffic and absorption?
Lee: Well, would you rather sell three “things” at $1M or 50 things at $350,000? It’s all about the math. Also, the quicker the property is sold out, the less the carrying costs. The problem comes in avoiding the “neither fish nor fowl” syndrome. If not handled property, the community remains in limbo as the perception of its market position becomes increasingly unclear.
BMB: What do you suggest to avoid that?
Lee: Developing a roadmap for success must include addressing not only product and pricing in the context of the community, but product and pricing in the context of the greater market area and developing new products that are not directly competitive but fill voids.
BMB: When repositioning to current pricing, how do you get around the price discrepancy between the existing housing and the new housing?
Lee: Communication. The roadmap must be plausible to the people driving the bus – the developer and the lender. That said, the homeowners have the most at stake with respect to their investment. If communicated effectively, the differences and how they will work over the long-term will allay homeowner’s fears and a mass exodus will be avoided, thereby keeping the community viable and vibrant.
It’s a process: Tell, show and tell. First tell them what you’re going to do, do it, and then tell them that you did it, and what the results have been. I’ve spent just as much time communicating with HOAs and resident members about where the money is being spent as I have with the developers and lenders.
BMB: Do you have a current anecdote that describes your typical process?
Lee: There really is no “typical” process but the most recent was late last year when I worked with an upscale second-home community in the western region of the country. The project had been in receivership with a lender that was also in trouble, so there were many lines drawn in the sand and many issues to deal with including getting the necessary entitlements. While more than $100 million had already been expended for infrastructure improvements and the property had been in the market for several years, just seven or eight properties had been built. The first hurdle was to get the entitlements in place.
BMB: Did you assist in that process?
Lee: Yes, and the result was $5M-$6M in sales. Unfortunately, the developer did not communicate that to the stakeholders in a bold enough fashion and the absence of that powerfully positive marketing tool served to keep the perception of the property as “troubled.”
BMB: What was your next step?
Lee: We focused on the development issues that had already been implemented. The clubhouse was unsustainable as it was too big and too costly to operate, so we focused on driving membership to support it. We also reduced the acreage of the golf course by 20% and rezoned about half of the property for higher density product. That allowed us the luxury of offering a smaller cabin product, which was priced to include the $100,000 membership fee. Ultimately, we got membership up to 385, which was sufficient to keep the amenities a core buying proposition without increasing density and altering the community’s market position.
BMB: Would you advise the master developer to sell off large parcels of land to builders so they can get their money out more quickly?
Lee: It’s a consideration, but it’s hard to control. You have to hold the builders’ feet to the fire with regard to the type of product they will build and the price points that must be in keeping with the overall plan.
BMB: Can you summarize what the basic issues to workout success are?
Lee: There are internal and external competing interests. Analyzing local market comparables is key. Often the original masterplan has ignored the competition in the context of the greater metro market. For instance, if there is an entry level project of 1,000 units right next door, you need to position your entry level product below that project’s price points or offer an entry level product that is of obviously higher value. The pricing for the various products must be logical and address internal resale competition, local resale competition and local new product competition.
BMB: Sounds tricky. How do you accomplish an understanding of this concept with the stakeholders?
Lee: I’m a numbers guy. I draft a series of proforma scenarios and then create bar charts to put the options into visual perspective. One scenario might show total absorption based on the highest pricing that may be considered achievable. But at $1.2 million, they might sell three or four homes per year. I then compare that to lower levels of pricing which typically escalates the absorption rate. The object is to get the highest dollar yield from the reposition in the least amount of time and the proformas are used as working tools to assist in that goal.
I call it reaping the rewards. If the re-development plan respects the existing homeowners and the community revitalizes, it will be quickly acknowledged within the regional marketplace. But that is just the first step. That initial success has to be communicated effectively by a good marketing/ public relations firm with a consistent and professional campaign. A workout is no excuse for an absence of marketing. The dollars must be expended to get the success message out there in order to generate further interest and traffic. Going forward, the developer builds on that success with accelerated absorption and strategic increases in pricing.
BMB: Who/what entity typically initiates the workout process?
Lee: Usually the lender. But the lender must be willing to write down what is owed and invest the necessary funds take to make the process work. Lenders tend to “extend and pretend” and the developer tends to procrastinate in a “hold” pattern -- both are waiting for the market to turn. These conditions are exacerbated by the absence of a well-conceived restart plan and a consistent marketing effort. This particular recessionary period has gone on way longer than anyone expected so the number of distressed properties is significantly higher, which in turn has kept pricing down. Burying one’s head in the sand is not conducive to resolving the problem. Action should be taken at the first sign of difficulty.
BMB: Bill, thank you for sharing your insight. Let’s hope that our colleagues are taking this “food for thought” seriously and the lenders do their part to ease the paralysis that has plagued our industry for half a decade now.
Editor’s Note: Bill Lee is a well-known expert in the residential development field. His company, Madison Residential Advisors acts as a consultant to residential developers and lenders. The company’s specific areas of expertise include master-planned communities and resorts, and affordable housing financed with low income housing tax credits. Bill may be reached at 512-328-0487 or blee@apttx.com
