Property Development

Assessing development risks

October 15, 2014

If I were starting a project today as the Development Manager, one of the first things I would want to understand is what are the strategic development risks that I must mitigate and manage for the project to be successful. I believe strongly that the developers and every other team member must be risk averse.

Rather than developing a long list of all project risks complete with a mitigation plan, I typically focus in 4 strategic areas:

1- Do I know the needs and wants of the user/customer team in detail?

2- Do I have a clear view of how capital will flow through the project?

3- Who are the governmental agencies that will regulate the design and construction process?

4- Do I understand how the site team will be constituted and managed, and how the QA/QC programs will be implemented through that team?

My sense is the detailed risks are captured and dealt with in these four strategic areas

Do I know the needs and wants of the user/customer team– in detail?

Owners are dealing with enormous changes in their workforce, especially with the inter-generational differences from the millennials to the baby boomers. Each generation has their own way of working and their comfort level with the evolving digital office. The younger workers have less need of a fixed or dedicated office and there is a growing focus on providing more collaborative work spaces throughout the tenant space. Oddly, that is accompanied by a growing need for access to private space for work that requires focus.

The October 2014 Harvard Business Review contains 3 critical articles about the work space. The articles are under the major heading of “The 21st-Century Workspace” and are titled:
1- Balancing “We” and “Me”
2- The Transparency Trap
3- Workspaces That Move People.
The research reflects a changing work environment where employees continue to use less space per person (from 225 sf per worker in 2010 to 190 sf per worker in 2013). That research also shows that the work space must accommodate the ubiquitous electronic support environment, where connectivity and availability are literally 24/7. Even amenity space such as fitness centers must be available 24/7, and privacy space is a growing need and is being provided in unique ways. My critical takeaway from this research is that “Office space is not just an amortized asset, but a strategic tool for growth” for your customers. My second takeaway is that every new building must be designed to “reflect how 21st Century digital work actually happens”. I was particularly struck by a statistic that “office utilization peaks at 42%” on any given day. That is a telling story as to how the work force relates to the office and how work is actually being accomplished.

The commentary above points out how critical it will be for any new office building design to address a wider range of tenant work force needs as part of the base building design—and how that space will include embedded systems to support that digital work environment. More than ever, the developer and the base building design team must spend significant time with each tenant and the tenant’s design team in understanding how they are organized, how their work force will function at initial occupancy, and how the tenant sees their workforce changing over time. The developer must also understand the changing amenity needs and uses in terms of communications systems, access to high speed internet, a building concierge, the need for retail and food service support that is close by- and so on.

A key area of change in all facilities is the need for parking. Today it is typical to design for 4 parking spaces per 1,000 sf of rentable square feet (RSF) for suburban space. The urban core need may be closer to 1/1000 RSF. The potential for change with the “Google” or driverless car, continued focus on mass transit, ride sharing and the general diminishing interest in owning a car on the part of the millennials may change parking needs dramatically. That dramatically changes design and pro-forma’s, and is just one more example of technology driven change.

The composition of the base building design team must be chosen rigorously. What is their experience working with innovative and technologically savvy tenants? How have they adapted to the changing design technology and tools within their own business? Has that change been successful? Who do they propose for their engineering team members and what is the teams experience in emerging technologies?

My challenge to the North Wing Building (1705 17th Street at Union Station) team in 2010 as we started the building design was to predict the systems that will be considered cutting edge in 2013 when this building opens? I was looking for more than a pat list of ideas from Popular Mechanics—I was looking for a design team – both engineers and architects—that were inquisitive, curious and truly enjoyed the challenges of providing a productive work place for our customers and simplifying the complexity of the building systems in the bargain. Most of all, I was looking for a team that could successfully collaborate with each User/ Customer.
In every sense, understanding your client/ user/ tenant is the critical step in the development process.

Do I have a clear view as to how capital will flow through the project?

Success is more than space design. It is also the successful use of other assets—most notable is capital, whether equity or debt. The developer must understand, as precisely as possible, how capital will flow throughout the life of the project. A number of “rules of thumb” and procedures have been developed by professional property investors, bankers, general contractors, financial analysts, etc. over many years. These rules and procedures must change as projects use; More prefabricated systems; A “manufacturing management’ approach for all site work and; A more highly educated (but smaller) work force on site. Today we can easily construct a cash flow analysis that predicts a fairly linear disbursement of cash during the design period and during the city review period, and then a less linear disbursement during construction. There are the obvious step functions at the acquisition of the property, at the funding of the construction loan, and at the sale of the property.

Managing the project cash flow is easy if you work from 100% equity, but the vast majority of projects will require at least one outside funding source. The rules and procedures the funding source has followed in the past will need to change– institutional change can be difficult. For example, if you use a prefabricated, pre-engineered system for the HVAC —you may need to ask your funding source to modify their review and payment requirements. That HVAC vendor may expect to be paid much like a manufacturer pays their vendors, ie, within 30 days. The system can be designed very precisely offsite, all of the materials fabricated and tested, and the final equipment installed, tested, approved and operational in a substantially shorter period than conventional construction. It is likely that the manufacturer could be complete, tested, approved and 100% off the site and still only be billed at 40% complete using the traditional pay application process. That will not be an acceptable approach for many system vendors. These changes should be discussed in detail before committing to project loans.

As we move to more prefabricated systems, we are likely to face many other cash flow related procedural challenges that must be resolved early with the lenders to match work completion with pay—otherwise it will be the developer’s equity being used to take advantage of the savings from using new technologies.

The same cash flow analysis will need to be applied to the tenant finish allowances, especially where the tenant uses even more prefabricated systems furniture, fixtures and equipment. Small retail operations have dealt with Vendors that deliver an entire store fit-out in a truck for setup in less than a week. That is great for the new store owner but sometimes a struggle for the lender.

In short—the introduction of more and more prefabricated and packaged systems will require that the developer, banks and all project professionals be able to predict with greater certainty the exact cash flow needs and timing and have early agreements with their bank as to alternate methods of funding these systems. It is quite likely that the traditional pay application process will not meet the needs of the Project Management entity (GC or other) and it is equally doubtful it will meet the needs of the vendor or the Developer and tenant.

Who are the Governmental agencies that will regulate the design and construction process?

A third area of major risk that the Developer needs to be focused on is the role that government agencies play in regulating the design and construction process. The Zoning Authorities, Building Departments, Utilities, and related agencies are focused on enforcement of existing ordinances and are capable of a certain degree of interpretation for unique circumstances. Over the past several years I have engaged with these different agencies helping them understand and evaluate new technologies in; 1- materials for strengthening structural systems, specifically Carbon Reinforced Polymers (CFRP); 2- HVAC systems, specifically the Variable Refrigerant flow systems (VRF) and; 3- the application of existing Zoning requirements to unique situations such as in the applications of “uniform” sign ordinances. In each of the noted instances I have found the agency professionals we worked with to be interested in understanding these new technologies and approaches, and they worked to find the best way to evaluate each new application. All three of the examples were eventually approved, but it took a great deal of time and effort.. There was never any agenda on the part of the agencies other than to do their best, and the interest of the intellectual challenge.

However, the Zoning and Building Department’s work is institutionalized and codified in City requirements. Their flexibility is limited and as the flow of new technologies and applications continues it is easy to see a point where the sheer amount of change will be overwhelming. They could easily assume a “by-the –numbers” interpretation of the building codes. That approach could slow down all project reviews and insert an unacceptable delay into the development process when a new technology is being proposed.

The solution to these delays lies in working with the building departments and other agencies as early as possible in the project to help them understand new technologies and develop a framework for evaluation. That sounds far easier than it has proven to be in real life, and involves a great deal of cooperation between the public and private sectors. A cooperative working relationship between the project team and the regulating agencies has always been important. Today it is critical.

Do I understand how the site team will be constituted and managed, and how the QA/QC programs will be implemented thru that team;

The last area of significant risk from a development standpoint relates to site management and Quality Assurance/ Quality Control (QA/QC). The reference here is to the actual construction/ delivery process whether in the field or with prefabricators and vendors. Construction has not changed much over many years, and as you would expect, there are many field- proven methods of completing projects successfully. These processes have served the Superintendents and other Field Personnel quite well, but that is now ending. In the place of rolls of plans and stick files in the construction office are IPads, light weight laptops, large screen TV’s on rollers so they can move from meeting to meeting, on-site, high speed networks—in fact all of the attributes of a typical, digitally enabled workplace. The project managers and superintendents are now college educated often with at least one advanced degree. In short, the construction industry has begun a slow change to a digital workplace—but not fast enough. There is no longer room for the superintendent that manages by intimidation. These experienced people were also the front line of QA/ QC on the project. They knew when a concrete pour was not set up correctly, or the electrician wasn’t taking the necessary time to install the conduit in a workman like manner. They also have an uncanny knack for working with the craft labor on site, whether the mason, finish carpenter, or form builder. The superintendent knew when the craft labor were skilled and should be left alone to do their job—or a journeymen that needed routine oversight.

Today there is a shortage in craft labor in all areas of construction, and the project superintendents are managing more from the metric side than the actual knowledge of acceptable construction standards—and that presents a significant risk to a project in all metrics—quality, schedule, budget. It will be critical for a Development Manager to work with the Contractor/ Site Manufacturer to ensure the site team that is assigned to your project can effectively and efficiently deliver a finished project—with a fully fleshed out QA/QC program that can be independently verified, and with the required skilled craft delivery using on site craftsmen or off site prefabrication. We always expect a cost effective and timely delivery; but above all—we must continue to demand a safe site.

In Summary

Technological change is beginning to impact development projects in a very significant way. It is now possible to deliver a project faster, with better systems and technology content and at a cost saving from the delivery schedule at a minimum. But it is not easier.

The pervasiveness of existing contract forms, reporting formats (see AIA), typical vendor agreements, close out documentation, surety requirements, etc., all insert a certain level of inertia over the acceptance and use of new technologies. Professionals will be hesitant to use a new technology if they believe it exposes them to additional risk. Owners will always be hesitant to use a new technology if their professional team is hesitant to use it. We are working today within a carefully crafted and tested methodology of designing and building projects. It may be out-of date.

We will be discussing Surety Risk and Insurance in subsequent postings. The conclusion of this post is simply— technological change is inevitable on all of our projects. The Developer must understand the risks and then proceed to manage and minimize the impact. The option of staying within the status quo is not viable-long or short term.


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