Architects and real estate developers have traditionally formed an uneasy alliance. That's because they exist on opposite ends of the disciplinary spectrum. One is trained to take the aesthetic high road; the other focuses on the bottom line. Among architects themselves, there is a similar kind of schism--between those who stake their reputation on one-of-a-kind, high-end design, and those who run a more business-oriented practice designing homes for hundreds of people at a time.
The trouble with both approaches, of course, is that they don't make much of an impact on the landscape at large. Custom-designed homes are rare in most residential towns across America. And truly innovative design too often loses out to the economies of scale imposed on production builders.
There is a third camp, though, of architects taking the leap into speculative real estate development. They're willing to risk more financially so they can both control their designs and compound their profits. Whether it's investing in one single-family home at a time or a village of condominiums, they're cleaning up in their communities--in more ways than one.
Risky business
"Over the last several decades, architects were getting great advice from attorneys and insurance agents on how to avoid risk. But then we started making ourselves less valuable," says Richard Kremer, FAIA, of Louis & Henry Group, a 60-year-old firm in Louisville, Ky. "And if you don't take risks, there's not as much reward."
His firm specializes in institutional multifamily projects such as senior housing and college dormitories. Seven years ago the practice evolved to include two separate divisions--construction management and real estate development. "The idea is, we hire ourselves to develop the real estate, then hire ourselves to design, and then hire ourselves to build," Kremer says. The partners took this more proactive approach to capitalize on the opportunities presented by their longtime clients, who often have outdated facilities but lack the expertise to find creative financing on their own. Typically, the Louis & Henry Group will approach such clients and offer to put all the pieces together.
"It's ingrained in architects to be creative problem solvers but not problem identifiers," Kremer says. "So many architects have decades-long clients who have facilities and land. The client could put such-and-such a building on that corner and make some money. But architects don't initiate the project. It's a different mind-set seeing the opportunity and knowing how to do that, but it puts you in a stronger position."
That's true even if you're not the party initiating the work. The same reality that drew architects Brad Buchan- an and John Yonushewski into construction led them to do development: It gets them into the design conversation further upstream. "Probably the single most valuable thing we bring to the table is our ability to conceptualize and price things early in the process," says Buchanan, AIA, Bu-chanan Yonushewski Group, Denver. "The old saying 'If you're in the room, you're in the deal' is true."
Many of the firm's cli-ents treat it like a mutual fund. They come with cash or land that they don't have the experience to deal with. BYG will act as the developer either for a fee or for an equity position, then serve as the architect and builder. "If we wanted to, we could be successful just doing development," Buchanan says. "But we love doing architecture and construction. The development piece feeds that machine, which is not as volatile and risky."
Indeed, the biggest risk factor is cash flow. It takes months and sometimes years of working without compensation to get a project entitled, or approved by bankers, city hall, and citizens' groups. "Developers take enormous risks," notes developer Joel Alstein of the FAR Group, Cambridge, Mass. "During the acquisition and financing phase, you need to put together a very comprehensive package to show financing institutions. Architects burn through perhaps 60 percent of their design budget during this phase."
And that's just design fees. Developers must pay for other services such as appraisals and traffic and environmental studies. They may have to dig deep into their pockets to come up with enough money for construction and scheduling overruns. And then there are marketing risks. What if nobody rents the units? "Like in love, timing is everything," Alstein says. "You have to be at the right place at the right time."
When it comes to managing design fees, however, Kremer offers some consolation. Developers often ask architects to do essentially the same thing, he says--submit free schematics in hopes of getting the commission. The advan-tage of initiating your own project, of course, is that you're not competing with other architects. If you succeed in packaging it, it's yours, and the pot is sweetened with a developer's fee paid by the lender--usually 5 percent to 10 percent of the construction budget.
Design-side economics
Next to the prospect of getting a bigger piece of the pie, the very idea of having absolute design control is too much for some architects to resist. "People say, 'I just want to spend my time doing design,'" Buchanan says. "But we get control of the design like they've never known."
Kremer concurs. "In a more conventional practice, the architect is sort of in a black hole. He doesn't see the impact of his design on the construction budget or the development budget. So knowing how to do development is a freeing process. If you have better control of the finances, you have bet-ter control of the design as well." He's taught his 30-some architects how to do pro formas on Excel spreadsheets, playing elements of the design against other itemized costs until a profitable cash flow is achieved.
Buchanan believes that the varied skills required to practice a broader and more integrative kind of architecture appeals to his 45 employees, too. "If you put them back into a normal architectural firm they'd probably shoot themselves," he says. "There's so much breadth in the questions they come up against every day.
"Our mantra is to think like the owner," he adds. "So be one. This is the world the owner lives in--a not-to-exceed, guaranteed-price world. A lot of times architects don't get that. It's a different conversation entirely than you'd have with other clients."
That approach gives the firm more credibility with other professionals and citizens' groups. Whereas developers have a reputation for cutting corners to reap bigger profits, when an architecture firm is the developer, the project's amenities and architectural style are less likely to be questioned. "We've gotten a reputation in city council and with the neighborhood groups that when we're involved in a project, the developer will do the right thing," Buchanan says. "We make choices that affect the bottom line because we think it's the right thing to do. We're architects--we can't help ourselves." For example, the firm regularly chooses not to max out allowable density. It might match a new building's setback with an adjacent building, rather than taking advantage of the minimum setback requirement. "We'll do that because it makes a great project," Buchanan says, "and a great project sells for more money."
Working on a smaller scale, Kevin Cavenaugh, with the architecture firm Fletcher Farr Ayotte, Portland, Ore., also revels in that artistic freedom. His latest personal project consists of a 54-foot by 100-foot piece of land on which he's constructing five loft-style apartments. "It was incredibly liberating to cut costs the way I wanted to," Cavenaugh says, "rather than the way someone sitting across the table from me wanted to." Integral to his design concept is $25,000 worth of exterior artwork by local artists. "A developer would never do that," he says.
Taste test
Just as they design the building and the financing, architects doing development have to design their level of risk. Until you learn the ropes, start with a small number, giving little and taking little. BYG is now a $60-million-a-year firm. But it began dabbling in development back when it was a small operation struggling to keep its doors open. The firm would contract to purchase an empty lot. In one day they'd draw a conceptual design for a spec house. Then they'd put together a pro forma and take the package to an investor or bank. Throwing in $5,000 or $10,000 of their own earnest money, the firm would set up a limited liability company with the investor, specifying an equity share in the deal while getting paid a minimal fee during design and construction--enough to cover their costs. Nearly all the financial gamble was the investor's. "Risk is a quantifiable element that can be managed," Buchanan says. "There are ways of setting up a taste test so you don't risk taking down your financial world."
That's the case whether you're part of a large firm or working alone. As the sole proprietor of his company, Gaver Nichols, AIA, Alexandria, Va., has snapped up nearly a dozen houses-- mostly four-squares and Sears bungalows--in his Del Ray neighborhood and resold them for a tidy profit--more than he would have made in custom de-sign fees, he says. Before that, he converted a Camden, N.J., firehouse into rental apartments. Along the way, he picked up a real estate license to lower transaction costs and help him understand financing and contract language. But he's since dropped it. "People think you're trying to rip them off," he says.
Starting out, Nichols would partner financially with friends or the builder. That lowered his risk and gave him the confidence to manage other people's money. Now he's targeting empty buildings in his neighborhood zoned for multiple use and asking private investors to fund the development. To limit his liability, he prefers to trade some of his design and development services for ownership of one of the finished rental units. Nichols' entrepreneurial arm generates a fair amount of infill custom work, too. Over 13 years, he's completed about 100 projects in his own community, ranging from porch additions and whole-house renovations to custom homes.
Bottom-line management
Development is much more oriented toward banking and the bottom line than architecture is. So architects aspiring to be developers should hone their business skills. Even on the lowest-risk ventures, it's a good idea to set up an LLC on a per-project basis. That legal model creates some degree of insulation, ensuring that any assets lost remain attached to a particular project. Many architectural firms also legally separate design and development services. Like BYG and its development entity, BY Properties, Pappageorge/Haymes, Chicago, is structured as two distinct firms--one handling architecture, the other development. "And never shall the two be mixed," says George Pappageorge, FAIA. "The cash flow situations are quite different. One pays the other's fees if it needs them."
One of the hazards of being a developer, too, is that your liabilities change. As a custom architect, you can get fired from a commission without great financial peril. But during a speculative project, both you and the client may own the house or building. "What if something happens to the buyer in the middle of construction?" Pappageorge asks. "What if they want to make the house three times bigger, or fail to make decisions in a timely manner? Or what if a purchaser files an action that ties up your house in court and you can't sell it? Every few years we learn about more ideas to include in the contract." He also recommends figuring out ahead of time how you'll get out of a deal in case the economy goes sour. Think hard about all possible scenarios, even if they don't seem plausible, and plan for them.
In the loop
The right connections are key to success in this tricky business. Finessing a deal that will fly takes not just luck and meticulous timing, but a lot of research. The canny architect will seek out someone doing exactly what she or he wants to do and ask for guidance. Kevin Cavenaugh got advice from local developers whose work he respected. He invited them to lunch and grilled them on such details as what line items to include in a pro forma.
Scope out attorneys who specialize in drafting development contracts. Get to know real estate agents and appraisers, who spend their days digging for current market information. And bankers are an undervalued source of information. "Most people have relationships with bankers that are distant and fuzzy," Buchanan says. "But they're looking to create opportunities and can give you tremendous amounts of information."
There's also the political piece. "Few architects get savvy about the political process in the area they're developing," Buchanan says. "Get to know the mayor, go to fund-raisers, eat chicken dinners, and introduce yourself to neighborhood groups. They're powerful entities and are fighting for the right thing." A lot of the firm's business is referred through those neighborhood groups. Someone will buy a piece of land and ask the local council whom to work with.
As chair of the Portland AIA housing committee, Cavenaugh organizes monthly tours of cutting-edge projects in the metro area. He sees what others are doing, asks what a project cost per square foot to build and how much it's renting for. "The knowledge gave me a skeletal pro forma to know I could go forward on my own project," he says.
Indeed, whatever the opportunity, make sure you know more about the deal than your real estate broker. "Check out trends happening in individual market segments," Pappageorge advises. "You have to know what you're doing in terms of targeting your market and making sure you're producing something that will be absorbed quickly."
For his part, Buchanan revels in the thrill of the game, which he plays as a precisely calculated gamble: "You'll run it up the flagpole sometimes and it won't work. Maybe the third deal you put together goes. But when it does, it's the most satisfying thing in the world, because you have created from nothing this project that's serving the city you live in. It's the essence of being a master builder. It's what gets us up in the morning."
Cheryl Weber is a contributing writer in Severna Park, Md.
Captains of Crunch
Real estate development may not be rocket science, but it requires a foolproof method for crunching numbers. Richard Kremer, FAIA, of Louis & Henry Group in Louisville, Ky., swears by a little financial calculator from Hewlett-Packard called the 12c rpn, which sells for $69 (available on the manufacturer's Web site, www.hewlett-packard.com). "It's one of the most valuable tools I've found," he says. "You can calculate mortgage payments and rates of return. It's taught me a lot."
Both Kremer and Brad Buchanan, AIA, of Buchanan Yonushewski Group, Denver, use Excel to work up project pro formas. While the documents vary in complexity with each project, every pro forma consists of the same basic components, according to Buchanan:
1. A buy category—what you're acquiring.
2. A build category—the construction cost.
3. Soft costs—these include such items as interest, accounting fees, attorney fees, and closing fees.
4. Marketing—what you'll pay to sell the project, such as a brokerage fee and marketing costs. A small project may require only a $50 marketing brochure; a $25 million project will require, say, a sales party, a ground-breaking party, and a slick brochure.
5. Sell/profit—a calculation of the square footage you'll sell times the cost per square foot. The profit line amounts to line item 5 minus items 1 through 4.
