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European Real Estate Society

Annual Conference 2014

João Manuel Carvalho

jmc@fa.ulisboa.pt

CIAUD

URBAN REHABILITATION – A NEW PARADIGM FOR REAL ESTATE DEVELOPMENT?

RESEARCH QUESTION

The paradigm shift the economic crisis may have brought to real estate development, even if just accelerating previous trends, goes on being a research issue;

G. Squires & E. Heurkens – International Approaches to RED Session E1 I. Anghel & P. Vlad – A new perspective for understanding the Real Estate Market...Session G5 C. Roche – Renegades of Real Estate: Novelties, Threats and Vanguards Session O8

Urban rehabilitation has proved to be the financially feasible domain for real estate development when business margins become too thin to allow for public costs imposed on land development;

Does urban rehabilitation represent the new paradigm?

Would case studies on urban rehabilitation provide the best evidence for featuring the real estate paradigm shift?

METHODOLOGY / CONTENTS

Defining real estate development and its scope, for the research purposes;

Selecting issues that are relevant for real estate development in

general, concerning either regulation or internal business;

Analyzing the behaviour of real estate development case studies for each of the above issues;

Comparing with past behaviours;

Modelling into a paradigm to discuss.

REAL ESTATE DEVELOPMENT (RED)

Two conceptual choices hereafter – 1) RED is an activity distinct from building works and 2) RED is a private business

1) RED starts by conceiving the business opportunity that resides in the transformation of a given space; then gathers the means to achieve it. The builder is one of the developer’s suppliers, even if an in-house one. RED is a top creative real estate business, that can take place as land development or as building development. These may, but need not, be combined.

2) Public real estate development is either urban development or a political solution for a space related problem. RED may have to comply with them but under a business approach.

RED IN ITS HISTORICAL CONTEXT (IN PORTUGAL)

The Portuguese Real Estate Developers’ Association was launched in 1991 and the Contractors’ one in the 1950s. In the beginning RED was house building to meet the demand of growing urban populations.

RED had however a specific role in land development, a high margin business which, on account of this, has been much sought after by real estate developers up to the present;

From the late 1960s on, tourism development was also important for contractors; no scheduled conference paper on tourism real estate;

Regulation has focused on restricting land development and on sharing the developers’ business margins.

TYPES OF RED AND THE EMERGENCE OF URBAN REHABILITATION

Land development became forbidden outside the city perimeters in 1991, though an exception was introduced in 1999 for tourism resort permits, originating an excess supply of tourism real estate;

The global liquidity boom induced RED that targeted real estate investors, namely office and shopping centre buildings, presently in excess of end-user demand;

Housing development became possible either through redevelopment or through rehabilitation, which meets the urban authorities’ aims and becomes therefore a RED business opportunity enhanced through a purposeful legal framework.

Real estate development under the urban rehabilitation banner is a diverse business and allows for a diverse real estate offer.

REGULATION ISSUES RELEVANT TO RED

Relationship with urban planning Land to cede compulsorily to the public domain for green spaces

and for the installation of public buildings (social equipment) Cash compensations due to municipal authorities for non-

compliance with land-to-cede ratios, if the municipality prefers to receive cash or accepts a request of the developer

Development taxes due to municipal authorities (independent of the final business outcome)

Parking provisions Heritage restrictions Construction norms Conservation and environment requirements

EVOLUTION WITHIN REGULATION ISSUES

Relationship with urban planning“no plan needed”–“previously existing plan”–“tailor-made plan” Land to cede compulsorily for green spaces and social equipment

“social need”–“environment”–“space differentiation” Cash compensations for non-ceded land“residual” – “significant” – “expensive” (cash-strapped authorities) Development taxes due to municipal authorities“very expensive”–”instrumental for PPP agreements” Parking provisions“need fulfilling”–”externality control”–”strategic” (mobility options)

abc (as) = área bruta de construção acima do solo (m2)cons = estado de conservação da construção (coeficiente pericial parametrizado)cc = custo da construção nova (€)terr = área do terreno (m2)dim = autonomia da dimensão do terreno para intervenção imobiliária (cpp)vtmin = valor mínimo do terreno / m2 de abc(as) na zona (€)loc = vantagens da localização / sítio (cpp)

EVOLUTION WITHIN THE REGULATION ISSUES (cont.)

Heritage restrictions“few cases”–”many cases”–”flexibility for selected components” Construction norms“outdated / circumvented”– “certification”– “sustainability options” Conservation and environment requirements“scale 1:25.000” (under revision)–“fine-tuned for RED” (difficult) Energy efficiency with minimum level and tax stimulus above it

RED INTERNAL BUSINESS ISSUESBusiness plan, real estate valuation, funding, permit and external design risk management

Business plan“Detailed construction budget”–”benchmarking for contractor tender” / “scenarios for global construction cost estimation”Permit periods, due diligence needs and municipal taxes predictive with decreasing uncertaintyProduct innovation unsystematic but tends to accrued importance Real estate valuation“Value statement”–”reasoned range of values for negotiation” (either for the property to purchase for development or for its value in the several development stages)

RED INTERNAL BUSINESS ISSUES (Cont.)

Funding“Bank funding”– “partnering with a real estate investor”–”equity” (prepared for delayed positive outcomes; that is how RED started) Permit and external design risk management “Individual” –”Global”–”Global and assured” (PPP)PPP and urban plans or equivalent (“instrumento próprio”)PPP, planning obligations and planning gainsPPP and the property rights of third parties

WHAT PARADIGM TO EXPECT?

PPP as the standard framework for REDWithin it, all RED payments due to local authorities, either compulsory or negotiated, as well as their schedule, are settled. PPP are transparentResting upon an urban plan (detailed design), or a specific document, submitted to formal public scrutiny, third parties’ rights being duly acknowledged . PPP allows for scheduling RED in the long-term without losing the

previous permit rights.

WHAT PARADIGM TO EXPECT? (Cont.)

Land ceded to municipality enhances the RED business (or significantly mitigate the cost of ceding developable land), through finding design and uses that differentiate the urban areas.

Parking provisions may go on being a tense issue between RED (public parking ratios and private parking are hard to fulfil in consolidated urban areas) and urban authorities (with sustainability led strategies that favour soft mobility and not car facilities).

RED is launched based on equity and so is a rarer business than previously (even discarding crisis effects), with a stronger bargaining power vis-à-vis contractors and urban authorities.

WHAT PARADIGM TO EXPECT? (Cont.)

Real estate valuation is an in-house device or a one-side contracted professional service to enhance RED bargaining power. Real estate independent expertise as an arbitrage between RED and third parties is just a formal step. Splits the real estate valuation professional services into 2 types.

A 2nd tier RED exists (within the PPP area awarded between urban authorities and the 1st tier developer) for smaller operations in which architectural design (space organization, construction features and image) is the central business issue.

Innovation in real estate goods will be needed to meet challenges of pre-existing space to rehabilitate and as a marketing device, requiring flexibility of construction norms. Seems an important area of research in real estate.

CASE STUDYURBAN REHABILITION RED WITH A ZONAL CONTENT

The “Príncipe Real Project” is a multi-building residential development in a Lisbon historically sensitive area, much valued for its amenities and central location. It is part of a main 18th – 19th century axis running along a dominant slump line, with a high residential status where well-off bourgeoisie and rich nobility built their 19th century town residences. One of the main anchors of this settlement – the 18th century “Colégio dos Nobres” – is a grand public building with a large botanical garden, both classified as national monuments. The botanical garden extends down the slope to reach the valley of the Av. da Liberdade, the main Lisbon street and a prime location for brand retail and offices.

THE DEVELOPER

The developer is a U.S.A. company which for the purpose works from Lisbon (incorporated in Portugal, under the Eastbanc insignia), through a small permanent team mostly led by Civil Engineers with expertise on real estate development and construction management. The company is adapting to Lisbon the strategy of its former successful real estate development in Georgetown (Washington, D.C.), which has induced the private requalification of an urban area larger than the one directly developed. The property acquisitions were selected in order to be neighbors to the botanical garden so that, through rear gardens, one might fancy a direct “green” public connection between Príncipe Real and Av. da Liberdade.

THE PROPERTIES TO DEVELOP

The properties have common architectural features that may be viewed in the internet site of Eastbanc . The buildings have a strong image, being high standard mostly 19th century palatial houses, in decay or with residual uses. Architects for the development have been carefully selected among internationally awarded Portuguese architects. Building works have just started (as of the 3rd quarter 2013). The multi-building character of the development makes public space features a common concern to both the developer and the municipality.http://eastbanc.pt/content/principe-real-project

THE FEATURED RED

The total construction area purchased for the development (i.e., the set of buildings around the botanical garden) is 12.162 sqm, distributed by five buildings of which three were palatial residences, one an apartment building and another a decayed and abandoned building. The construction area after development will be 16.948 sqm, mostly for housing targeting mid-cycle families in the luxury segment, with retail on the ground floors and a hospitality component (5.680 sqm). There are increases in the construction density and also an overall increase in dwelling density, since the palatial properties had not previously been divided, though ill-accommodating non-residential uses.

THE FEATURED RED (cont.)

The retail component has a zonal content since the developer already owns c. 50 shops in the quarter.The most notorious building (located in a quite visible corner and featuring Arabian Architecture “Casa Árabe”) – will be allocated to the hospitality component, through being a hotel or serviced apartments with the possibility of providing like-services to all the other developed buildings.Flats will be for sale, but shops will be kept in the developer’s portfolio. The hospitality building, once the final lay-out of accommodation units is settled, could either be sold to a real estate investor, further to being managed by a hotel company, or be sold to end-users or investors under the possibilities allowed by the tourism condominium law.

THE RELEVANT REGULATION ISSUES FOR RED

The total amount of expected urbanization taxes to be paid by the developer, which concern new construction area, is estimated at c. 4% of the corresponding construction costs.

The surrounding area is from the start very well endowed with green areas and in no need of new social equipments; no land is therefore required to be added to the public domain. This means property developers won’t have to cede land to the municipality, though cash “compensations” might be an issue. Rebates may however be expected in the case study since private green areas belonging to the developer will be allocated to an important public green track connecting the Príncipe Real quarter to the Av. da Liberdade.

THE RELEVANT REGULATION ISSUES FOR RED (cont.)

Architectural conservation restrictions had to be met, given the acknowledged heritage value of the buildings. The demolition of an abandoned early 19th century mid-sized construction, was however allowed and its substitution by two new buildings permitted. Likewise, the demolition and substitution (with c. 40 sqm given up by the developer) of an early 1900’s rear annex to a 17-18th century palatial house were allowed, though a 19th-20th century terraced extension in the same building, in a bad condition and with no evident relationship with the historical building, had to be kept. These were discretionary outcomes of technical arguments with the authorities, made possible since buildings are globally classified but without detailed rules for each component.

THE RELEVANT REGULATION ISSUES FOR RED (cont.)

The parking provision is an issue, namely given the high market target of RED; the municipality itself is studying the need to install more public parking. Recently, political problems emerged within the municipality on the issue.

Construction norms may generate a mismatch in the case of the two buildings that will be built anew, as the developer envisages opening kitchens to the living room. The market look at the apartments will be kitchen and living room area corresponding to a “living room with incorporated kitchen” and the regulatory one will be “one large kitchen that includes the living room area and one of the sleeping rooms counting as living room”.

THE RELEVANT INTERNAL BUSINESS ISSUES FOR RED

The budgeting for the main individual building works was not too detailed and the business plan rested on overall unitary costs per sqm, though these were differentiated for each building, to take account of initial condition or specific works (e.g., demolitions and structural rehabilitation) and tested against selected scenarios.

Differentiation in product design was not sought after beyond the location and architectural features of the existing buildings. The features of the dwellings (e.g., internal plan) are therefore the outcome of the architects’ choices – under a budget ceiling – and not the outcome of market research on demand preferences.

THE RELEVANT INTERNAL BUSINESS ISSUES FOR RED (cont.)

The lay-out of the existing buildings made it natural that large dwellings should be installed, targeting mid-cycle families at the top of the market; this product design is therefore expected to meet the preferences of such families. The two buildings that will take the place of the only demolished building target much smaller households and, as there is the freedom of choice allowed by completely new buildings, the developer is leading the design concept ahead of the architects’ choices. There is however a strong bet on product differentiation through the quality of construction, which the developer makes a point of emphasizing by going on to be the owner of the shops in the buildings.

THE RELEVANT INTERNAL BUSINESS ISSUES FOR RED (cont.)

Due diligence on property mostly focused on making clear who was the lawful owner of a part of one of the buildings which was mingled into another one and in the analysis of the original tenancy contracts. The developer considers however that the due diligence costs were relevant.

Delays on permit issuance were actually an issue and caught the developer by surprise, as for initial stages approval a period of 8 months had been scheduled within the business plan and the final period came to be 24 months.

THE RELEVANT INTERNAL BUSINESS ISSUES FOR RED (cont.)

The relationship with external real estate valuation was featured both by the high expertise on real estate of the company’s team and by the funding options of the venture. The value of the targeted properties for RED purposes was therefore settled internally and external valuations were not even an issue. Besides the expected redundancy of the external valuations, the envisaged RED business would bring together a set of properties so that the overall value would be greater than the sum of the parts, the “plus” being hard to determine by external current building valuation.

THE RELEVANT INTERNAL BUSINESS ISSUES FOR RED (cont.)

External real estate valuations became necessary when the properties were given as covenant for debt capital, a requirement of banks for mortgage purposes. Furthermore, for fiscal efficiency and easing of equity movements, a real estate rehabilitation investment fund was launched; the acquisition of the developer’s properties by the instrumental fund also required formal external real estate valuations, which have to be made by appraisers the Lisbon Stock Exchange regulator (CMVM) accredits.

The present unavailability of banks for real estate debt led RED to rely on equity and to the re-scheduling of operations, in order to mitigate unbalanced cash-flows.

THE RELEVANT INTERNAL BUSINESS ISSUES FOR RED (cont.)

The public walking connection through gardens between the top-of-the-hill Príncipe Real and the valley-located Av. da Liberdade was made possible only through a joint-venture between the developer, who owns part of the necessary green areas, and the State, that owns the botanical garden.

The municipality’s rehabilitation aims are met through RED. Therefore, though no formal agreement has been settled between the developer and the municipality, collaboration was natural and started with the financial support the developer gave to a Detailed Plan, through paying its professional fees, though the planning team was selected by the municipality.

THE RELEVANT INTERNAL BUSINESS ISSUES FOR RED (cont.)

Public space design and functions that the Detailed Plan would achieve were a fundamental framework for the developer. Furthermore, the developer’s permit strategy (scheduled in the medium-term) rested on provisional permits (“Pedidos de Informação Prévia” – “PIP”), which allow for obtaining construction rights without having to submit technical projects, whose risk – derived from the provisional character – would vanish once the Detailed Plan got fully legal.

Some of the objectives remained however an open issue, such as the sufficiency of private parking provision and the revamping of the botanical garden that could make the most of the new walking track, dependent on State decision.

THE RELEVANT INTERNAL BUSINESS ISSUES FOR RED (cont.)

Detailed Plans normally include a “perequação” algorithm, but this plan explicitly dispenses with one, on the stated grounds that changes in the existing property features are not big enough to justify it. This is only partially true since construction and dwelling densities increase. The plan deals with the subject through creating “accomplishment units” (within which the “perequação” would eventually have to be carried out) where no major changes occur, the exception being an “accomplishment unit” where there are major changes but all the properties belong to the developer. This procedure, a lawful urban planning practice, shows the informal agreement between private and public parties and the commitment of the municipality to urban rehabilitation.