The Developer Chronicles: Master-planned Projects
In this series, I describe master-planned projects. The discussion focuses on the difference between a one-off project and a multi-stage, multi-year planned development. I explore the factors that great development teams grapple with every day. I hope you find it of value.
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Master-planned Projects #7 Scale Thinking
We touched on the concept of scale thinking last time in relation to design. Most people would think about the opportunities that scale provides, but there are also the negatives, like ‘at scale complacency’ in design.
To start, we’ll deconstruct the meaning of scale. If we assume a master-planned project is bigger and takes longer than a one-off project [according to my definition] then a master-planned project IS an at-scale project.
At scale means more than being physically big. Size is relative anyway. One hectare in Manhatten might represent 10 buildings to be constructed over ten years. That’s a big master-planned project. Whereas one hundred hectares in Montana might just mean 10 lifestyle ranches, a relatively small project. It’s all about the dimension of scale that you are referring to.
Scale Dimensions
No not the ones on a ruler! There are different dimensions to scale when you delve deep into a master-planned development. Often interrelated and all relative:
- Size. If one hectare is a decent sized townhouse project, then one hundred hectares of townhomes is definitely at scale.
- Price. A one billion dollar office park is scale compared with a twenty million dollar office building.
- Unit Volume. One thousand single-family homes is scale compared to fifty.
- Time. A project expected to take a decade is scale compared to one finishing in two years.
- Repetition. Three hundred custom doors is not scale compared to 3,000 of the exact same door. Similarly, one floor-plan replicated 300 times enables ‘scale’ more than thirty customizable plans replicated 10 times each.
- Consistency. Ten industrial warehouses a year, every year for twenty years can be considered at scale compared to 3 warehouses this year, twenty next and 2 the following. One house completed every 5 days, could be considered scale versus 100 houses completed in 12 months and nothing for the next six months.
- Certainty. If we know we are going to ‘win’ 10 tenders a year for an average of 50 social housing units each, is scale, versus having no idea if we are going to win five tenders or thirty in the coming year. Pipeline forecasts to demonstrate certainty of scale are often used by governments with the intention of gearing up public infrastructure industries.
Working the Benefits of Scale
So, what are the opportunities that scale presents?
Well, one of the most obvious would appear to be cost savings through bulk purchases. If you buy one widget at a unit price of $10, buying one-thousand might only be $7 per unit. That’s because the manufacturer has managed to cut incremental production costs, and charge you less and still produce the same margin. Because you are ordering at volume, they might even sacrifice a little per unit margin, because the absolute margin is so much bigger. Economies of scale they call it. Wikipedia describes it this way:
“economies of scale are the cost advantages that enterprises obtain due to their scale of operation (typically measured by the amount of output produced), with cost per unit of output decreasing with increasing scale.”
Take this example. You are developing a master-planned light industrial estate, including all the buildings. To spruce up the monotony of it all the draughtsman has gone all artsy placing a fancy art -deco style pattern set into one of the precast concrete panels on one wall of a building. No one pays any attention until the precast panel price comes back months later. That single wall is double the unit price the quantity surveyor had estimated.
“Why is this,” the QS frustratedly asks the pre-cast supplier manager.
“Well to do that one-off design we have to create a special mold. That will cost us about ten grand to sort out. Every other panel goes through the standard template. So whilst we can deliver 100 standard panels at $10,000 each – a clean $1million- this special panel alone is going to cost you double the rate at $20,000.”
“And if we go all Frank Lloyd Wright and imprint the design on every panel, what will 100 of them cost me,” the QS curiously asks.
“One million and ten thousand dollars. Because we are now replicating the same design, from the same mold at scale, Ms. Client QS.”
The QS ponders her companies business plan for the next five years on this master-planned project, before asking, “OK you priced me for 100 panels. But, what if I place a larger order for 2,000 panels, with 200 to be delivered on the first of March every year?”
After running the numbers the precast supplier manager calls the QS back, “If you agree to pay first-year price plus CPI inflation in subsequent years, we can pre-order concrete and materials, as well as lock in our delivery suppliers. That will get the first-year price down to $8,000 per unit.”
That’s scale (according to almost all of the dimensions we describe above) working for everyone.
In property development, cost savings and efficiencies enabled by scale can flow into different areas up and down the production chain. For example:
Design. One house that is to be exactly replicated 100 times in a subdivision only needs to be designed once. That’s one architectural and engineering fee. It also means a cost-estimator only has to calculate the quantities once. It means pre-nail truss and wall providers, or steel wall fabricators only have to create one set of shop drawings. Similarly, one kitchen design and shop drawing, one electrical layout, one plumbing layout. One set of specifications.
Consenting/Permitting. In some jurisdictions, you can get ‘blanket’ consents for a house plan type. With that consent in place, each time you have a new house to be approved you only have to advise the variations to what has been consented. This can reduce building permit costs and the time it takes to obtain official approval. Consider an arrangement where you get a building permit for a blanket range of details and so long as your consent application only includes those details, you will be granted approval. One builder had an ingenious way of getting this scale-flexibility permitted. He had designed and approved one of the most ridiculous houses ever. Each external wall, floor, and roof junction had different materials. Think brick wall with an aluminum window meets weatherboard wall and a steel roof on one top corner and Cedar siding with a wooden window, meets weatherboard wall meets steel roof meets shingle roof on the next corner! With the improbable house consented, only details in new houses that were not in that original consent needed further approval.
Financial Feasibilities. We discussed feasibilities here but one thing we didn’t touch on is how scale can be your friend when undertaking feasibilities. If you have twenty identical suburban office buildings, indistinguishable in location, then conceptually you have one feasibility replicated twenty times – barring some time-based assumptions over sale, cost and yield ‘flation’ (in or de). That is more efficient than doing 20 different individual feasibilities.
Further, for any building and/or super-lot it’s not like you just get the architect to draw up a bulk and location plan and do one feasibility. It’s going to take a bit of back and forth to get the most profitable (or at least fundable) scheme. It might take you a dozen times (if you are truly persistent to secure as much profit as possible). A dozen multiplied by twenty is a lot of bulk and location plans and feasibilities!
Partnerships. A large long-term master-planned project opens up long-term partnership opportunities. Who doesn’t like to secure work for many years? With a bit of foresight and a little more work upfront this can make your project procurement and management processes much more efficient.
Let’s take procuring a civil contractor, in a one-off project, like a subdivision of 100 houses. Typically you create a tender package (drawings, schedule of quantities, specifications) of all the works and send it out to two or three interested companies, that you have identified via consultants, your network, google or if you are lucky past pleasant experience. Then, with a few questions bouncing back and forth, you wait six weeks to get the prices back and work to clarify (‘negotiate’) with each tenderer. Eventually, you select one company for the business end of the negotiations. However, negotiation only gets you so far so you call the design team back to value-engineer for the contractor to find some savings. Finally, with a price you can live with, and your funders and/or investors agree to, you can sign them up. The next project comes along and you repeat the process all over again.
In a master-planned project, if you spend time to make sure your civil contractor has the experience and financial fortitude to handle the longterm commitment, once the first tender is in place and you have confidence in their delivery, you can effectively form a partnership. For future stages of work rather than re-tender work to multiple parties, you work together to keep rates down and the incumbent gets the job. To some, this may seem counter-intuitive – won’t the contractor simply add cost because the job is already in the hand? Well no, that’s not a partnership. A partnership is where both parties collaborate (remember this) for mutual benefit. The civil contractor doesn’t have to close up shop and start somewhere new, with a new unknown client. The developer doesn’t have to risk a tender situation where everyone’s rates have gone up because of demand in the marketplace or worse the industry is so busy no one else has the capacity. Of course, a regular stream of work (and prompt payment) is important to keep this partnership together.
The same approach can be taken with consultants, builders and suppliers. A master-planned project provides the opportunity to grow supporting businesses along the way. In theory the more dependent the partner on the developer’s project arguably the leverage the developer has over that partner. But in practice, a couple of things counteract this. One, often on the back of a successful multi-stage project, the partner’s business also expands elsewhere, sometimes becoming bigger than the project and less reliant on it. Two, overtime the developer gets lulled into the ease of dealing with the same partners and the partners, perhaps unconsciously, allow fee creep to manifest.
Insourcing. This can take a whole edition of the Developer’s Chronicles on its own, but if you want to know more about the pros and cons of insourcing versus outsourcing now then I devote some time to it here. In short, with a project large enough, you might find it more beneficially (both for control and profitability) to internalize many of the project team. That can help team collaboration and streamline delivery. Of course, then you have to create a management structure, complete with HR and IT, office space and all the foibles of employer-employee relations.
A middle-ground position, often sat up for large infrastructure projects, is to rent office space, hire admin and create a place for the team to (co)operate. Rather than employees of the principal, the team member is seconded (se-con-ded) full-time from their respective organization to work for the project. All normal employer-employee relationships are maintained for each person in the team. The difficulty is that over time, it gets cloudy who is a client and who is one’s boss.
Flexibility. Scale provides ample opportunity to be flexible. If your master-planned project suits a range of product types (retail versus residential, high density versus low density etc.) you can adjust your delivery to focus on the most profitable. You can also test products, perhaps via a presale strategy in some areas of the development whilst delivering in others. It could be that you completely reconfigure the output of your site to match the best market at the time.
Having a flexible strategy (and ideally funders and investors) that embrace what the market ‘could’ throw at you is important in all but the most plain-vanilla master-planned projects.
Kicking the Can. With a flexible sizeable master-planned project comes the chance to kick less profitable products down the road (often literally). This might be a valid strategy. If you believe in property cycles, that what is down today, is sure to rise back up tomorrow then there is no point persisting with a low margin endeavor when you can wait that out and concentrate on something else more profitable.
It might not be a choice. External variables like city officials changing their minds over infrastructure investment may force you to delay project delivery. Take for example the situation when the city had agreed to upgrade a $10m intersection, critical to enabling your development’s traffic flows, but now has determined it doesn’t have the budget for another three years. On a one-off shorter-term project, such a delay can be crippling. You may have to stall the project. But on a scale master-planned project you kick that can down the road and change direction for three years to focus on other areas that are not affected.
Kaizen. Constant improvement. One-off projects, especially boutique ones take time and effort. Being one-off means the project is unique with a lot to accomplish to get it right. But there is only so far you can go before you run out of time. So you typically just manage to get it ‘right-enough’.
However, a master-planned project that embodies scale can dramatically increase your resource capacity per unit. For example, let’s assume that on a one-off building of 200 condominiums your project team has 1,000 person-hours to spend on above-ground ‘thinking’ or 5 hours per unit. Most of that time will be addressing everything that is done to get the plans and specifications ‘right enough’. Say 4 hours per unit, 800 hours in total. Leaving 200 hours for improvement.
Now consider a master-planned project where you have ten of the exact same 200 unit condominium buildings. All-else being equal you now have 10,000 person-hours to spend. The team spends the same 800 hours sorting out the ‘right-enough’ matter but now find themselves with 9200 hours for improvement. That’s a whopping 46 times the poor developer with the one-off project. Gosh halve it and halve it again and you still have ten times as much time resource to look for improvements. A wise master-planned project manager uses that time to constantly improve and refine.
With more time you can dig deeper. Whereas on the one-off project you might have had time to evaluate concrete framing versus steel framing, on the scale development you can also dig into the cost benefits of laminated timber or modular methodologies. Where you almost ran out of time analyzing the difference between poured in place versus precast shear walls on a one-off project, now you have time to scrutinize twenty different suppliers of the reinforcing mesh within that concrete mix.
With enough scale, you might have the time to improve every single nail and screw that goes into the project.
Scale working against you.
Of course, economists like theoretical worlds where supply and demand produce expected outputs and external variables don’t get in the way. If there is one thing any seasoned developer knows, project success (or lack of) is all about external variables. And it’s more about your luck in what external variables are thrown at you than your ability to control them! With scale, your risk exposure is, well, exposed. Let’s look at the flip side of scale projects:
Land. One thousand homes, exactly the same – sounds like an architect’s nightmare and a builders dream doesn’t it? Whilst it is all very well and good to have standard house plans that are replicated, there is one little thing that gets in the way. This makes property development different from any other industry where mass production is available. And it is an important matter that many who proclaim offsite construction as the future fail to acknowledge. Every piece of land a house sits on is unique.
There are two facets to land that make every single parcel unique: location (via its legal boundaries), and its physical nature. Every single piece of land, the most important ‘component’ of a building is different. It could be shape, size, topography, soil bearing capacity, or a hundred other things. Every building that goes on land requires at least some customization. It might simply be mirroring the floor plan (and services, and foundations) to allow for solar access. Or it could require independently designed foundations specific to the ground conditions below. And depending on the cost of that, the building above may have to be built out of completely different materials. There goes some of your ability to leverage scale.
Resource constraints. Resources can be constrained when either the scale of your project is much bigger than anything else in the area, or when the industry itself is constrained. If you are about to develop 500 houses annually in a town that has never before built more than 300 houses in total in any given year, then the operators in that town may not be able to handle your scale. Likewise, if you are the first apartment tower in a city that has never built above three levels before, there may be no local operators able to service your supply chain. It doesn’t mean you can’t overcome this obstacle but it does add complexity to your project, Local developers with smaller projects may not have this complication.
As another example, take our precast concrete panel supplier from earlier. We have done a deal where we take 200 panels a year. It’s at a great price. All about scale. 100ha next door has just come up for sale, so naturally, we acquire it and our master-planned project has now doubled in size. With that, we decide to double our build volume and request 400 panels a year, every year for the next five.
“That will be $12,000 a unit.”
“What? Why has the price gone up?” the QS responds perplexed.
“Well, our factory’s capacity is only 300 per year. At 400 you absorb all our available space and we will need to buy and fit out another factory. The cost of that has to be passed on I’m afraid.”
This happens all the time in property development. Subcontractors, main contractors, consultants, council permitting offices, everyone in boom times experience capacity constraints. They simply can’t do any more work – at least at a price that makes it economical for the developer. It also happens when a market starts to turn for the better before the construciton industry has had a chance to gear up. That’s because resource constraints typically move in tandem with real estate market cycles. A scale project may prove difficult to scale-up-to.
Cycles. Supply is inelastic to demand in property development. Real estate is chunky. Take the residential real estate market. The market is dead, nothing is selling. Few houses are being built. Then it shows signs of life. Houses start to sell. Sales increase, listings increase – now that vendors can finally sell. Prices rise. Developers start to get interested. Price rises accelerate. Developers buy land and start building. But the problem is there are few builders around. Construction costs go up. Everyone from consultants to suppliers ramps up their prices in many multiples of the general economy’s inflation. As build margins start to increase, more builders magically appear (many who have been hibernating in recession land since the last boom plus foreigners ready to capitalize). Prices are still going up so developers build as fast as possible. Eventually, construction cost escalation kills affordability. Price rises stop and may even retreat. Developers first refocus on lower priced product but eventually can’t eek out a margin anywhere. Then a double whammy occurs, migration or immigration reverses, the economy tanks and the housing market stops dead in its tracks. Once again few houses are being built. [Sound familiar to anyone?]
With this type of boom-bust market – typical of real estate in western growth cities for centuries – scale is both your friend and your foe. If you buy in the depression, and start building just as things start to pick up your margins could be on a one-way trajectory towards the treetops. But if you buy at the peak and start building as the depression is gaining downwards momentum, your margin and your massive master-planned project might grind to a halt. Then you have a painful wait (especially painful depending on your exposure to debt) until the market rebounds.
Political cycles can also influence scale projects. Carrying a large project – especially one with vested public interest – throughout successive local, state or national governments encourages all sorts of risk to materialize. For example:
- Local government can increase their development levies in tune with tax policy and public opinion – pro rates payer and your charges go up, pro-development and they come down.
- The planning and building codes can change. Whilst you may have locked in your planning at the outset, typically you can’t lock in building code regulations until you actually are ready to build. Even with planning locked, the detail rules can change, and that might effectively make as much difference anyway.
- If your master-planned development involves any public-private partnerships like social housing, developing a school or creating wider area public infrastructure – then what the original political entity agreed to may not survive an election.
Funding. A master-planned project is bigger and is going to take longer than a one-off project. That means you need more money, for longer. More money might necessitate more than one money source. It could mean a consortium of banks and/or bigger banks. It might mean joint venture partners or multiple direct investors. You may have to start out without having the funding allocated to finish the project (never a terribly great idea). And you could be faced with changing (or topping up) financiers along the way. It all points to more paperwork, reporting, and equity-debt restructuring. It also means reporting to more sophisticated organizations, some of whom may not share the same risk-acceptance-profile that developers are accustom to. This can make funding all the more complex than a one-off project.
Front-loading Costs. A master-planned project by definition occupies a more expensive and/or larger piece of dirt. You have to pay for that – typically upfront. For the master-planned project that has grown out of strategic land banking (for example when farmland on the outskirts of a city is purchased, anticipating urban growth that eventually causes the rural-urban boundary to move, upzoning your site) your purchase costs may have been very low. Lucky (and patient) you! But for the rest, purchasing a scale project site is going to burn a few pretty pennies. And that incurs finance or opportunity costs from day one. A cost that can run for many years.
When developing a site of any significant size, it is likely you are going to have to pay for new public infrastructure and/or upgrading existing infrastructure – especially roads on greenfield sites. This can be required well in advance of completing sellable space. So you will need deep pockets to cashflow it.
Even if you don’t have to build infrastructure, from a marketing and sales point of view you might want to. A tree-lined avenue and a picturesque park complete with lakes and playgrounds might be the kickstart that your master-planned project needs to get sales. Once again, a lot of cash being spent upfront, well in advance of seeing the return.
Size. Bigger is better some would say. But not always. One of the problems with large-master planned projects is that they are simply so big. Amplification can hurt. When things are going well and sales prices for 3,000 homes increase 5% per annum your profits are going to soar. But if it goes the other way, you might be quickly underwater. This is no different with any property development project. But because you are more than likely to have funders from larger public organizations, they (or their shareholders) may be less willing or able to see it through to better times.
Another negative is when the size of your master-planned project dwarfs other projects in your area. Effectively you have all your eggs in one basket. Comparatively smaller competitors may be able to eat away at your market share by developing sites that don’t have the infrastructure implications that your site creates. Scale does not always mean you can deliver product cheaper.
Time. Whilst ‘time heals many wounds in real estate’, the contradiction is ‘the longer it takes, the more that can go wrong’. A worthy property development business model to reduce risk is to get in and out of the project in the same market. That’s pretty much impossible for anyone to time, but the probability of timing it correctly is higher for a one-off project with a short duration (Note: I don’t have maths to back this assertion up but it certainly feels right!). If your project is going to take time, and by my definition a master-planned project does, then it is going to experience different markets. Ideally, you start delivering into a hot and rising market, so the excess profits you initially generate set you up to weather any subsequent downturn.
Too Big Too Soon. Scale is great if you can handle it. Deep pockets, lots of capacity to create & manage resource and bigger picture flexible operational decision making is mandatory. Unfortunately, if you don’t have those three ingredients you are quite prone to what Ian Cassels, a developer in Wellington, New Zealand surmises.
“We’ve all heard it before from Sir Robert Jones: “all developers go bust”. I know I have heard it many times. I have my own version of this which is “if development for sale is your business then you’re likely to go bust”. – If more famous quotes about real estate development are your thing then read this!
And many of those who go bust do so because they have gone too big too soon. A couple of single-family home renovations turns into a terrace home subdivision. One project becomes five. And then in no-time, the billion-dollar deal of the century is stitched together, with bankers who have previously expanded their wallets and risk appetite on the developer’s coat-tails. Problem is, the project needs all three secret ingredients, well at least enough of the first one. Few developers on the fast-track without cashflow to see out a downturn (and the mounting debt) transition well.
At Scale Complacency. Earlier we discussed the potential for at-scale-complacency in design. This malady of magnitude can permeate through planning, feasibilities, construction, sales and all things quality control. Thus, just because it’s big, doesnt mean everyone can forget about the detail. One little issue, lots of times, can end up being a big collective issue. Or skimping over the occasional detail can add up to a sizeable lost opportunity.
Butterfly Effect. A decision made early on a one-off project could have ramifications but because of its limited time span and size, the damage will be contained (relatively speaking). In a large scale master-planned project a similar decision early on could, over years or decades, ripple creating unexpected and significant consequences. With all that traffic, bet you wish you didn’t put that through road there now? Or why did we lessen our design standards so early on, now we can’t capitalize on the profit potential of higher value product? Who would have thought tenants would demand that feature when we committed to this? And so on. Of course, this is a problem without a readily apparent solution. Suffice to say it pays to think thrice about the implications of the decisions you are making today and how they could impact overall project profitability and success.
Getting Kicked in the Can. Whilst having the luxury of kicking the can down the road is appealing early on, someone has to pay the piper eventually. And time may have not been the original problems friend. Because problems in property development never seem to fix themselves, maybe addressing issues head-on when the surface is the best strategy.
And that will do us until the next edition.
Cheers
Andrew CrosbyR
The DC: Master-planned Projects – All published editions.
#1 Roads
#2 Net Developable Area
#3 Feasibilities
#4 Stages
#5 Team Collaboration
#6 Architectural Design
#7 Scale Thinking
#8 Selling the Dream Location
P.S.
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