The Great Recession of 2008/09 has caused fundamental changes in the financing of real estate development, changes that will persist for years as the industry de-leverages, vacancies rise and cap rates increase. Valuations of existing properties have plunged, no one knows for sure by how much, but discounts of 40% to 50% are not unusual. Each sector faces its own unique challenges:
- The retail sector, already hard hit with lower sales, is particularly distressed with high
vacancy rates (current estimates are 12% vacancy, a total of 40 square miles of vacant
space), caused by a combination of overbuilding and a wave of retailer bankruptcies.
- In addition to the loss of jobs, the office sector faces a decline in square footage per
worker as technology enables work virtually;
- With further declines and outsourcing in manufacturing, the industrial sector adds to its
growing inventory of vacant square footage;
- Hospitality, a sector that has a history of boom and bust, has a glut of inventory from
prior cycles that can no longer compete in a high amenity marketplace where newer
product sets the pace.
This “perfect storm” of lower leverage, reduced demand, and high inventory has highlighted the growing supply of obsolete, underutilized properties which face bleak prospects for renewal because current valuations of competing properties are lower than replacement, putting a limit on the ability to attract scarce private capital for renewal.
The iconic example of these conditions is the dead shopping mall. At one time, hailed by ULI as, “the quintessential American contribution to the world’s consumer culture”, the conditions that led to the creation of shopping malls and sustained them for decades are changing rapidly. These large unwieldy properties now face the need to convert the vast parking lots and clunky structures into contemporary places. But, where will the capital to fund this conversion come from given that current market conditions will make it mpossible to use purely private sources?
The answer lies in a poorly understood and emerging source of development capital; namely,
public private partnerships. These partnerships address five critical tasks to convert obsolete
1. Lower entitlement risk and funding of pre-development
: The public sector can lower
entitlement risk and reduce pre-development funding requirements by taking the lead on
creating a community-based plan for conversion,
2. Site and access reconfiguration
: Public sector assistance is crucial to improve the usually
poor access and reconfigure parcel lines that constrain conversion.
3. Debt funding
: The public sector can use low cost municipal debt (land secured, tax
increment or lease revenue bonds) to fund infrastructure, parking and other project
components, thus lowering debt costs.
4. Equity funding
: The public sector can provide some portion of the equity component
using land value, tax increment or tax credit funding.
5. Gap funding
: Public sector funding is replacing mezzanine funding as the “value-add”
gap funding that used to be a common component of the private capital stack.
The Great Recession has accelerated an already existing trend toward public private partnerships,which have become inherent to the more economically and physically complex, contemporary style of development. And yet, as important as public partnerships have become in contemporary development financing, frequently opportunities are missed and deals badly made because the state of the art for formulating and executing public private partnerships is still relatively new and evolving. Many public agencies still have a weak understanding of the private real estate process and its economics, resulting in unrealistic or constraint-driven deal making. Similarly, the private sector frequently misses opportunities because it is uncertain on how to craft a partnership and is frustrated with what it considers a bewildering, time-consuming decision making process.
Our session on “Using public private partnerships to create value-added conversions” will cover the principles and practice of successfully creating diverse and complex public-private partnerships to capitalize on the inventory of properties that are ripe for value-added conversion.
The webinar will explore case studies and will provide a download of background material and models that provide you a perspective on how you can pursue opportunities for these transactions in the real world regardless of whether you approach these from the public or private sectors.
April 30, 2010 1:30 PM Eastern