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During the early days of the New Zealand leaky building crisis I used to spout this throwaway comment: “Man has been building houses for over 2000 years and it’s only now we have learned how to really stuff them up –  so much for innovation”

In a persistent 16 year search to innovate in property development, to do things differently, to embrace change, to improve upon the status quo and to think outside the square/box/boundaries/whatever I have reached a cynical crossroads:

I have grown sick of the word ‘innovation’.

Alongside one of the most overused terms in the property industry you can add to my list of disdain these words:
– demonstration
– pilot
– exemplar
– bluesky thinking
– leading edge
– cutting edge
– pioneering

Why, you ask, would I be sick of innovation?

Could this be the result from a lack of success with innovation ?  Probably – I haven’t picked up a Forbes magazine lately but I can assure you I’m not on the cover.

Could this be jealousy of those who truly can innovate and profit hansonely from it? More than likely – last time I looked at my share broking account, I didn’t see my name listed as a founding director of Google or Facebook.

Do I have high expectations of what innovation actually is? Maybe. I see true innovation as a bar set very high that will deliver impressive results. That could be my problem. However, my problem is exacerbated by how innovation is touted by many in the wider market.

In my experience, all too often ‘innovation’ is used to describe a situation where from the status quo, one will make a massive leap forward, seemingly overnight. The expectation is that significant problems will have been resolved and massive benefits conferred – just like that.

Many times this expectation arises when those outside of an industry make demands of those within industry without a grip on reality (I mean industry complexities) and their modus operandi is instant gratification (I mean above market and upfront profits).

Whilst solving through innovation is a noble pursuit, there is real risk in thinking of innovation as the goose that will lay the golden egg. There are simple analogies with gambling. Rather than investing in a slow growth investment account from the age of 30, you wait until you are 60 go to Vegas and put your life savings on red. That’s fine if you understand and accept the risk, but if you conveniently ignore the risk aspect you can set yourself up for spectacular failure.

Let me illustrate via some charts.

Assume we have a target to increase benefits by $1,000,000 over 10 months. The green star is the target and the red line our progress in reaching that target. A dashed red line indicates a route anticipated but not taken.

To reach this target we are going to innovate, be innovative and create sublime innovation. I will call soley innovating to meet this target the ‘holy grail expectation’ as represented by Chart One.

Chart One

 

With a large focus on simply being innovative to meet such an ambitious target, the risk of achieving the target through using innovation alone can easily result in what is depicted in Chart Two. That is a spectacular failure to come close to the target set. Worse, no improvement may be practically found, the resource wasted and the exercise undertaken rendered completely futile. This is the likely reality of trying to finding the goose that lays a golden egg.

Chart Two

 

So innovation is risky, but why shouldn’t you try? Why do attempts to be innovative, especially in something as pratical as the construction sector often fail?  I argue that if you devote resources to finding a golden egg innovation solution you run a real risk of not only not getting no where near your target but also run the risk of going backwards on your core bread and butter competencies.

I have seen it many times now. Resource is so focused on finding the holy grail of a solution that the potentially much more productive exercise of simply improving the day to day operations takes a back seat.

There is a saying in project management for Privately Financed Infrastructure Initiatives (at least by the World Bank) that “risks should be allocated to those best placed to manage them”.

Beckers, Chiara, Flesch, Maly, Silva and Stegemann, McKinsey Working Papers on Risk, Number 52 A risk-management approach to a successful infrastructure project initiation, financing, and execution, November 2013, explain in terms of risk ownership and strategy:

” a conscious optimization effort to protect and create value by allocating risks to the best risk owners across the life cycle, including an explicit reflection of the respective risk appetite of these risk owners, for example, private financiers”

The attempt to be innovative introduces real risk to property development (as if it wasn’t risky enough). The risks include construction product and installation failure,  innovation causing conflicting and unclear objectives, prolonged programmes and project failures especially when promises are broken based on unrealistic risk adjusted expectations.

I would like to rephrase the allocation of risk statements to make it applicable to our intent to be all things innovative:
“the work of innovation should be allocated to those best placed to find it “

For everyone else, concentrate on your your day job!

Chart Three re-frames the all-in innovative holy grail approach to a more gradual but consistent approach to meet our ambitious target. Borrowing from the Japanese principle of Kaizen made famous by The Toyota Way this approach is simple: look for and implement continuous improvement.

Put another way, just find ways to do your day job better!

Chart Three

Improve productivity, gain upfront clarity over client needs, better planning, better design, better project management, more efficient procurement, great communication, strong contractual relationships and getting it right the first time. All those basic things will over time and over all the clients, consultants, contractors and other parties involved in a development project contribute greatly.

For example:
– Whilst many are looking for the most innovative modular technique that will supposedly supplant site built construction why not focus on getting your design and variation management process in check?
– Whilst others look at the plethora of innovation during the risk transfer approach in Private Public Partnerships, why not see how you can get your funding down 50 basis points?
– When subcontractors are running to the next building project for an extra $5 per hour, why not look at a long term reward mechanism to keep them on your projects now and in the future.
– Consider the simple act of communication, as a client are you always clear in what you are asking for? Clarity can control cost.
– Is your organisation focused on the day to day tasks at hand for a project and is there sufficient protection for the project doers from the non-project talkers? Being more focused means more attention to detail, provides for proactive rather than reactive risk control and better deadline performance.

Get the simple things right first. Be innovative on the details, starting in your own back yard. You might reach your target without having to take a spin on the roulette wheel.

Once you have the day job under control with gradual but consistent improvement then, only with dedicated specialist resource, feel free to really take a look at innovative ways to make leaps in advancement. If your innovative goose does manage to lay a golden egg then as shown in Chart Four you will be all the better off.

Chart Four

Whilst still a little nauseous over the misuse of ‘innovation’ just writing about it has spurred me to divert my attention and look at some innovative ideas!

Oh well…old habits die hard and human psychology can take a powerful hold when it is in your bones to find that golden egg laying goose.

 

Cheers

Andrew Crosby

 

 

 

 

 

 

[Update  2018] Real estate development books now available via Amazon or direct from publisher in New Zealand. Contact publishing@aenspire.com for special rates. Go to www.developmentprofit.com to view publications available.

A crack specialist property team is enlisted to realise revenue from surplus property assets. Rather than a pure sales spree, management is encouraged to maximise value strategically. The rolling meadows of the idea can turn into a serious mountain climb without a well conceived and implemented Surplus Asset Strategy (SAS).

For business owners, government agencies, transport and infrastructure providers the real property assets owned may not be being fully utilised as part of business operations. Entire parcels of land or portions of a site may be surplus to requirements. In turn, this can present opportunities to raise additional cash by strategic divestment and redevelopment.

There are two fundamental decisions to be made regarding permanently surplus property assets:
– What are they?
– How to get the most value when disposing them?

What are the surplus property assets?
A companies asset management strategy informs management as to the assets required to operate the business over the short, medium and long term. It converts the objectives of the business strategic plan via asset management policy into a high-level, long-term action plan for the asset portfolio – including real estate assets.

Each property within the portfolio should have its own tactical asset management plan in order to support operations. Asset management plans typically include lifecycle budgets for planned maintenance and capital replacement, look at the age and condition of properties, their ‘fitness for purpose’, book and market values and how they perform in relation to industry benchmarks and the overall asset portfolio.

Good asset management plans take a look at how efficient the real estate is being used to deliver business operations. They look at optimisation solutions to determine if and what real estate is surplus to current and forecast operational demand. This is especially important when the asset is being used in a complex manner. For example it is often fairly simple to know if you have too much office  space – the unused floor space will be all too apparent, however it is much more difficult where the operation is complex like a manufacturing plant or the use is for public amenity.

The best optimisation solutions come from looking at how the business operates in regards to the underlying real estate in the context of the changing real estate market.

This level of analysis typically requires external specialist property advice to assist asset managers to determine how surplus or not a real estate asset really is.

Each business obviously uses the real estate it owns in different ways – as different as the business themselves. Determining if there is surplus real estate will typically involve many stakeholders within the business and they will provide conflicting view points because a change to the real estate asset base may affect their area of influence.

To illustrate, lets say an Australian timber company operates 10 yards in their national portfolio.  The Sydney yard operates on 10,000m2  of land whereas the portfolio average is 8,000m2. On the face of it the asset manager believes there is potential to downsize the 10,000m2 yard to 8,000m2 without affecting current and forecast revenue.

Before the asset manager engages with real estate expertise to assist her decision she convenes all the internal stakeholders to present their views:
– The local general manager, says he cannot possibly reduce the site size, they have always been 10,000m2 and look how full the yard is. If we reduce the size of the yard, everyone will be falling over each other and we will not be able to stock enough product.
– The PR department say, this is not a good look to downsize – it will send a signal to our customers that we are somewhat withdrawing from the Sydney market, this could impact on our reputation nationally.
– The finance department are very interested in realising a site size reduction, according to them this will reduce operating expenses by 10%, and can realise much needed cash to help service nationwide expansion into the provincial towns. However, they caution that they need at achieve at least 20% of the Net Book Value upon sale, otherwise a write down will occur and affect their balance sheet.
– HQ marketing and demand analysts caution whilst the current asset management strategy supports asset optimisation they are currently working on a new product line that would ideally need 500 to 1,000m2 of additional space to each store.
– Floor staff advise there is no way you can do that as that will probably mean narrower isles and that would leave no room for forklifts. Some staff  voice their concerns that they do not want to lose car parking at the rear of the site.

Even on something as simple as a timber yard reducing its footprint can raise a myriad of issues and internal anxieties that will need to be resolved. In businesses with complex operational requirements the potential issues can multiply exponentially.

Surplus asset decisions for entities delivering public services can solicit extreme viewpoints (think judges influencing court buildings and doctors on hospitals). Reaching a decision to optimise these real estate assets is all the more difficult with strong vested stakeholder influences and potential political interference.

Therefore, a clearly formed Surplus Asset Strategy with top level management buy-in, a robust governance structure and detailed clear decision making criteria, all upfront, is very important. If high level analysis has already been undertaken then a target range of expectation can further clarify and incentivise decisions moving forward – for example reduce real estate holdings by 20% and unlock $50M in capital whilst maintaining 95% existing operational performance.

It is important the project governance group specify the ‘rules of the game’ in advance of trying to implement the SAS. You do not want to have to bring a potential solution to top management to have it rebuked because it does meet an unforeseen business restriction – whether it is opinion or structural.

Going back to our timber yard asset manager….
With all the internal viewpoints in hand the asset manager digs deeper. She benchmarks the property against the Sydney wide peers and finds that the average size of similar timber yard operations with similar revenue and stock levels is 7,000m2. Visiting competing stores she finds timber packed 6 shelves high, compared to only 4 shelves high at her store.

This has the potential reduce at least 1,000m2 in her store and still provide room for some of the new product if it ever does eventuate. PR are happy that they can spin the reconfigured store as still being larger than the industry benchmark. The GM is happy as in order to achieve 6 pallets high, he gets to trade in smaller forklifts for the latest high reach modern models. Everyone agrees they need to retain parking.

Further  property advice shows not only is the value of the land exceed the book value by a considerable amount (appeasing the accountants) but also there may be potential to realise air-rights over the car-park at the back, which adjoins a medium density residential street. This could effectively free up another 1,000m2 of surplus asset.

The asset manager has a strong case that there is a total 2,000m2 of surplus real estate and she believes she has met all the criteria pre-agreed in the SAS.

The surplus asset project governance board agrees. Now they ask
“What are you going to  do with it?”

 

How to maximise value when disposing surplus real estate assets

There are three key outputs to a Surplus Asset Strategy that will inform disposal implementation:
1. Register of surplus assets (the pipeline)
2. Prioritisation
3. Disposal options

These three key outputs are inter-related and somewhat inform each other and therefore require an element of iterative analysis. Keeping as many variables constant as possible (through the SAS project governance board) once decisions have been made is critical to enable successful implementation.

1. The first key output of the SAS is a register or pipeline of all surplus real estate assets at a particular point in time. The point in time is critical, as in an ever changing business environment what is surplus today may not be surplus tomorrow, and what isn’t forecast to be surplus this year may end up being surplus next year.

In addition, just because a real estate asset is surplus, does not mean there is a viable opportunity yet to realise value for a whole plethora of reasons:
– Planning rules restricting subdivision
– Planning rules restricting alternative uses
– Site needs decontamination
– Not sufficient market demand (air-rights are a little different if our timber yard is on the outskirts of Tamworth, rather than inner Sydney)
– Can’t get access to the surplus real estate (landlocked)
– Book value higher than market value (help and a psychologist needed to tackle this one)
– Restrictions on what the asset can be eventually used for (prevalent in public sector, but also you may not want to give competitors any opportunities if they are a likely current buyer)
– Neighboring property or community issues

A good SAS structures a clear process to deal with changing asset issues over time and can be updated accordingly. You want to know when a business or market trigger makes disposal more or less attractive.

2. The second key output of the SAS is to prioritise. One practical way to rank the priority of assets for a large and complex organisation is to use a layered filter system. That is you take the total list of surplus assets and apply the most important filter first, and then the second most and so on. The assets that meet the most filters go to the top of the list. This can also be used for some businesses to help identify which real estate is surplus in the first place. Having the filters and their cut-off metrics pre-approved as part of the SAS governance is important.

As an example in the timber yard business the first filter may be the ‘condition of the property’ and the metric to measure against maybe ‘forecast maintenance liability greater than $50,000’. The second filter maybe ‘PR risk’ and the metric to measure against ‘High, Medium, Low’.

The priority ranking assigned to each surplus real estate asset will be informed by a number of factors (potential filters):
–  Absolute realisable value potential  (focus resource on the big prizes first)
– Forecast maintenance and operating liability (old, poorly maintained, expensive to run properties)
– Public relations risk
– Political risk
– Ease/cost/time to transform and move operations to enable surplus asset to be disposed
– Management resource liability (how much time will this asset take from senior management)
– Planning and consenting duration
– Market demand
– Disposal option risk
– Disposal option resources (human + capital) required
– Timing in relation to financial year
– Tax implications

The ranking may be supplemented with a probability of success rating as well to forecast a weighted average return on the surplus asset pipeline. Although the probability of being able to realise a return quickly, itself, is one of the prime factors pushing it up the priority list – the ‘low hanging fruit’ approach. Many businesses that have been asset stripped over time don’t have too many low hanging fruit left. Even so, improving real estate markets can create substantial new opportunities and grow new low hanging fruit .

3. The third output is the analysis of disposal options aiming to find that option that will yield maximum value. Typically it is a risk vs. reward equation and the most common options include:
– Sell as-is
– Improve and sell
– Redevelopment

Each of these should be considered against the base option for each surplus real estate asset. The base option can be ‘Do Nothing’ but even that must take account of the minimum actions the business will be ultimately forced to do if it continues to hold the asset. Most real estate assets require at least security and insurance. Even vacant land needs to be mowed, rates and taxes paid and depending on your jurisdiction you may still require public liability insurance (yes for the homeless guy who walks on site and trips and hurts his back!).

For some assets there may be contingent liabilities that need to be allowed for in the base case. These can include the potential ramifications from pending political, planning, code or court decisions. For example new building regulations that require you to upgrade existing structures to satisfy earthquake ratings or new fire codes. Or there could be changes to who becomes responsible for decontamination and land remediation, or possible heritage listings preventing some disposal options.

The base case can also carry public relations risk such as in holding onto a derelict asset that is blighting an area.

Sell as-is
To sell ‘as-is’ may be the most appropriate option where there is competing market demand for your surplus asset, few obstacles to selling and others are better placed (according to your risk profile) to undertake redevelopment or improvement into alternative uses. It also usually means the shortest time to realise cash.

This is a fairly easy option to evaluate, a valuer will give you an opinion of the sale price and then you let the real estate brokers at it.

In our timber yard example earlier, it may be as simple as taking the surplus real estate including ‘air-rights’ to the market by an agent. The sale agreement would be likely conditional on gaining subdivision consent, a satisfactory buy back provision for car parking and a settlement period long enough to give the timber yard time to reconfigure their operations.

Improve then sell
Of course if the property has liabilities then the buyer is going to take that into account and may tag their offer for purchase with many conditions. That leads us to the improve first then sell option. Improvement can take numerous forms depending on the level of risk and investment required.

Improvement can be viewed as:
– Removing uncertainty and liabilities to enable a smoother sale at the market based value, or
– Adding value while the asset is in your ownership, effectively taking risk on your investment to generate a profit. The profit representing the price difference between selling as-is and selling improved less any costs of improvement.

Improvement before selling techniques for real estate assets include:
– Obtain planning consents to change site to highest and best market use
– Repair property condition to a usable, leasable or livable standard
– Renovate existing property to a modern standard
– Attend to a neighboring property to clean up area
– Decontamination and land remediation
– Heritage de-listing
– Demolition of existing properties

The asset manager for our timber yard may decide to tidy up the boundaries and fence appropriately to make the for sale lot more appealing. In addition rather than selling with conditions they undertake subdivision and set up the appropriate body corporate/owners association for the car parking themselves.

Redevelopment
Redeveloping the property can potentially yield the highest return but can also involve the highest risk – especially if the redevelopment is into a use that the business is not familiar with. Redevelopment is a higher financial return option when the anticipated profit on a change in use exceeds the likely proceeds from sale or undertaking lesser improvements and selling.

Sales risk can be mitigated through pre-selling (or pre-leasing and pre-selling) the finished product before construction commences. Construction risk can be mitigated through tight contracts. Planning risks (time to achieve rezoning for example) is already somewhat mitigated in that you already own the surplus land so may have time on your side at a lower asset book value than a developer would of had to purchase at.

Redevelopment is not for the feint hearted, especially if development or speculative investment is not a current characteristic of the business.

There are multiple scenarios for any development project that will need to be analysed to test feasibility and find the best solution. The business will need to allocate sufficient expert resource to undertake this analysis and note that it is often an artistic skill more than a science project to achieve a successful development outcome.

Redevelopment can take a number of deal structures including:
– Business redevelops surplus asset at their own risk and sells finished product. For example our timber yard asset manager may hire a development manager to undertake all activities to create apartments for sale over the car parking lot. This may mean the business sets-up a separate development entity to isolate resource, collateral and risks.
– Business enters into a joint venture with a developer, typically with the land component forming the asset owners equity into the project. The business and  developer share in the profit or loss and share funding risk.
– Business sells asset to developer with a profit share on completion arrangement in consideration for a lengthy conditional period for the developer to obtain planning consents.

Finding the correct development manager or development partner is paramount to success.  That means a rigorous and thorough process to not only identify the talent required but also to ensure you will be comfortable working with the partner. That is important in redevelopment, as the only certainty is that there will be problems along the way.

Portfolio vs Individual Disposal
One  final point to consider is whether there is additional value in packaging assets together for disposal versus disposing them individually. This will be a judgement call depending on the likely market demand for the disposed assets.
– If all the assets are highly specialised (like ex manufacturing plant sites) and only a few likely buyers then there may be greater value through selling the whole lot as one portfolio.
– If some assets have limited attractiveness to the market, and others are likely to generate real demand then combining into a single portfolio may enable you to dispose of all. However, whether they are bundled or separated each asset is likely to be addressed on its own merits and the price paid will be adjusted accordingly – No free lunch!

——

With the register of identified surplus assets, ranked in priority and suitable options identified for disposal your Surplus Asset Strategy is ready to be implemented. Of course this article really only touches the foothills of the K2 style complexity many surplus asset strategies must work through.

www.aenspire.com

 

 

 

 

“Smack” that was the sound of me hitting the broken asphalt.

“Wrgghhhhh, whhroof, woof” that’s the sound coming out of the dog chasing me.

“Splosh” that’s my hand finding a puddle of an an unidentified liquid as I try to push myself up.

It’s 5 something AM on a Sunday morning. Pitch black and I am walking and then running from one end of an old plywood factory to the other. As I fend off the live-in security guard’s canine companions I reach the roller doors to the main street entrance and meet my development manager accomplice. Today we are going to turn this temporarily surplus asset into cash flow. At $10 a head we are taking on the car fair and swap meet market…this asset, a future development site, is going to be sweated.

Four hours later, after not exactly replicating the numbers that attend the historic car parade preceding Daytona 500 we shut the roller door and go home.

Part One: Temporarily Surplus Asset Utilisation

To a developer anything with land under it is a potentially under utilised asset. If you own it, you are paying for it, and usually you are paying  a lot. It is rare where a developer purchases an asset with an intention to develop that makes a return that covers all holding costs. Turning that asset into a development project, with construction underway as quickly as possible, is a developers business as usual.

In the interim period between site purchase and construction the asset is temporarily surplus and the developer may look to opportunities to realise cash flow.  ‘Interim’ for a large project or when markets tank or where planning consents drag on, can be a long time. If the asset was purchased with long term leases in place then the likelihood is most tenants will want to move on upon expiry given the uncertainty over development. Similarly a developer does not want to be tied into long term leases as their primary motivation is to get the development underway without fixed leases delaying commencement.

Temporarily surplus asset utilisation opportunities include:

– Subletting space on a month to month or short-term demo clause basis to be used in line with previous business activities on site (an option that deteriorates over time as you spend less money maintaining the property and keeping tenants happy in anticipation of development)
– Short term lease of space for all types of storage (security becomes paramount)
– Erect temporary structures to create leaseable space – including inflatable structures
– Pop up retail and restaurants
– Low rent creative premises and ‘incubators’
– Car parking, public pay as you use
– Car parking, short term lease to others
– Temporary housing and accommodation (outside of disaster relief there are lots of expensive complications like the need to provide infrastructure and services but in some circumstances…)
– Car fairs and swap meets
– Film and television sets or staging areas
– Event space
– Art galleries and sculpture parks
– Farmers markets, arts and crafts, food trucks, coffee carts
– Entertainment (carnival type attractions,  roller coasters)
– Agriculture (yes I have seen land rezoned from residential back into agriculture)
– Urban farms, urban orchards and community gardens
– Trailer park
– All types of signage and billboards for advertising ( this includes parking a truck trailer covered in company logos on site and advertising on fence wraps)
– Demonstration and exhibition space
– Relocatable house showroom
– Car, boat or heavy machinery sales yards and popup showrooms
– Concerts & festivals
– Sports training and temporary event facilities
– Photography studio (one example was a development project site in waiting where they had a ‘drive in’ photography studio for car magazines)
– Trash recycling collection point (actually this is what is going to happen whether you like it or not on most unsecured sites!)
– Vending machines (assuming you have passing foot traffic)
– Urban parks
– Tree farms (when development has stalled for a very long time!)
– Educational and work training premises
– Construction product or system testing
– Bomb squad dog explosives detection training (yep, been there)
– Volunteer or community organisation meeting and information place
– Theatres
– Ice rinks
– Urban beaches
– Playgrounds, obstacle courses, skate parks, outdoor basketball courts, bmx track

An interesting comment from opengreenspace.com is how people can perceive temporary uses that when done well appear to be a permanent fixture. This is especially pertinent where a use has been temporarily brought into the public domain and then removed once the temporary use is no longer required.
“Temporary uses should, however, be approached with caution as there may be a risk that, over time, local communities and stakeholders will associate a permanence and potentially ecological value with a particular space, making future changes difficult to promote without attracting opposition. In considering such opportunities therefore, it is advisable to identify an exit strategy and to ensure that there is ongoing clarity about the temporary nature of a site.”

To actually succeed at extracting cash flow to help fund site holding costs temporary uses have to generate more cash flow than the investment required to commence and operate them. When the duration is uncertain developers are heavily constrained as quite often you don’t have (or know you have) a long enough period to generate sufficient cash to pay back any temporary investment. This of course assumes there is market or public entity demand willing to pay a high enough rate for temporary space/use in the first place.

Vacant land is generally more difficult than existing buildings to generate a temporary return. Even land used for a car park can require significant investment to comply with council/city regulations as well as being able to collect the income. Often it is simply not worth it except in Central Business District type locations where parking enjoys a high price premium. Zoning and other code regulations can permit only limited activities on a site further restricting any temporary use.

However, it may be best to find an alternative temporary use than to do nothing with an asset in transit.  There may be council/city requirements to offset stalled development site blight or ‘Empty Lot Syndrome‘. You also want to prevent unsolicited trash dumping and homeless invasions and other issues that end up costing money and potentially cause a public relations nightmare. Donating the site, temporarily, to enable a community endeavor may even help placate potential opposition in upcoming zoning and planning hearings.

I had the inconvenience of dealing with a relentless homeless invasion. We had an old house that we used as an office on a development site. When we had completed the show home at an alternative location we moved out of the old house. The intention was to keep the property until construction was approved and then demolish as part of the overall contract – essentially let’s not spend any money until we need to. We looked at offering the building for temporary lease but the lease market was flat and we didn’t want to spend any money on the property to get it up to a leaseable condition. Plus we only anticipated a vacant period of 3 to 6 months.

It started with a few break ins that set off the alarm. Police were called and a homeless man was moved on. Next week, rinse and repeat with an increased number of occupants. Each subsequent time a little more copper wire had been removed and a little more neighborhood trash collected. Then one very ambitious individual cut the main electrical line from the power pole to the building (I have no idea how) – disarming the alarm in a very dangerous manner.

So we got a battery powered alarm system, that survived a week or two and you guessed it, they stole the alarm! Nothing would stop these guys, they didn’t mind that it was 115 degrees nor that the water was turned off (but kept using the bathroom!). So I let them have it and we decided to demolish the building early.

These poor homeless guys were persistent to the extent they would lie there quite happy to let you yell at them to get out and then still not move. After signing the demolition contract I asked the burly demolition contractor what his procedure would be to remove my favorite residents prior to the bulldozer going in. I was thinking he is going to have to call back the police or worse take the physical moving of them into his own hands.

“No problem, this is par for the course on our demos – no one stays in there once they hear me start the engine”

 

www.aenspire.com

 

Part Two in an upcoming post will address extracting maximum value from real property assets surplus to what is required to run normal business operations.  We will look at strategies how you identify and prioritise surplus real estate as well as evaluate disposal and redevelopment options in light of risk and opportunity.

“Real estate is all about people and relationships” proclaimed the energetic owner of a very successful local real estate agency.  Enthusiasm can be infectious. There is no more positive way to start the day than having coffee with a master in their field with a real intuitive ‘gut feel’ for the market and a passion to match.

It is certainly much more enjoyable than staring into a spreadsheet with hundreds of rows of data and calculations. This quantitative feasibility model attempts to predict the future viability of a property development project. It is based on testing logical hypotheses using past numerical evidence and objective ‘humanless’ measurement in an assumed world of fully informed rational participants…..if only.

The authors of “The Moment of Clarity” describe how LEGO, Adidas, Intel, Samsung and others use ‘Sense-making’ to turnaround performance, improve product design and set strategy for their businesses using a very human experiential and contextual approach.

[Madsbjerg, Christian and Mikkel B. Rasmussen, “The Moment of Clarity: Using the Human Sciences to Solve Your Toughest Business Problems”, Harvard Business Review Press, 2014.]

Madsbjerg and Rasmussen describe how relying on quantitative analysis and default thinking means you can miss the future for your business. If you are constantly looking into the past rather than experiencing the present, you will have real trouble grasping the future.
“We call our method sense-making because it describes the experience of connecting the dots amid a sea of confusing data. Through sense-making we arrive at moments of clarity” [page 78].

Sense-making is about really understanding your customers by observing them in their real life context.  You collect as much data about them and their interactions as possible. The data is trawled through and analysts given time to let the information ferment to identify patterns from which you create key insights.  You forecast the potential impact on your business and only then do you look to build forward looking business solutions [page 105].

Sense-making has many applications to real estate. Especially in residential real estate the numbers you ‘forecast’ are only ever likely to be proven wrong. The most sophisticated econometric analysis cannot predict the turning of a real estate market nor inform us as to the financial metrics of herd mentality.

Purchasing a home characterises the findings of recent studies evaluating how people buy.
“We rarely know what we want. We almost never fully grasp the market and most important, we almost always buy something at a different price than we thought we would” [page 32].

Houses may be purchased in dollars, loans granted in ratios and percentages and floor plans measured in square metres but value is perceived in a very human context. This is where psychology and culture tend to dominate and very often overrule so called rationale behavior (despite what many Valuers think!).

The first action when sense-making is to re-frame your problem as a phenomenon.
“Phenomenology is the study of how people experience life” [page 79].

Rather than trying to jump to find solutions to the question ‘how do we sell more apartments?’ you ask ‘what is the role of inner city living?’.
Instead of saying ‘how do we deliver 1000 houses profitably over the next 2 years?’ you investigate ‘what makes a house a valuable home and where is this value missing most in our society’.

Yes it all sounds very soft and fluffy, but the authors do a much better job than me in showing how this can be used to solve business’s biggest problems.

“Ethnography, the process of observing documenting and then analysing behavior” [page 90] can be used to examine and collect data on inner city living.
Why do people want or need to live in the CBD?
How do they live in their apartment?
How do they travel and what common activities do they undertake?
What do they actually use in the kitchen?
What shops do they commonly visit on their way to and from work?
How do they use cars and parking?
How do they arrange furniture and store household items?
What do they show friends and family when they come to visit?
How is their timetable different or similar to people living outside the CBD?

Let’s say you analyse how people live in the CBD and find a pattern, that whilst everyone has a kitchen, they use the oven on average only once every two weeks but use the microwave daily.  On initial inspection of this data ovens are not an important item. However, when guests come over they all comment on how ‘cool’ the kitchen with the large wall oven looks. This may lead to the insight that many apartment dwellers like to be seen to have a full Masterchef kitchen, but rarely actually use it.

The potential business impact when selling could be to focus on the look of the wall oven, not its functionality and sell up the benefits of a full function and regularly used microwave. [Page 155 for associated discussion how Samsung improved market share around by focusing on televisions as stylish pieces of furniture].

Or what if the ethnographer documents the daily activities of stay at home mums (and dads) in a large subdivision. A pattern is discovered how time efficiency for the stay at home parent provides the most value – more ‘valuable’ than the effect of the bread winner’s lengthy commute.

The stay at home parent values a logical and consistent traffic free route from home, to pre-school, to school, to supermarket or other task centres and back to home in the mornings. A similar journey albeit loaded with after school activities and other tasks occurs in the afternoons.  In the intervening period whilst at home the kitchen has become a default office – with online trading (goods and investments) undertaken by the stay at home parent an emerging theme.

This may provide the insight that stay at home parents are busy, have time constraints, value efficient transport routes and when at home now tend to spend more time in a business like activity than household chores.

The impact for property development business could be a sales focus less on distance to work and more on specific amenity in the surrounding area. It could also mean developing to embrace stay at home parents taking a more active role in online based investing and design in ‘kitchen or pantry offices’.

When we were researching to develop a medical center I remember one site visit where the architect asked me to look up while we walked around the halls of the clinic. They had done extensive investigation from the patients view point whilst being wheeled around on the hospital bed ready to go into the pre-surgery area. The result was calming artwork and way finding signage (to reduce disorientation) on the ceiling.  Perhaps a similar sense-making type exercise helped create this luminous ceiling Philips have developed for an Intensive Care unit in Germany.

The authors provide more sophisticated examples of sense-making in other industries and tackling strategy as well as product and environment design.

They extend the discussion to leadership and the need for leaders with perspective [page 173]. The understanding of consumer behavior can be wasted if leaders do not find a way to interpret and implement appropriate strategy across an organisation – connecting the different quantitative and qualitative worlds.

The authors contend that leaders should look out to the furthest of four horizons; moving past yourself (career) and the company towards industry and society [page 173].

It is then, once the organisation knows how customers actually experience life when moments of clarity happen [page 173] .

 

www.aenspire.com

 

 

The assessment of risk in property development is often very basic. The best case ‘evidence based’ scenario is presented to funders with a project contingency and margin to cover known risks.

In residential property development, for a lender to fund 80% of development costs they may expect to see a 5% contingency, a robust construction contract, a 20% return on cost profit margin and 50% pre-sales before releasing funds to start construction. This obviously varies depending on a range of factors including the market, the developer and who is providing guarantees and equity.

‘Megaprojects and Risk: An Anatomy of Ambition’ provides a detailed insight into how poorly risk is treated on some of the worlds largest infrastructure projects.
[Flyvbjerg, Bent, Nils Bruzelius and Werner Rothengatter, ‘Megaprojects and Risk: An Anatomy of Ambition‘, Cambridge University Press, 2003]

The authors pull no punches in their critique but also offer  solutions to how risk should really be treated. Their research covers a number of projects from the Eurotunnel, to bridges and tunnels connecting Denmark and Sweden to metro subways, high speed rail and airports around the world.

The reason for their research is simple: many megaprojects experience a double whammy of cost overruns and missed revenue forecasts in a very public forum.

Effectively risk has not been correctly identified, publicised or managed, as the authors describe:

“We will show in terns of risk, most appraisals of of megaprojects  assume, or pretend to assume, that infrastructure policies and projects exist in a predictable Newtonian world of cause and effect where things go according to plan. In  reality the world of megaproject preparation and implementation is a highly risky one where things happen only with a certain probability and rarely turn out as originally intended.”  [page 6]

“Megaprojects are increasingly becoming highly public and intensely politicised ventures drawing substantial international attention with much potential for generating negative publicity.” [page 9]

“A first step in reducing cost overrun is to acknowledge that a substantial risk for overrun exists and cannot be completely eliminated; but it can be moderated.” [page 11]

“A next step is to allocate the risk of overrun to those best able to manage it.” [page 12]

There are lots of examples with massive cost overruns and revenues never getting close to initial expectations – the Chunnel for example only had 18% of of forecast traffic in its first year of operation, beaten by Calcutta’s metro which had a measly 5% ! [page 25].

The discussion is also very critical of the lack of accountability and optimism bias of political and private promoters of such projects.

I know very little about large infrastructure projects, let alone megaprojects. I once developed  software that was used on motorways (freeways), wastewater upgrades, hospitals, prisons, airport and rail projects in New Zealand for document and consultant collaboration. The software’s objective was to improve communication, variation management and indirectly reduce risk but I had little knowledge of how feasibility and initial assessment of risk was treated on those projects.

However, after reading this book you could quite easily substitute the words ‘property development’ for megaproject. Except for the most basic, short term and complying projects,  property developments are susceptible to many of the same risk causes as the authors describe in megaprojects. This is especially so in publically funded projects but even private developments have many political and public risk factors.

Large scale property developments take time. The longer the programme the more likely you are susceptible to (changing) property market risk, capital market risk and policy risk [page 77 for associated discussion].

The larger the property development project the greater the potential implication on project costs, negative publicity and political decisions.

What the authors found is that a mechanical approach to risk analysis (static +- sensitivity analysis) often led to an incorrect belief that the course charted is the most likely [page 77]. They describe the problems when looking from what the World bank describes as the EGAP approach ‘everything goes according to plan’ [page 80].

“…in reality in the world of megaproject planning an implementation is a highly stochastic one where things happen only with a certain probability and rarely turn out as originally intended.” [page 73]

“…what people may think is the mean of all possible outcomes it actually the very unlikely best possible outcome”  [page 77]

” …the result is that the real costs and real risks do not surface until construction is well underway” [page 44].

The authors describe a better mechanism for risk analysis where you assign probabilities to potential outcomes and provide a more realistic assessment of what could happen and the effects on project investors and stakeholders. This helps remove some optimism bias (politicians like to make promises, builders like to build, developers like going for high profits) and to uncover the all important worst case scenario [page 81].

Whilst determining probabilities itself can be very subjective and montecarlo simulation analysis may appear overkill in property development, merely looking to apply the principles can create a more rigorous risk assessment. With the risk assessed, alternative scenarios can be formulated or contingency plans produced to mitigate that risk should it arise.

If the worse case is beyond your speculative inclination you can drop the project altogether. If the worse case isn’t actually that bad, then that may influence your decision to proceed even if there are significant risks (yes I run the ‘risk’ of sounding contradictory!).

Private business, undertaking work for public entities often miscalculate policy and stakeholder risk. One important way to reduce that risk is to get as much upfront agreement and clarity around objectives and decision making processes as possible – ideally binding contracts. It is also important to monitor those risks in line with the agreements in place. This works both ways; it protects the private interest from expending resource in anticipation of a successful outcome only to face policy change down the line; and it reduces overall cost to the public entity because clarity (especially when contracted) reduces the margin a prudent private business needs to place on policy and stakeholder risk.

The book has many lessons applicable to large scale property development and I recommend it as essential reading, especially for any organisation involved in private-public development initiatives.

 

Andrew Crosby

For my own take on managing project risk visit www.developmentrisk.com and read more in Turnaround Success: How to Resurrect Failed Real Estate Developments.