Finance & Accounting Apr 3, 2015
Always Be Closing
Practical tips for success in real estate development.
When people imagine an entrepreneur, they tend to envision a tech guru with a passion for apps and wearable gadgets, not the young executive who aspires to build the next big hospital, apartment building, or cultural venue. But for David Cocagne, an adjunct professor of real estate at the Kellogg School and the CEO of Vermilion Development, these are the projects that really matter.
“There are few professions that touch on all aspects of peoples lives,” he says. “Developers fundamentally shape how we work, how we live, and how we play. It may not always seem sexy or cool, but the results are very tangible.”
As a real estate developer, Cocagne was able to achieve results early in his career. In 2010, at age thirty-three, he and his company won a bid to develop Harper Court, a mixed-use project in Hyde Park that was jointly initiated by the city of Chicago and the University of Chicago. “We were by far the smallest company competing for that development,” he says. “We were up against a lot of big names.” After financing, building, and selling the project—which, at $140 million, was one of the largest in Hyde Park in recent years, and a major contribution towards the neighborhood’s revitalization—Cocagne was widely celebrated as a positive influence on urban development. Crain’s Chicago Business selected him for its 2013 “40 under 40” list.
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As Cocagne sees it, success in real estate development requires three essential qualities: persistence, the ability to mitigate risk, and creativity.
Playing the long game
For Cocagne, the development process begins with an overall vision. “It’s looking at a piece of property, seeing what’s missing, and figuring out how to make something unique,” he says. This is especially important because major development projects do not happen overnight. The bidding process for Harper Court began in November 2008, but the project was not complete until November 2013. Part of the bidding and vetting processes for these kinds of developments involves determining whether a company and its partners are likely to go the distance. “We have very long gestation periods,” Cocagne says. “Longer than elephants.”
“Developers fundamentally shape how we work, how we live, and how we play.”
“Even in two or three years, a lot can change,” Cocagne says. Over the lifecycle of a project, shifts in the political and macroeconomic environments can complicate things. “The market can shift from apartments to condos—or there could be a credit crunch. Until you get to the closing table, you are always exposed.”
Ultimately, though, developers keep their focus on the community that their project proposes to serve. “Real estate is a local commodity when it comes to the fundamentals of supply and demand,” Cocagne says, “so it’s hard to speak in averages. The vacancy rate in San Francisco is very different from the vacancy rate in Detroit, but looking at the average of those two really tells you nothing about the market in either one of those locations.” A successful development project is one that meets existing demand while also addressing the long-term needs of a neighborhood or a community.
Balancing risk and reward
When a development project goes well, the payoff can be enormous. But people often underestimate the risk profile. “In real estate,” he says, “we talk as much about the risk side of the equation as we do about reward. When people think about developing, they think about exciting stuff like the ribbon cutting. That’s great, but it’s about one half of one percent of what goes on. It’s really about the day-in, day-out management of risk.”
For the developers themselves, the risks can be huge. “Everyone hears about the big names in development and sees how wealthy those guys become. What they may not appreciate as much is that those people are signing personal guarantees. So if a project goes badly, the lender can come after their personal assets.” Most entrepreneurs are not in the habit of risking personal bankruptcy; developers are a different breed. “In real estate, we’re saying to the bank: we promise personally to pay back this loan.” Cocagne says this arrangement was an eye-opener: The first deal he made money on, the amount of the guarantee was about three times that of his net worth.
While it is possible for a developer to secure “non-recourse” financing—a loan that does not entitle the bank to the borrower’s personal assets—doing so may limit the potential for high returns due to steeper interest rates and lower ability to leverage. Still, there are ways to manage risk without necessarily foregoing profits. A majority of construction loans are variable rate loans, which leave developers exposed to fluctuating interest rates. “What we often do is secure a floating rate loan, but we also buy a rate cap.” This is a way to protect against a scenario in which interest rates spike.
From Cocagne’s perspective, the ability to manage risk separates those who survive from those who do not. This was certainly true in the wake of the recent financial crisis, which demonstrated for him the truth of Warren Buffet’s stance on investing: You do not know who is swimming naked until the tide goes out.
A different kind of creativity
“Few people think of real estate as a creative business,” Cocagne says. “But the fact is that you encounter a lot of obstacles, and you have to find a way to get around them.” The key is figuring out how to align various stakeholders’ interests. That is where creativity comes in. “It may not be creativity in the traditional sense,” he says, “but it certainly isn’t easy or straightforward.”
This is especially true for mixed-use development projects like Harper Court. When Vermilion was developing the project, the company had to take into account the objectives and needs of both the university and the city—not all of which overlapped. The city wanted a high level of retail occupancy, but the university had more specific criteria for what kinds of stores belonged near campus. “We had to find retailers that satisfied both parties,” he says.
Moreover, from a design perspective, mixed-use projects must cater to a diverse clientele, including office workers, retail employees, hotel staff and guests; a developer needs to find creative ways to avoid conflicts. “You have to understand how providing loading docks for retailers on the ground floor interfaces with the service areas for residential tenants,” Cocagne says, or how to ensure that a residential lobby feels distinct from a retail one without taking up too much leasable space.
Mixed-use projects can also present unique opportunities. For example, a hotel needs parking at precisely the hours an office building does not, and retailers certainly benefit from the presence of workers and guests. The symbiotic relationship among these uses allows for the sharing of fixed costs.
In order to capitalize on these opportunities, it helps to build strong partnerships on the basis of common goals, which is possible when a developer listens closely to the needs of every stakeholder. The main objective of Harper Court was to make the neighborhood more appealing for residents, students, faculty, and visitors. The university saw the benefit of adding a major office component to lease and occupy, and the city saw the advantage of driving pedestrian traffic to the area. Both had an incentive to make a historic district more appealing.
“It’s about understanding who else has a vested interest in your project,” he says, “and enlisting other stakeholders to support what you are doing,” as well as acknowledging that not every stakeholder will be equally engaged. Finding out what exactly their interests are, “changes the tenor of the conversation. That is a key element of success: learning how to build a stakeholder base and a constituency around a project in order to get it done.”
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