There is a version of property flipping and development of commercial real estate, which is also referred to as merchant development. A merchant builder is a developer that specializes in building buildings for near-term resale. For example, let’s suppose a developer has a relationship with an industrial user that needs a 100,000 square-foot industrial building. Before beginning construction, the developer signs a long-term lease with that company.
The developer finds the land, gets the entitlements, zoning approvals, gets his building permit, gets his financing, and awards the construction to a contractor who builds the building, and now it’s all shiny and new, and it’s fully leased.
At that moment in time, with a fully leased industrial property with a long-term lease, in a good location, the developer has created a very, very hot commodity. Very often, a merchant developer elects to sell immediately, within as little as a year after opening the building. That way, they eliminate their risk of holding long term, and they may realize an immediate profit. However, that’s not something that we like to do. We like long term holds, which we believe is the way to create long term value.
If you go back to my first major development in New York (Tower 45), our total project cost was $140 million. At the time we completed the building (1990), the financial markets had nearly collapsed and we thought that the cost of the building was such that we would never succeed with the property. Recently, this building sold for $364 million.
Related: What is the difference between Class A, B, and C properties?
Building a Marketing Strategy for a New Development Project
Park Tower / Tampa, FL
Remember that you’re building a building from the ground up. There needs to be a lot of excitement generated around the building to drive sales/leases. While it’s under construction, it’s not yet on the radar of a lot of brokers until it gets closer to opening, and that’s because brokers want to make money by entering into a lease that they can collect a commission on. If the building is just a raw piece of land, it’s most often viewed by the real estate world as being somewhat far off and not as exciting a place to bring clients to right away.
This means that the amount of effort on a development deal in the way of marketing needs to be ramped up very significantly. The amount of energy and effort that goes into marketing a new development project is significantly higher than it is with respect to an existing building.
It requires an intense amount of knocking on doors and an awareness campaign, letting people know where you are on construction, when the building will be ready, as well as announcing exciting developments like newly signed leases. If the project is an office building, an exciting new tenant like Google or Apple would be a sexy tenant that might attract other tenants to the building. In the case of a retail property, the anchor tenant may be the vitally important tenant that draws other retail tenants to the shopping center. Think announcing an anchor tenant like Whole Foods or Nordstrom’s.
You want to keep the news fresh and moving and you want to keep it in the eyes of the real estate broker. Almost every week, some kind of newsworthy event should be reported and promoted. The general cost of marketing and the general push for a building that’s being developed needs to be multiples greater than what it is for an existing building.
Creating a Holding Strategy
Let’s suppose you developed a new building, but for some reason, you did not get a lot of long term leases from the initial lease-up. It would be a mistake to try to sell that building with a fairly unstable rent roll. The buyer would have the risk of knowing that in a short period, a large amount of the space may roll to market and the buyer could find himself with a nearly vacant building.
Therefore, your holding strategy might be created based upon the length of the lease terms that you were able to obtain. The longer the lease term that can get, the more patient you can be before you sell. On the other hand, long-term leases will generate a very desirable sales price if you elect to sell the property as soon as you build it. Following the severe recession of 2008, investors want long-term leases with strong credit tenants. the value of commercial real estate is directly correlated to the longevity and reliability of the cash flow.
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City Center / St. Petersburg