Fundamentals of

Real Estate
Development
Originally published in 1981

James A. Graaskamp

Keywords: Development appraisal — property rights — most

probable use — risk management — feasibility studies — market
research

Summary development process is so much a creature of the

political process that society has a new opportu-
The real estate development process involves nity with each major project to negotiate, debate
three major groups — a consumer group, aand pro-reconsider the basic issues of an enterprise
duction group and a public infrastructure economy, ie who pays, who benefits, who risks
group. Each group benefits from cooperation and who has standing to participate in the deci-
and a full understanding of the values, short- sion process. Thus the development process
and long-term objectives and major limitations remains a high profile topic for an articulate and
controlling the other two groups. A major lim i-
politically sophisticated society. The best risk
tation shared by all groups is the fact that each
management device for the producer group,
is a cash cycle enterprise which must remain which is usually the lead group in the initiation
solvent to survive and which must create a of sur-a project, is thorough research so that the
plus over time to maintain credibility with oth-
development product fits as closely as possible
ers. Cash cycle enterprises must continually the needs of the tenant or purchaser, the values
make assumptions about future social norms, of the politically active collective consumers and
technologies and the direction of complexthe land use ethic of the society.
changes in personal, natural and political condi-
tions. The degree of error between assumptions
and realisations is what is termed risk, and Basic
in concepts
an enterprise economy most parties are attempt-Introduction
ing to shift a disproportionate share of the risk
to others while retaining a larger share of theSomeone rolled a rock to the entrance of a
benefits. Unlike many mass production indus- cave and created an enclosed space for his
tries, each real estate project is unique andfamily
the — a warmer, more defendable shel-

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ter, distinct from the surrounding environ- Basic real estate relationships
ment. This can be called the first real estate
development. Since then real estate activity The real estate process is the constant
has evolved and taken many forms to meet interaction of three groups — space users
the needs of man and society. Once based (consumers), space producers (those with
on need and custom, real estate is now site specific expertise) and public infras-
based on social economics and statute. tructures (off-site services and facilities).
Real estate can be defined generally as The space consumer group includes indi-
space delineated by man, relative to a fixed vidual space users attempting to rent or buy
geography, intended to contain an activity real estate space to house their specific
for a specific period of time. To the three needs. This group operates individually in
dimensions of space (length, width and the marketplace. The individuals' goals are
height) then, real estate has a fourth dimen- to survive and to improve their sense of sat-
sion — time for possession and benefit. isfaction and security, using their own
This can be referred to as a space-time char- funds. In order to achieve the unique com-
acteristic. The space-time concept is illus- bination of attributes each desires, there are
trated by the terms apartment per month, trade-offs, such as location, space and oper-
motel rooms per night, square footage per ating cost, that must be made and which
year and tennis courts per hour. A funda- influence real estate decisions. Collective
mental element in real estate is that any users generally pursue their interests in real
space-time unit has a corresponding mone- estate activity through the political systems
tary value. While many of the value judg- that purchase open space, provide for pub-
ments and debates about real estate projects lic infrastructures or regulate space produc-
relate to elusive criteria of what is good and tion with pooled funds from taxes,
beautiful, in a money economy the ultimate bonding, etc. Future users are typically rep-
criterion is cash. resented by proxy, either by developers
The creation and management of space- who anticipate the need to change the use
time units is termed real estate develop- of a building in the future or by the judi-
ment. Real estate developments range from ciary or special interest groups, who per-
a simple cave to the complex technology of ceive some trusteeship of the land for
the Park Avenue skyscraper. Like a manu- future generations. Provision for future
factured product, a real estate project is users is a hidden charge to present con-
part of a larger physical system pro- sumers.
grammed to achieve long-term objectives, The space production group includes all
but each real estate project is also a small forms of expertise necessary to convert
business enterprise of its own. Thus, the from space-time requirements to money-
development process is a continuum of time. The system includes those who
construction technology, financing, market- assemble the capital and those who prepare
ing skills, administrative controls and reha- materials as well as those who contribute to
bilitation required to operate the real estate the assembly of these on site. Architect and
enterprise over many years. mortgage banker, lumberman and lawyer,
Real estate development also is a com- city planner and hotel manager are all in
plex, collective process, not only accommo- the real estate business. The real estate busi-
dating an activity within the parcel, but ness includes any person with expertise in
also adapting to the context of a specific creating and maintaining spaces to house
surrounding environment, involving differ- activities of space users in the marketplace.
ent personalities and interest groups, as The public infrastructure group in-
well as limited resources. The political and cludes all those enterprises that provide a
social process to produce a real estate prod- network of tangible and intangible off-site
uct must consider a diversity of impacts to systems for the individual space user,
find equitable reconciliation between who including physical networks of street and
pays and who benefits. sewer and other utilities, services like edu-

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cation, police and fire and operational sys- and cash surplus the measure of survival
tems for deed registration, governmental risk.
regulation, adjudication and all forms of Therefore, a basic axiom for determining
economic activity with efficiencies of scale real estate actions is that a desirable real es-
that suggest collective off-site action. Note tate programme permits maximum satisfac-
that the difference between space produc- tion of the consumer within an affordable
tion and public infrastructure has nothing structure, while respecting environmental
to do with private or public ownership limits of the natural resources and permit-
since private companies may provide utili- ting the public infrastructure and space
ties and public agencies may develop real production groups to achieve cash sol-
estate. A necessary service, like sewer and vency, termed a cash break-even or default
water, schools and libraries, becomes an point in financial planning. Several impor-
element of infrastructure when there are tant implications of this view of the real
economies of scale to be enjoyed through estate process are:
collective action of many parcels, leading to (1) The true profit centres in the real estate
off-site centralisation. development process are in cash rev-
enues created by the developers' exper-
Cash solvency: the critical common tise in producing space-time units.
concern (2) Equity ownership is the degree to which
any one enterprise can control or divert
Each of these three functional groups, and cash flows from a real estate project to
any subgroup therein, represents an organ- compensate for its contribution of land,
ised, rational undertaking, called an enter- materials, money and/or expertise.
prise in the language of systems (Beckett, (3) Since the public has constitutional rights
1971). In an industrial society each enter- to divert cash productivity of the prop-
prise is a cash cycle operation. Each begins erty via the real estate tax and user fees,
with certain cash resources with which to the public has direct ownership of
purchase raw materials and services, to add every taxable parcel to some degree, is
value through expertise, and to exchange a preferred partner in the ownership
finished inventory for accounts receivable structure and possesses real assets in
and back to cash. Most such enterprises, be terms of taxes, net service costs and
it a hospital, a city, a household, a univer- user fees (Caro, 1974).
sity, or a single student, are not attempting (4) Site selection represents a consensus of
to make a profit, but each and every enter- cash cycle forces, with the cost of site
prise is constrained by the need to maintain preparation acceptable within solvency
cash solvency, both in the short- and the limits, which are determined by rent
long-term, or become bankrupt. Cash sol- levels, real estate taxes and an infinite
vency of each enterprise in the total pro- number of factors reflecting the eco-
cess, not maximisation of value, is the nomic characteristics of the user, the
pivotal issue of survival and the one mea- producer and the cost of infrastructure
sure of self-interest that all these conflicting services at alternative sites.
entities have in common. Only a few enter- (5) Control of land through ownership,
prises are intended to be profit-oriented. option or alliance can indicate who in a
Cities, school districts and home builders real estate project will be hired, what
are all cash cycle enterprises. Of course, sol- materials will be purchased and where
vency plus a surplus at the end of a year all the cash flows generated by devel-
can mean the city manager, the hospital opment and management can be
director and the home builder will enjoy directed. That is why architects, mort-
praise, trust and greater latitude to try new gage bankers, public authorities and
things from their city council, hospital cities become developers — to capture
board or bank loan committee. Cash sol- some small percentage of the cash flow
vency is a continuing test of management, benefits to their enterprises.

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Land versus location ple often employ networks of pipes, paving

and wires directly to the site so that some
Land is not location, property rights or the linkages become physically set due to
most important aspect of a project site; economies of scale in reducing the costs of
instead, land is a natural resource upon friction. Some communities have expanded
which real estate decisions come to bear. It the web of physical linkages to include
is that which can be brought under the con- pneumatic-tube garbage collection, cen-
trol of man to bear structures. It is a finite tralised heating and cooling, cable TV, sky-
resource that can be exhausted by extrac- way systems and pedestrian tunnels.
tive industries, destroyed by seismic and However, most linkage relationships are
ocean upheaval or wasted by ignorance of subtle, systematic, behavioural patterns
its processes. It is a limiting factor in devel-
that require a thorough understanding of
opment and both a reference and a bearing particular establishments and are the basis
point for space-time units. for marketing.
The physical land attributes with legal-
political constraints, linkage attributes that Linkages, location and cash cycles
define location, dynamic attributes that
exist in the eye of the beholder (such as Location as an attribute of the establish-
prestige, anxiety and claustrophobia) and ment rather than a physical site can be
attributes of a larger environmental system understood by a look at simple financial
create a site. Location is often identified as plans of hypothetical industrial establish-
the critical factor in a site, but it is seldom ments. In Figure 1 the relative revenues and
understood that location value is related to expenses of two alternative plant locations
the functional needs of the activity and not are presented. Notice that the linkages in
the site. The family unit is a common exam- each community to customers provide dif-
ple of multiple functions involving employ- ferent sales estimates, while expenses are
ment, school, shopping and recreation. The also altered by the proximity of each site to
family chooses a home site that balances raw materials, distribution points and the
convenience against the cost of inconve- availability of labour pools with different
nience. Each relationship between a house- expectations of hourly wages, vacation time
hold and another point requires movement and benefits. Indeed, benefit costs may be
of persons, goods or messages. This is lower because the average age of the popu-
termed a linkage, and the time, stress and lation in site B is much younger than in site
dollar costs involved are referred to as the A, reducing hospital costs, pension costs
costs of friction. Each establishment seeks a and the prerogatives of long-time seniority.
location defined as a set of linkages that will On the other hand, administrative salaries
minimise these costs. As the costs of are higher in order to compensate execu-
energy, congestion and time have risen for tives for doing without certain amenities
commuters and the need for suburban not available in a small town, such as a
school linkages has diminished, the oppor- country club, a parish school or diverse
tunity for reducing costs of friction by trad- medical services. Real estate taxes may be
ing the house in the suburbs for a minimal because government services are
condominium downtown has been trans- much less comprehensive and fire insur-
ferred into rent or the price of a condo- ance may be higher due to a remote fire sta-
minium. Rent differentials for location tion. Utilities may be lower because of
reflect market recognition of perceived linkages to hydroelectric power rather than
costs of friction to desired amenities. There- coal-fired plants for site A. Even the capital
fore, locational value is in the mind of the costs are modified by the intensity of
space user rather than inherent in the land, nearby land development and the willing-
and demand pressures on land shift as his ness of state governments to subsidise the
perceptions of convenience shift. Of course, costs of relocation. All these factors are
movements of goods and services and peo- linkages for an industrial establishment

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Figure 1 Industrial site alternatives

Site A Site B
Northern city Southern town

Revenues
Unit sales 11,000 10,000
x Price/unit $110 $110
= Dollar sales $1,210,000 $1,100,000

Expenses
Raw materials $110,000 $100,000
Transportation:
Raw materials 11,000 5,000
Finished goods 55,000 110,000
Labour:
Productive labour hours/unit 10.0 10.0
+ Productive hours as
percentage of clock time 0.8 0.95
= Total hours on wage bill 12.5 10.5
Direct labour cost/unit/hour $4.00 $4.00
+ Indirect labour cost/unit/hour $1.00 $0.50
x = Total labour cost/unit/hour $5.00 $4.50
= Total labour costs/unit $62.50 $47.25
Total labour costs 687,500 472,500
Administrative salaries 90,000 150,000
Real estate taxes 60,000 20,000
Utilities: heat, light, power 75,000 60,000
Total expenses 1,088,500 917,500
Net profit before taxes $121,500 $182,500

Capital costs (US$)

Land 50,000 20,000
Building and machinery 400,000 250,000
Cost of relocation 0 100,000
Net capital employed $450,000 $370,000

Rate of return on capital (US$) 0.27 0.49

Number of years for payback of relocation costs 1.3 years

which alters its cash flow, business and Many of the most subtle linkages are
financial risks and profitability. In theory it involved in selecting a housing unit for the
could pay more for site B because of the family household. Linkages of the home
increment in the efficiency of its operations. site in terms of density per acre and a pres-

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tigious location must be traded off with Environmental Impact Statement (EIS) for
neighbourhoods which have homes of dif- all proposed large developments. A care-
ferent sizes and quality in order to arrive at fully researched EIS may sometimes be of
a monthly housing cost which is acceptable help to both the developer and the city
within cash limits of the household. The planner by pinpointing major problem
family is tempted to strain the cash budget areas and suggesting alternative courses of
because the house purchase is perceived as action. An inadequately researched state-
a major investment opportunity that may ment can waste everyone's time and
provide significant capital appreciation. money, either during the planning stage or
This capital gain is thought to reduce their later during the project's use. Generally a
net housing cost below that of rental alter- shorter environmental impact evaluation of
natives in the long term. Combine net hous- critical issues is the most cost effective.
ing costs with costs of transportation to Recently, many planning departments
work, play and shopping, and with possi- and conservationists have used the EIS and
ble costs of poor schools or exposure to nat- other provisions of the 1969 Act to thwart
ural disaster, and the choice of a house growth in their cities and towns, which was
becomes a problem. not the original intent of the Act (Frieden,
1979). Frieden warns that a new 'exclusion-
Cash cycle of the user versus cash cycle of ism' is surfacing across the country: where
the collective consumer the old exclusionism attempted to exclude
only low-cost housing in an effort to keep
Public decision groups, like city councils, out minorities and the poor, this new exclu-
school boards and county governments, sionism attempts to keep out everyone —
often fail to recognise the relationship rich, poor and middle-class alike. This
between the cost of their decisions and the restriction on growth, especially in the sub-
true cost of land since the land cost is out of urbs and in-fill areas of the cities, Frieden
one pocketbook while the costs of friction claims, results in higher prices for housing,
are shifted to others who may not vote in reduced choice of housing location, and
their district. Consider the community col- longer commuting distances, and it dis-
lege district which purchases a cheap rural courages carefully planned developments
site rather than assembling a more expen- by the large developers. In the same vein,
sive urban campus because the five rural political use of infrastructure systems has
counties in the district can outvote the sin- become an oblique and debatable extension
gle urban centre county. While capital cost of land use control law for exclusionary
to the community college funds is reduced, purposes.
there is a significant increase in the total The collective consumers are moralistic
ongoing cost to students who must com- in public statements but are generally moti-
mute long distances to school and part-time vated to enhance their own cash positions.
jobs, to the urban community in terms of For example, in a city south of San Fran-
underutilised residential land and to retail cisco, Palo AIto, further residential growth
real estate near the abandoned old campus. would require present homeowners to
More recently, with population pres- share the subsidy of residential services
sures, depletion and occasional misuse in from the industrial tax base with new resi-
the past, natural resources are becoming dents. Thus they voted to commit 7,000
scarcer. Mindful of this, Congress passed acres of development land to open space,
the National Environmental Policy Act in estates and some new industrial parks in
1969. Its purpose was to prevent or min- the name of environmental quality. The
imise damage to the environment by new monopoly created by growth management
industrial and residential development for causes home prices to rocket sky high to the
the benefit of all present and future con- advantage of existing residents, while
sumers. To implement this act, most state exclusionary zoning may make it unneces-
and local governments now require an sary to finance expansion of sewer and

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water facilities by raising everyone's water The combination of new residents and new
service fees. Those who benefit as existing jobs was the final burden on the sewer and
residents control local votes and those who water systems which required expanding
must ultimately pay monopoly prices have the processing plant and well system to
no standing to vote. Thus the collective con- anticipate growth for the next ten years.
sumer will operate to block or imbalance How does one allocate the current costs for
development to protect its short-term cash expanding the water system and the street
interest; by the same token, the collective capacity between residential and industrial
consumer as a builder of public facilities users and further subdivide the burden
often thinks of only its own budget and not between present users and future users still
of the shift of hidden costs to consumers to come? Fiscal zoning of land use mix
and taxpayers. within a community requires open-minded
flexibility to balance cash revenues and
The cash cycle of infrastructure cash expenses with mixed-use land plan-
ning concepts and multiple development
Every real estate development creates a proposals spanning different development
new customer for the public infrastructure time frames (Burchell and Listokin, 1978). A
which surrounds the development site. new industrial plan may create a tax sur-
Each home constructed creates a new cus- plus which will be consumed in providing
tomer for the water service, the school sys- services for new residents hoping to work
tem and the fire department, and generates at the plant. But these new residents in turn
revenue in the form of meter charges for will prompt commercial development
utilities, real estate taxes and other receipts which will further expand the tax base and
such as a share of gasoline taxes for street may restore some real estate tax surplus
maintenance and state aid for education five to seven years after construction of the
based on a per student formula. There are first new plant. The interplay over time
secondary revenues, albeit indirect, in between cash cycles of users, collective
terms of increased retail sales levels, com- users and the infrastructure system is the
mercial land values and assessments and, base for the interface between economics
therefore, real estate taxes on ancillary uses. and property rights.
There is no aspect of cash forecasting more
difficult than fiscal planning for the impact The concept of property rights
on revenues and service expenses of alter-
native land use plans, but much has been Individual and collective use of space-time
learned in recent years about the techniques resources and land has always been regu-
of forecasting cash cycle implications of lated by society, in part through law and in
alternative development (Vollman, 1973). the larger part through political administra-
In the past there was a tendency to over- tion of the laws so that it is always neces-
simplify revenue/cost implications with sary to speak of the legal-political
broad generalisations: mobile home parks attributes of a site. The rights to use or
presumably had low assessed value but abuse, to provide expertise or choose con-
high educational cost burdens and high ser- tractors, the rights to prohibit or to condi-
vice cost implications for welfare and secu- tion use in certain ways, or to transfer
rity; everybody knew that industrial plants rights from one person to another are
produced far more tax revenue than defined as property rights. Society creates
required for service costs since there were and continually modifies the allocation of
no children to educate or streets to clear in property rights among private ownership,
winter. On the other hand, industrial plants public institutional ownership and com-
attracted the workers at wage scales which mon ownership indivisible among all mem-
could only finance mobile home housing bers of society. A primary function of
and contributed to highway congestion property rights is to provide incentives for
which led to street widening programmes. specific parties to take responsibility for

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development as well as conservation of the sure, failures and disturbances not unlike
resource. The market system rewards those, those caused by faults in the earth's crust
in terms of consumer satisfaction, who pro- itself, and new social problems appear. Big
duce the best buildings for the lowest cost cars are expected to depreciate in a few
of construction and operation. years under the best assumptions, and the
Until the early 1700s in England, each owners can minimise the losses by paying
community had common lands available more for gasoline, reducing their mileage
for everyone to graze their livestock. No and postponing sale for a few years. But the
one had a vested interest in maintaining large capital investments in land develop-
some grass for tomorrow or the right to ment, buildings, machinery or ships are
exclude animals to permit regeneration of depreciated instantly when laws like down-
the grasses, and the resource was crushed zoning, rent control, pollution controls or
by overgrazing. The commons were territorial fishing limits change their antici-
abruptly fenced to permit controlled graz- pated income sources or costs of operation.
ing by the rich, to the great discomfort of Unlike the car ownership which involves a
the poor. three- to seven-year cash cycle, larger capi-
Similarly, better information about eco- tal enterprises with major debt structures
nomic and environmental cause and effect anticipate useful lives of 25 years or more:
leads to more sensitive, refined allocation of with an intensive fixed cost of operation
rights. Property rights attempt to incorpo- they are quickly rendered insolvent by
rate responsibility and its corresponding unexpected changes in the legal environ-
cost with land use decisions that are fairer ment. Such allocations generally involve
to all members of a society. Therefore, cash conflict between equally valid points of
flow revenues and outlays provide one way view and rights of survival and may trans-
to measure the relative burden on interact- fer great wealth in the form of capitalised
ing parties and to refine allocations of cash flows from landlord to tenant or col-
rights and responsibilities, that is, benefits lective consumer.
and costs. Although the language of real estate
Information techniques, property rights seems static, it is not. Many terms used
and economics continually interact. The today, such as fee simple ownership, had
supply and demand for rights to be bought, their origins in medieval England. Their
sold, leased or otherwise exchanged current meanings, however, are quite dif-
depends on the benefit and cost of those ferent from their medieval definition. Prop-
rights to someone at a certain point in time erty rights do change and exist in a certain
and the scope of those rights as defined by form only as long as society achieves its
law. The ownership of a car becomes less objectives in terms of encouraging develop-
attractive as a commodity when the ment and husbandry. Nevertheless, change
increasing gasoline prices, transportation in property rights must be implemented at
taxes, insurance costs for injury caused by a rate which each enterprise can tolerate in
the auto and emission control costs are terms of its cash cycle and the threshold of
included. Society may further restrict the insolvency or there could be a taking of
hours, speed, purpose or locations for property without due process.
which an auto may be used — the scope of
property rights in an auto. Dramatic Most fitting and most probable use
changes in gasoline prices produce rapid
price reduction in large, gas-hogging auto- Until recently the economic theory of real
mobiles. As long as the interaction of law estate decision-making was built on the
and economics is gradual, almost unno- premise that the system was committed to
ticed, there is some degree of certainty finding that private use of a parcel of land
about future assumptions. Should rights-to- that would maximise the owner's wealth by
use change abruptly, the interface between being the most profitable use of the site
the law and economics is marked by fis- linkages or physical land. Presumably, the

626
Journal of Property Valuation & Investment: 10 Graaskamp

only criterion was profit, hence the cryptic must then be evaluated and ranked in
term 'highest', and as an inheritance from terms of their acceptability and probability
Adam Smith, there was the further pre- to choose the appropriate plan of action.
sumption that maximum profit was 'best' Typically, a set of consequences is com-
for society. Actually, the allocation of land pared to some set of standards which
to those who would pay the most or defines the acceptable, the undesirable and
develop it most intensively was characteris- the unthinkable. These standards can be
tic of 19th century America, when society somewhat altruistic, or what might be
needed to reward those who would modify defined as the norms to which a society is
the frontier to accommodate a rush of striving. The concept of most fitting use is
immigrants. At the same time, society had normative, that is, the optimal reconcilia-
not melded to a point where it could find a tion of affected consumer demands, the cost
consensus on land use priorities and social of production, the cost of infrastructure ser-
objectives. However, it was only as recently vices and the fiscal and environmental
as 1975 that the fundamental economic impact on third parties. Reconciliation
premise of 'highest and best use' was rede- involves financial impact analysis of who
fined as that use on a given date that could pays and who benefits in cash terms as well
be selected as most profitable from reason- as compatibility analysis of the collective
able and probable alternatives that were consumer's perception of environmental
physically possible, legally permissible and quality and impact on the good life — elu-
financially viable, given a specific level of sive standards at best. The concept of most
effective demand and costs of production fitting use assumes the goals and limita-
(Boyce, 1975). The official definition further tions have been well defined and that mis-
made it explicit that wealth maximisation fits between proposed solution and
was to be qualified by recognition of how a standards can be recognised.
specific use would contribute to commu- Experience tells us that most plans,
nity environment and community develop- development or otherwise, fall short of the
ment goals. Thus, it has been recognised ideal. This tendency is implied by the con-
that the development of each parcel must cept of most probable use. Most probable use
be considered within a larger system and is that alternative course of action which is
pattern of land uses and the frequent use of closest to being the most fitting use while
the words 'reasonable and probable' re- recognising strong constraints imposed by
veals a recognition of many of the uncer- current political factors, real estate technol-
tainties that attend assumptions required in ogy, the personalities and talents responsi-
the decision to use and develop a parcel. At ble, the money market and short-term
best, however, the term 'highest and best solvency pressures on consumer, producer
use' is an anachronism from laissez-faire atti- and public infrastructure.
tudes of the 19th century that have under- Any enterprise is a compromise because
gone an evolution in meaning like the the form it takes, in terms of both its config-
concept of fee simple title. At worst, it uration and its behaviour, reflects a negoti-
implies certainty of one man's judgment, a ated consensus between two general
one-dimensional measure of the adequacy sources of power — the power of its envi-
of a development concept and cash for the ronment to dictate form and the power of
landowner even when it is apparent that the organisation itself to decide what its
there are many vested interests in the cash characteristics and behaviour will be (Beck-
flows that are affected by a given land use ett, 1971). In the process of development the
decision. Therefore, it is useful to replace elements of law, public infrastructure and
this terminology with the terminology of consumer preference are the external forces
most fitting use and of most probable use. affecting behaviour, and the ability to
Any decision process requires identifica- respond from within the organisation is a
tion of alternative courses of action and function of talent, money and political
their consequences, and the consequences skills.

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Journal of Property Valuation & Investment: 10 Graaskamp

Risk management in development Control of this variance is called risk

management. There is a continual refining
Conditions of uncertainty in development of assumptions to convert as much specula-
tion to fact as is possible and to provide tol-
All parties in the development process erance for the uncontrollable surprises. Risk
must accept significant levels of uncertainty management is not only a philosophy of
about their cash budgets and other expecta- inquiry and problem solving, but also a pri-
tions as each enters the development pro- mary objective of market research, of
cess with a set of assumptions about the contract negotiation and of strategic posi-
future in a society that has been changing at tioning of any enterprise or investment
an accelerating rate. The amount of uncer- selection pattern.
tainty for an enterprise varies according to
its needs and income. The homebuyer
expects to have the same job and the same Basic risk management techniques
family needs and disposable income for at Aside from the outright avoidance or
least several years, but must organise fam- acceptance of the unknown, the business
ily finances through insurance and savings risk situation can be improved through
to anticipate unemployment, illness and application of one of the following tech-
even death. The pushcart vending business niques:
can change its location, its prices, its prod-
uct mix of flowers and bouquets almost (1) Improving forecasts through statistical
hourly and clean out its inventory by research of the critical facts. For exam-
evening. Should it be unsatisfied with its ple, the reliability of a forecast is
business, it can convert from flowers to improved by increasing the sample size
scrap collection or popcorn sales the very (the standard error of the estimate is
next day, unless frustrated by municipal reduced by the square root of the
permits. The retailing business needs six expansion in the sample size). While
months to reform its inventory to changing not all real estate research is statistical
consumer tastes and the manufacturer research, nevertheless, the general prin-
needs five years to research and develop a ciple is that the exposure to surprise can
new product line or relocate its plant. But be reduced by knowing more about the
the real estate developer is locked into a problem in a systematic fashion. Survey
specific location with an immovable inven- research of the consumer, soil testing
and quality control of materials are all
tory of room nights, apartment months or elements of risk reduction through
square feet of leasable area that must be research and information processing.
priced and sold many times, for as long as
25 years, before the total capital investment (2) Combining risks by pooling resources,
is recovered. That is a unique risk manage- by diversifying investments and by
ment assignment, and the developer who improving forecasting through scale of
succeeds most often is the one who takes operations. A four-unit apartment with
most care to validate the assumptions over a single vacancy has lost 25 per cent of
which it has some control and to cushion its income while a 100-unit building
the enterprise with tolerance for surprise with ten vacancies has a 10 per cent
and those changing conditions over which vacancy loss to gross income, a far more
there is little control. The real estate process stable situation.
is concerned with identification of the (3) Shifting risks by insurance contract,
explicit and implicit assumptions on which accepting the small certain loss of an
each consumer group, each infrastructure insurance premium rather than the
and each production element of expertise is unpredictable loss of unknown fre-
operating in order to allocate risks among quency and severity of some insurable
those who benefit and those who pay each catastrophe like fire, collapse, death or
development alternative. disability. Most static risks, contingen-
cies which are sudden, external, ran-

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Journal of Property Valuation & Investment: 10 Graaskamp

dom and unpredictable as to time, are give up the property to the lender
insurable. through foreclosure or voluntary con-
(4) Shifting the risk by two-party contract. veyance of deed in lieu of foreclosure.
The escalator clause in leases is a classic Business censure for mortgage default,
example of shifting the variance in ris- while still damaging to the developer,
ing operating expenses or real estate has weakened significantly in recent
taxes to the tenant; the construction years.
contract shifts some of the risk of rising Not only do the parties to the development
material and labour prices to the gen- process seek to arrange the best possible
eral contractor, but in recent years there solution to their problems, but also they
has been hard bargaining so that devel- must anticipate the many less favourable
oper and contractor each share a part of alternative outcomes to a given set of
the risk. Careful study of development assumptions in order to survive an upset of
ventures between private and public their plans.
agencies will show that the majority of
the contract is allocating responsibility
for political administration or construc- Time as a critical risk element
tion according to the expertise of each.
The passing of time is the most critical risk
For the dynamic risks of management, in the development process. Time permits
the best controls are the pains of penal- the power of compound interest to erode
ties for the failure to perform and the the developer's resources, and it allows the
profits that go with expertise in the exe- conditions of competition and consumer
cution of a plan. needs which were true when the project
(5) Limiting liability for losses, through the started to change significantly. Perhaps it is
form of ownership as a corporation or the impact of compound interest which is
limited partnership, or exculpatory least understood by most government regu-
clauses (which say the lender can only lators and most often used for extortion by
take the property in case of foreclosure) those few who do understand it. Remember
with which one party releases a second that a project with US$1,000,000 invested at
from an obligation to perform or for a nominal construction interest rate as low
damages as a result of failure to per- as 12 per cent per annum costs US$10,000
form. interest for the first month, US$333 a day
(6) Hedging is a term which covers a wide and then US$11,200 the second month, etc.
variety of devices for protecting oneself If the developer had hoped for a net profit
against future price fluctuations or of US$50,000, a total delay of four months
other future contingencies. For example in completing the project will not only
a buyer can make an offer to purchase, cause the loss of that profit in additional"
contingent on future realisation of polit- interest charges, but also may give the ten-
ical approvals, financing or other ant the right to break his lease, the owner
requirements. An option to buy, an the right to invoke a loss of use penalty, the
option to repurchase or a variable inter- mortgage lender the right to renegotiate
est rate mortgage are forms of hedges. more expensive terms than those in the
The classic hedge in real estate is a original commitment and a competitor the
mortgage loan for nearly 100 per cent of opportunity to finish first and capture the
the development cost without personal market.
endorsements. If the project succeeds, As money and time are expended on the
the borrower can call out the equity project, time becomes of the essence in
profits by selling the property and pay- achieving expected revenues from sales and
ing the loan from the proceeds. On the rentals. Thus, it is not uncommon to see tall
other hand, should cash flows and buildings where the top floors are still
appreciation prove inadequate, the bor- being structured while the bottom floors
rower can default on the mortgage and are already receiving tenants. In a slow

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Journal of Property Valuation & Investment: 10 Graaskamp

office market it may be cheaper to build Figure 2 Report type categories within
three 100,000 sq. ft buildings, one after the general category of feasibility analysis*
other, rather than a single large 300,000 sq.
ft building where the economies of scale Strategy study: selection of objectives, tactics and
can be quickly lost to the cost of carrying a decision criteria
vacant inventory of space for even a rela- Market study: economic base studies or other
tively few number of months or years. The related aggregate data review
cost of carrying a vacant inventory of space
Merchandising studies: consumer surveys, com-
can sometimes be controlled and often sig- petitive property analysis, marketability evalua-
nificantly reduced by an investment in mar- tion, etc
ket and merchandising research. It is a
customer and the rate at which customers Legal studies: opinion on potential legal con-
absorb space that drives the cash cycle straints, model contracts or forms of organisa-
tion and political briefs
development process. A careful study of
each market segment for demographic Physical design studies: engineering, land plan-
characteristics, the needs and motivation of ning and architectural studies
the consumer, priorities in terms of a fin-
ished product and the price the consumer Compatibility studies: impact analysis of project
on community planning, environmental quality,
would be willing to pay is merchandising fiscal solvency or other public policies
research. American developers have tended
to neglect marketing research in risk man- Financial studies: economic modelling, capital
agement in favour of faster construction budgets, present value and discounted cash
methods and more elaborate contract allo- flow forecasts, rate of return analysis and finan-
cial packages.
cations of risk among money partners and
government agencies. Nevertheless, cash * Modified from work of J. A. Graaskamp, Guide to Feasibility
from rapid occupancy or sales turnover of Analysis, 3rd ed., Society of Real Estate Appraisers,
Chicago,1980.
inventory as a result of careful research is
the best method for reducing the relentless
pressure of compound interest.
vidual or firm deal with all of the feasibility
Preliminary budget concerns: topics and report types equally well due to
producer group the necessity of specialisation, the bias of a
single viewpoint and the gaps in profes-
Feasibility analysis sional education.
The sequencing of analysis depends on
Feasibility analysis is a generic term which the problem, and ultimately there are only
groups a variety of predevelopment studies
three types of real estate feasibility prob-
by generalists and specialists in a system-
lems:
atic philosophy of inquiry to determine
facts that are reliable, assumptions about (1) the search for the most fitting site for a
the future that are consistent with past use(s)
experience and tactics which will minimise (2) the search for the most fitting use(s) for
the variance between objectives and realisa- a specific site
tions (Graaskamp, 1980; Messner, Boyce, (3) the search for the most suitable invest-
Trimble and Ward, 1977). A real estate con- ment by investors.
sultant would categorise various report
types as suggested in Figure 2. A developer The most common situation is the site in
builds only what it can finance, and lenders search of a programme for use by the spec-
should finance only those projects for ulative developer. The use in search of a
which there is a defined consumer group site, such as the family unit seeking new
representing effective demand in a speci- housing for its activities, is generally in a
fied period of time. Seldom can one indi- more flexible position of first specifying a

630
Journal of Property Valuation & Investment: 10 Graaskamp

programme and then searching for the est and principal payments divided by
most fitting site. The development process gross rents indicates that the breakeven
is most successful when the developer first point is too high at .89, even without
researches a programme in terms of a mar- allowance for cash replacements and
keting target and investment criteria and improvements to the property. A cash
then acquires land most likely to advance breakeven or default ratio of .85 would
that programme. mean a developer could survive a 15 per
cent vacancy or an increase in operating
Approaches to determining feasibility expenses and real estate taxes of 19 per cent
[(268,421 x .10) ÷ 112,176 = .239 or 24 per
The revenues of a development come from cent less 5 per cent vacancy]. At this point,
either rental income or sale of space-time the project would have to be scrapped,
unit and the real estate development postponed, or sent back for redesign. It
intended for rental purposes provides the would make more sense to begin with mar-
clearest and simplest demonstration of how ket rent and solve for the total capital bud-
a space-time unit and a corresponding get that would be justified. Moving from
monetary value are irrevocably linked rent to budget is sometimes called the 'back
together. If the total capital budget has been door' approach but is the essence of many
set by a completed architectural pro- feasibility studies and required on the FHA
gramme, it is then possible to determine the 2013 form for all multi-family FHA insured
rent required per unit — a 'front door' rental projects, and most state housing
approach; more realistically, the developer finance agency forms. The justified building
should determine the market rents and budget, once determined, becomes part of
additional supply of space required in a the programme but may be modified by
given sector and then work backwards to adjustments for the discounted value of
establish the capital budget justified by rev- other investment objectives such as infla-
enues and control of the design. Too often tion gains, income tax benefits or advertis-
the design specifications are set so that the ing value and other benefits to the owner/
rents required to justify the project are out occupant.
of reach of prospects in the marketplace.
As serious as the marketing problem Regulation of capital
may be to the developer, the key financial
ratios of debt cover and default ratios There was a time when the real estate
would be unacceptable to any mortgage development process involved individual
lender. The debt cover ratio is the relation- small firms specialising in just one step of
ship of net income to debt service; and for the total development procedure. One firm
office buildings, institutional lenders would subdivide lots, another would build
demand that the pro forma ratio fall between the houses, a third would build the retail
1.2 and 1.3, a parameter which has been rel- buildings and a fourth would specialise in
atively constant for many years (ratios office and industrial facilities. The latter
available from the American Life Insurance were typically built primarily by users who
Institute, Washington, DC). The solvency rented their surplus space to the general
test is the cash breakeven point of the public. Projects were small, prices were
building as a business, often termed the lower and risk capital was local, although
default ratio. Lenders and equity investors commercial property loans were available
may agree that for the small suburban from national insurance companies. Today
office building with multi-tenants with the larger development firms have inte-
three- to five-year leases, they would like to grated the entire development process from
see a cushion of 15-20 per cent between the conversion of raw land to building sites
gross rents and all operating expenses and through the construction, marketing and
debt service commitments. The sum of management of the total neighbourhood.
operating expenses, real estate taxes, inter- Not only has the scale and required capital

631
Journal of Property Valuation & Investment: 10 Graaskamp

expanded significantly from small develop- more regulated than capital in the private
ments to large mixed-use developments, sector. Referendums are required for
but also the variety of expertise and there- municipal bond issues. The IRS closely
fore profit centres retained by a single firm reviews economic development bonds and
has expanded in a corresponding fashion. state and municipal charters. Also, Con-
The development firm is attempting to con- gress is reconsidering the proper uses of
trol as many profit centres in the develop- tax-exempt bonding because voters and
ment process as possible in order to legislators at all levels are more nervous
increase its share of the cash flows that are about capital risk than are private investors.
generated by the development and opera-
tions process. However, larger scale pro- Investment purchase of after-tax cash flow
jects in an economy of generally rising and
inflationary costs require very large Money managers for long-term investment
amounts of capital. Therefore, the develop- funds are purchasing a stream of cash pay-
ment process is a partnership between ments over many periods of investment
those with the expertise to produce the which are generated by real estate. Cash
product and manage the development busi- payments may result from rental opera-
ness and those with capital, typically more tions (subject to the income tax), occasional
passive institutions and investor groups. A refinancing of the rental project (generally
shortage of high-quality buildings and not subject to tax), net profits from resale
changes in tax laws should reduce turnover (generally subject to capital gains tax) or tax
and lengthen holding periods to span sig- savings to other income of the investor due
nificant changes in future use. A general to temporary deductions for accelerated
trend in the real estate development pro- depreciation, investment tax credits or
cess toward selective investment by groups other tax incentives. It is this stream of cash
of individuals, institutions, or consortiums which is termed cash throw-off before taxes
of public agencies and private real estate or cash flow after taxes. When this cash
investors is leading toward more regulation flow is increased by a tax shelter of other
of real estate financial instruments, similar income or occasional surpluses from refi-
to the regulation of securities by the SEC. nancing, it is termed spendable after-tax cash.
The Internal Revenue Service (IRS) is con- Once the basic financial parameters of a
cerned with the various tax attributes of project have been estimated using the front
each financial format and of the participat- door and the back door approach and stud-
ing members in the investment. ies discussed earlier, then the financial ana-
Since pension funds may provide large lysts convert these facts and assumptions to
amounts of equity for real estate in the cash flow projections over five to ten years'
future, the investment standards of the time using annual, semi-annual or some-
Employees Retirement Insurance and Secu- times quarterly projections. Those who reg-
rity Act (ERISA) will influence real estate ulate real estate investment are providing
development. Federal levels of regulation administrative rules and parameters on
of real estate investment may be expanded cash flow projections so that financial anal-
if efforts to control inflation shift towards ysis must move on from the simple basic
selective credit control rather than general front door/back door approaches outlined
monetary and fiscal controls. In short, the in this paper.
public controls on land use and consumer Different investors may participate in the
protection which have so complicated real estate project simultaneously by means
development are being matched by pro- of a variety of financial instruments,
gressively more complex federal, state and depending on their investment profile per-
trade association rules on capital invest- ceptions for income, capital gain, safety,
ment in real estate (Roulac, 1976). management ability, etc. One investor may
Capital investment by municipal govern- own the land and lease it to the real estate
ment and infrastructure agencies may be venture for a steady rate of return over a

632
Journal of Property Valuation & Investment: 10 Graaskamp

40-year time span, expecting some protec- typically are not adequate to provide for
tion from inflation because at the end of 40 price cutting. As one analyst once stated: 'If
years he or she will own the land and you compete on price, there is always
building. The second investor may prefer to someone who can build for less, and by the
be in the position of mortgage lender, grad- time he learns his true costs, all of us will be
ually recovering the investment from amor- broke'. Therefore, marketing is intended to
tisation and possibly avoiding inflation by create a product which is unique, in terms
participating in a share of the increases in of sensitivity to the needs of the consumer,
gross rent or net income. A third investor and which reduces the other costs of the
might be willing to accept a small cash divi- consumer to a point where the intended
dend and be entitled to use all of the buyer or tenant will pay full price.
income tax benefits available to the equity A strong marketing position requires
owner of the project, while still a fourth careful research of the needs and budget
investor would pay hard dollars up front limits of the prospective user. No American
for the right to manage the property for a industry spends less on legitimate con-
certain percentage of the gross rent and the sumer research and product development
cash throw-off. The supply of capital from a than does the real estate industry. This fail-
variety of sources, contract instruments and ure to spend even 1 per cent of project bud-
rate of return viewpoints is called tiering gets on primary research about the
and requires a thorough knowledge of cash intended consumer is one explanation for
flow planning and financial ratio analysis many business failures of real estate pro-
as well as the present value concept of jects across the land. Developers simply
money. In recent years, tiering of capital for misjudge the number of consumers in the
real estate has generally included public market, the needs as those consumers per-
capital. ceive them and the rate at which new units
can be absorbed in the marketplace. There
is great irony in the fact that mortgage
Marketing: the key to development lenders expect insurance premiums to be
Market research paid in advance in case the project should
burn down but typically require nothing in
The revenue flow, on which all assump- the way of original research to discover
tions for raising capital to build the real whether the project will rent up. Neverthe-
estate rest, begins with a customer. Selling less, real security for their loan is a cus-
is a method of persuading the customer to tomer, not a fire. Lenders assume that a
accept what is being sold, while marketing developer with 'a track record' knows its
helps shape the product and the service to market from past projects, but past success
the needs of the user (Roca, 1980). Market- is no guarantee that any demand remains
ing must serve three ultimate user groups: unsatisfied or that market action has not
the individual purchaser or tenant, the col- shifted its location and product preferences.
lective users operating through the political Design serves society best when it serves
process to approve or disapprove a project the intended user rather than the normative
proposal, and future users who can be standards of the designer or developer or
expected to convert a structure to changing yesterday's market.
lifestyles and needs at some point in the
future. Market data versus merchandising data
Marketing is also intended to protect the
developer from the uncertainty of competi- Market data is typically aggregate data
tive pricing. Free enterprise includes the art describing population by age group,
of creating a monopoly, if only for a income category, business activity, location
moment, so that as a developer one is not of residence, average price of home and
forced to use price cutting as a primary other statistical information typically col-
device to acquire business. Profit margins lected by planning offices, census data and

633
Journal of Property Valuation & Investment: 10 Graaskamp

other public sources. Market data will assist the same net product of useable space. Cus-
in scaling the project so that 800 housing tomers may be attracted to a store with bet-
units are not planned for a community that ter access to parking, wider parking stalls
will only need 600 in the foreseeable future. or better linkages to work and home. An
It may measure the expected rate of absorp- alternative is to reduce the level of anxiety
tion for broad categories of space, say of the user in terms of security of property
500,000 sq. ft of class A office space, 200 and person or as to future adjacent devel-
condominium units or 600 single-family opment or control of other tenants in the
lots per year. More to the point, however, is project. A third method of creating a com-
how much of that potential market can be petitive edge is to enhance the consumer's
captured for a specific project and this cap- sense of well-being by selling the more
ture rate is related to merchandising data. comfortable romantic lifestyle of a particu-
Merchandising data is typically collected lar project, or the prestige which is to be
with a specific project in mind and involves transferred and contributed to the con-
primary research by the analyst with the sumer tor locating in a specific project.
objective of determining the competitive Another method of building a competitive
standard of project attributes and discover- edge is to shift the balance of who typically
ing the unmet needs in the market which pays and who typically benefits in the mar-
could provide the competitive edge. In someketplace. For example, the apartment pro-
markets, the competitive standard becomes ject located on the site adjacent to a major
a very precise and well-known set of speci- park provides all the benefits of open space,
fications. The competitive standard in control of neighbouring properties and con-
apartments in the South-West reveals con- venience of recreational alternatives with-
sistent standards for the number of inches out necessarily requiring the tenant to pay
of counter space, cabinet fronts, the weight the true cost. Of course, it may be that the
of carpeting, the cost of the dining room fix- site is more valuable because of its proxim-
tures and the basic size of rooms. The con- ity to publicly maintained and operated
sumer has taken these for granted and amenities. Nevertheless, in the long run,
competitive developers have studied each there is a significant cash cost benefit shift
other carefully to measure what the con- from those who live closest and enjoy the
sumer expects as a basic minimum. Every- park most to those who are expected to pay
one expects a bathroom; however, the real estate taxes in general to support parks
bathroom may have a variety of layouts in other parts of town from where they
which are more convenient, private, spa- themselves live.
cious, etc. Office buildings also may have a Finally, the competitive edge may be cre-
basic competitive standard of one parking ated by shifting or reducing the risk of
stall for every 300 sq. ft of gross leasable change. For example, a primary advantage
area. Ceiling and lighting systems may be of a shopping centre development where
standard, and wall systems may be stan- the developer has achieved an operating
dard. agreement with three or four major depart-
A competitive edge depends on finding a ment stores is that it can now promise the
true unmet need of a particular consumer smaller retailers who locate within that
group. It is not an edge obtained through shopping centre control of the total shop-
gimmicks and cleverness on the part of the ping environment by a single landlord. In
designer or the developer. The competitive addition, the operating agreement guaran-
edge typically is created by finding meth- tees joint marketing and promotion of the
ods to enhance user self-esteem or to centre by major department stores who
reduce the cost of friction, of anxiety or of have committed themselves to operate
inefficient space layouts housing the user's under their own brand names for at least 25
activity. Medical office layouts can be more years in the future. The developer will
efficient with structural column systems maintain certain tenant mixes, parking
which may not fit general office use with ratios and housekeeping standards for long

634
Journal of Property Valuation & Investment: 10 Graaskamp

periods of time. Thus, the small retail busi- ment attitude studies in advance of public
ness is willing to pay a premium rent to be and private planning efforts.
in a shopping centre as opposed to locating For example, a developer acquired a
in a commercial strip where there is no three-block area of a downtown, single-
assurance that those department stores on family residential area with the intent to
which it may depend for primary draw, the upzone the land for garden apartments.
parking on which it may depend for conve- The plot had been vacant for many years,
nience and the tenant mix and marketing and there was now a scattered stand of wal-
efforts in its symbiotic relationships can be nut and maple trees. A political survey by
sustained over long periods of time without mail of residents within half a mile of the
drastic and critical changes detrimental to site generated a high rate of response so
its business. that the developer was able to defuse latent
There is little monopoly to be gained by fears before any preliminary plan gal-
providing the identical product as those vanised the neighbourhood into an unnec-
already in the marketplace. Monopoly is essary political confrontation. The plan
achieved when you can find a group showed that two dead-end streets were cul-
unserved adequately by present offers, a de-saced and flanked with single family
gap, if you will, of unmet needs within an townhouses compatible with existing
array of small micro-markets that in total homes. Favourite neighbourhood pathways
create that vague and nonexistent phe- were maintained in the site plan, paved and
nomenon called the real estate market. Con- lit up. Resident parking was placed below
sider that a 25-unit apartment project today the proposed structures; trees were
may require as much as US$1,000,000 in mapped and virtually all were saved in the
capital and US$240,000 of annual rents placement of structures. Guest parking was
(sales), which is more capital and more bermed and driveway outlets carefully
sales than is characteristic of 65 per cent of placed to avoid conflict with a neighbour-
all American enterprises. Nevertheless, this ing church, arterial roads and bus stops.
big business needs only 25 customers who The architectural styling required use of old
find it unique because of its sensitivity to brick, shingles and the wood detailing of
their needs. the early Victorian and midwest farm styles
which characterised the neighbourhood.
Finally, a Victorian gazebo was placed at
Marketing research and the collective
the key intersection as a bus stop and as the
consumer
logo for the development.
Recently, marketing research survey tech- The neighbourhood ad hoc committee not
niques have been used advantageously to only approved the architectural pro-
control political risks which are inherent in gramme, but also secured the approvals of
a regulated process like development. the City Planning Commission, which
Before spokesmen for neighbourhoods or issued a commendation. Research pre-
trade associations or other collective seg- vented inadvertent detailing of preliminary
ments of the community can render public plans which might have triggered bitter
opinions which are difficult to retract, it is political resistance leading to a hardening
useful to discover whether expressions of of positions to avoid personal embarrass-
concern about traffic congestion, environ- ment. Egos in place of facts ultimately leads
ment or fiscal impacts are only good rea- to unreasonable and noncommunicative
sons for the tendency of people to fear negotiations of all parties in the real estate
change in the physical status quo of their development permit process.
lives. These fears can be recognised and Another primary problem in marketing
resolved in preliminary plans to defuse research is determining whether the collec-
negative political action. Indeed, some tive consumer truly understands the fiscal
political pollster firms can be found doing impacts of broad-value judgments which
housing, downtown mall and redevelop- are often the grist for newspaper and politi-

635
Journal of Property Valuation & Investment: 10 Graaskamp

cal debates. Growth management may need A significant part of the merchandising
to be redefined in terms of long-term fiscal strategy is anticipation in the design pro-
impacts, as has been done for a number of gramme and product perception by means
communities in California (ie, San Jose) and of the sales themes, logos and competitive
elsewhere recently (Roca, 1980; Gruen sales points to be advanced by the project.
Gruen and Associates, 1976). The residents Moreover, the designer needs to consider
may be working against their better interest what will be used as an initial sales area,
by blocking further development of a tax which units may serve as models and
base which can share in the costs of provid- whether the approach zone to the project is
ing adequate water treatment, expanded a positive reinforcement of project image
sewer facilities and other services desired The approach zone, of course, will consider
by the community. signs, entrances, paving, site development
and the visibility of positive project ameni-
ties to the 'prospects' arriving on site by
The pre-architectural marketing foot or by car. Too often the architect treats
programme the merchandising campaign of the devel-
Careful consumer marketing research oper's marketing force as an area of disci-
through a telephone survey, mail question- pline remote and unrelated to the design
naire and personal interview permits devel- process. The result will be projects like
those designed for the New York Housing
opment of a pre-architectural marketing
and Urban Development Authority, which
programme for each project proposal. First, placed chic, cubist, early Marekesh, epoxy
it is necessary to define a particular market apartments in small New York com-
segment or micro-market toward which the munities which favoured the New England
project is directed. One developer in the colonial and early American styles of archi-
Chicago market has identified 13 single- tecture. Neither logo, project title nor fur-
family home purchase groups ranging from nishings related to the preferences and
the young family with children to the patterns of the community, and the initial
unmarried, single individuals seeking some fears of subsidised housing were simply
tax shelter for their professional income. aggravated by providing no sense of archi-
Each group is surprisingly predictable in tectural identification with the community.
terms of needs, budgets, season of the year Marketing is not a distinct discipline from
for purchase and style preferences. Another design but is in fact a significant portion of
award-winning builder in Denver summa- the pre-architectural programme.
rized the personality of single-family home-
buyer segments at the upper end of the
market by stating that his firm catered to Anticipating the future user
the French cuff and studs set, competitor A Most structures outlive the lifestyle, cul-
reached the button-down collar boys, while tural and business needs for which they
competitor B focused on the Pendleton were originally intended. Recently, devel-
plaid woollen shirt crowd. Similarly, office opment emphasis has been placed on the
building users can be segmented by those refurbishment of older buildings to new
whose customers come to them versus and unintended uses as compared with
those who go out to meet the customer on their original function. These adaptive use
his turf, those linked to the courthouse or efforts have been most successful where
the financial district and those linked to the floor load capacity in the old structures was
suburban service base, those linked to pro- generous, ceiling heights were adequate
duction facilities and those closely linked to and column spacing was modular and flexi-
merchandising areas, and so on. Each will ble. Long-term investors now recognise the
rank style, convenient access of parking, probability that many buildings will change
special linkages, monthly costs and peer uses during the time of ownership so that
group proximity quite differently. investment safety is linked to project

636
Journal of Property Valuation & Investment: 10 Graaskamp

designs which anticipate convertibility of avoiding the wholesale obsolescence of

space-time units from one function to neighbourhoods, the glacial pace of land-
another. use succession and the intolerable cost of
The alternative to recycling is a high past urban renewal programmes.
profit margin and high rate of return on Foreseeable future trends have many
capital which permits rapid recovery of subtle impacts on real estate development.
investment and junking of improvements at Conservation of prime agricultural lands
the end of their useful life. A multi-story for future food supplies may shift residen-
parking garage might be better designed so tial development into the hills or into
that the floors are flat rather than sloped higher density condominiums in formerly
and have a higher floor load capacity than exclusive, detached single-family home
required for American over-sized automo- areas. Subdivision layouts w i l l recognise
biles. In the foreseeable future smaller cars the need for better solar orientation of
will mean a higher concentration of weight structures, to anticipate improved technol-
loads, and in the longer term it may be ogy and changing cost effectiveness ratios
desirable to convert parking garages to for solar energy, and home design will
office space or warehouses. The added cost invest in features which reduce heat gains
might be offset by parking fees, higher sal- and losses, not only to reduce current
vage costs in the structure or lower interest energy consumption, but also to attract
rates on capital provided. even more energy-conscious buyers at the
For many years, rental office buildings time of resale, thus protecting investment
have used utility grid systems, modular value. As these added costs modify the
ceiling units and H V A C systems which pricing structure and trade-off issues for
anticipate continual rearrangement of office the real estate consumer, the defined com-
layouts and equipment. This anticipation of petitive standard will begin to shift. For
future users must be extended to other example, in California the basic 1,500 sq. ft
forms of real estate and the added capital house has shrunk recently to perhaps 1,300
cost incorporated in the capital budget and sq. ft in order to maintain price, to reduce
rent structure. Computer cash flow models the space that must be heated and cooled
have made it possible to compare cost bene- and to hold total monthly housing costs
fits of alternative building concepts in within income limitations of the consumer.
terms of maximising the present value of Notice that the ability to internalise these
spendable cash for private investors or min- requirements in the capital cost/monthly
imising the present value of building life- payments and therefore the cash cycle of
cycle cost outlays on public buildings. It is the user begins to provide an infinite num-
imperative that all parties in the develop- ber of trade-off decisions for the developer,
ment process learn present value methods the consumer and the public agencies regu-
of money management reflecting com- lating the development process. Over-regu-
pound interest over time (Grant and Ireson, lation can adversely influence capital cost
1970). Although future needs and lifestyles and monthly cash payments (US General
cannot be anticipated with great accuracy, Accounting Office, 1978). Sensitivity to the
there is growing recognition that the unde- cash cycle and therefore the rent or pur-
fined future user must be considered chase price that is within the means of the
explicitly in the initial investment formula consumer permits a gradual and economi-
and design programme. Institutional cally smoother transition to a modified
investors need long-term productive invest- view of the marketing and development
ments with protection against the reverses process.
of a fast changing society; society needs
structures which can be recycled in order to
The ethics of fit and monopoly
conserve the energy required of new devel-
opment and to speed the response of the The concept of monopoly or design to
urban fabric to changing conditions, thus channel demand insulated from direct price

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Journal of Property Valuation & Investment: 10 Graaskamp

competition to a project is often regarded as which capital budgeting decisions are made
suspect with respect to the free enterprise in the development process.
system, but just the opposite has been
demonstrated here. There is a direct rela-
tionship between the ethics of fitting a pro- Conclusion
ject to the environmental constraints of a Each new development, large or small, is
site, to the needs and budget of the even- an enterprise and a sub-system within a
tual user and to the concerns and fears of larger environment. The form and
the collective consumer, and the unique- behaviour of that enterprise will be a con-
ness of a project which creates a monopolis- sensus or equilibrium between external
tic dimension in its pricing. A full price forces of interest and the force of talents,
willingly paid by the individual user mea- energies and resources internal to the
sures satisfaction and maximises invest- development enterprise. Such an equilib-
ment value by stabilising many of the rium is reached more efficiently through an
critical risks of the development process for appreciation of joint objectives of develop-
the investor. Feasibility was defined as ment participants rather than through con-
measuring the fit of the project to its physi- frontation and desperate pursuit of total
cal context, to its intended users, to the victory in a contest of wills. All of the
objectives of the investor and to the limited development groups — the consumer
resources of the developer and the commu- group, the production group and the public
nity. While fit of a project design to soil infrastructure group — are limited by their
profiles and topography maps is taken for cash receipts and the need for solvency as
granted, lest the structure collapse or sag, it well as dependent upon one another for
is not generally accepted that the project their cash income; each has a financial
will financially collapse if it is not sensitive interest in the survival of the others. Thus,
to customer profiles and cash cycle topol- solutions to business and political problems
ogy. These steps will greatly reduce both are most productive in a cooperative envi-
the variance between expected revenues ronment (McDonald, 1977).
and those which are achieved, and the vari- The development process is a loop sys-
ance in cost from budgets to those which tem involving many sub-systems or cash
are actually incurred, as well as reduce the cycles. Today's buyer of a development
risk of upset due to political resistance, product is tomorrow's customer for ser-
rejection by the financial markets or inflexi- vices from the public infrastructure. With-
bility to changing conditions and market out new customers the infrastructure may
needs. Sensitivity is the source of monopoly not operate at its most efficient scale, thus
pricing, and strong demand with stability overcharging consumers or deferring char-
of the pricing structure is the primary con- ges to future users.
cern of the financial manager, the market- The development process is the interac-
ing director and the physical planner. In the tion of the three major groups to produce
past, pre-architectural or design pro- land use plans and building specifications
grammes were primarily concerned with where the present value of the benefits to
product specification and site characteris- each group exceeds the present value of all
tics. However, modern design philosophy expenditures that will be required of each
has been broadened to recognise that the group over the life of the development.
product and the site contribute significantly More specifically, it is a cash cycle invest-
to revenues and expenses of the enterprise. ment which requires: (1) present value of
Because the financial flows of the project the benefits to equal or exceed present
are intimately and inseparably related to value of the cash outlays; and (2) cash
the design product, it is necessary to recog- receipts from all sources including borrow-
nise the cash cycle criteria of the users, the ing and ownership interest to equal or
selection criteria of capital investors and the exceed net cash outlays, including repay-
mechanisms of risk management with ment of debt and dividends on ownership

638
Journal of Property Valuation & Investment: 10 Graaskamp

capital in each accounting period, in order Acknowledgments

to survive as a justified economic project.
Public buildings should be designed to This paper is published with kind permission of the
Urban Land Institute. It was originally published in
minimise the present value of all cash out- 1981 as part of the Development Component Series.
lays, direct and indirect, over the life of the
facility, and private development should
maximise the present value of spendable
cash dollars after all expenditures, includ- References
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