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ОглавлениеChapter 3
The Real Estate Development Process
There is a reason for everything with each developer and each project is a big life story making its way into the building.
—John Carroll, Portland, Oregon, real estate developer1
Real Estate Development as Product Development
Real estate means different things to different people. To most of us it means the physical homes we live in and the office buildings where we go to work. To city planners, real estate development is a way to mesh the economic goals of private developers and their investors with a city’s larger economic and social goals, from business growth to job creation and housing production. Planners may influence the geographic direction of development, for example, by encouraging ground-floor retail in buildings that will be built on commercial corridors or by encouraging higher-density and mixed-use development around transit stations. For elected politicians, development is a way to encourage investment in the city—in ways that are in concert with policies, plans, and the desires of their constituents—and as a way to attract and retain businesses, house residents, and expand the city’s tax base. For architects, a real estate development project means the opportunity to design a building that will generate fees and can lead to repeat business, allow them to practice their craft, and explore their own aesthetic ideas. If their peers consider their work important, they may also win design awards and attract positive media attention. To wealthy investors, real estate development is a way to earn a higher rate of return on their money than they can earn through the stock market or other less risky investments. From the developer’s viewpoint, real estate is all of these things but first and foremost it is “product” and real estate development is “product development.”
In the same way that Apple Computer, Inc., developed the next generation of computers, phones, pods, pads, and other must-have gadgets, real estate developers constantly work to produce the next generation of office spaces, warehouses, retail centers, or housing units. Developers even use the same language as other product manufacturers. They “develop,” “design,” “produce,” “market,” and “sell,” and they talk about what is in “the pipeline,” whether or not they have enough “sales velocity,” and the problem of having too much “inventory” or “product on the shelf.” Products change over time, however, and if there is one constant to the product-development process—and the real estate development process—it is innovation.
The Role of Innovation in Real Estate Development
In The Innovator’s Dilemma: When New Technologies Cause Great Firms to Fail, Clayton Christensen differentiates between “sustaining” and “disruptive” innovation. Sustaining innovation is an innovation that does not affect existing markets and can either be “evolutionary” or “revolutionary.” An evolutionary innovation is an improvement to an existing product that consumers expect, such as fuel injection for automobile engines. A revolutionary innovation is one that is new and unexpected but that does not affect existing markets. The automobile itself, for example, did not affect the horse-drawn carriage business because it was so costly and out of reach for the average consumer.2
Disruptive innovation, however, creates a new market by “applying a different set of values,” and it ultimately and sometimes unexpectedly overtakes an existing market. The use of the assembly line to manufacture the Ford Model T at a significantly lower cost is an example of disruptive innovation because it overtook the entire existing automobile industry and made cars cheap for the masses. Products based on disruptive technologies are typically cheaper, simpler, smaller, and more convenient to use.3 Examples of disruptive innovations and the markets they overtook include over-the-road trucking and railroads, digital photography and chemical photography, and cloud computing and USB flash drives.4
Real estate usually falls in the category of sustaining innovation, with evolutionary innovations including incremental improvements to materials and building systems for all product types as in the increasing emphasis on sustainable design and construction. Revolutionary innovations in real estate often take the form of variations on existing product types and locations. Over the past century, revolutionary jumps in retail products, for example, have led from downtown department stores to suburban strip malls, regional shopping centers, mega-malls, entertainment centers, and lifestyle centers. Similarly, revolutionary jumps in residential products have led from dense single-family and multifamily housing in cities to single-family homes and townhomes in the suburbs and then back downtown to loft conversions, new townhomes, high-rise condominiums, senior housing, student housing, and luxury apartments.
Whether evolutionary or revolutionary, different types of products evolve at different rates. In his book about product design and development, Where Stuff Comes From, Harvey Molotch points out that the introduction of entirely new products is relatively rare, and most products are based on existing but constantly evolving “type forms.” Vacuum cleaners, toasters, and other household goods evolve over time but do not change in terms of their general look and function. Across the spectrum of goods, “quick-turn” type forms like mobile phones evolve rapidly while products such as household appliances, automobiles, and homes that are more costly and expected to last much longer are called “slow-turn” type forms. In product-development terms, real estate is a “slow-turn type form,” and there are a number of reasons for this.5
First, real estate development is very risky. Every time a developer initiates a project he or she is attempting something that has, in effect, never been done before. Each project represents a unique combination of price, product, location, and market timing. Second, real estate development is very costly. Unlike other entrepreneurial ventures that can be cash-flowed or “bootstrapped,” development requires the upfront investment of large amounts of capital. Developers use their own risk capital—cash—and that of their investors to obtain control over a piece of property, complete a conceptual design, seek and obtain key approvals, and test the market for their product. The expenditure of these funds, however, is no guarantee of success and if the project does not get completed those funds are lost. So in order to preserve capital and minimize risk, developers are more inclined to adapt a product slightly rather than strike out into the unknown and try something significantly different. Equity investors and banks take a similarly conservative view—they want their money returned and so they are less inclined to try far-out things. For example, a developer may not think he needs to provide as much parking as a typical project because the site is near a transit line. He may have difficulty, however, obtaining a construction loan because the product does not provide the same basic features as its competitors, so the bank sees increased risk. On the other side, the market’s tastes evolve slowly too, so developers are careful not to get too far ahead of their buyers in terms of price, product, or location. There have been plenty of examples of development projects that were too exotic, in the wrong place, mispriced, or simply before their time, which is why, as one saying goes, “pioneering developers are the ones with arrows in their backs.”
When compared to the latest cell phone, real estate—housing, office, retail, and industrial—is a product type that evolves slowly, and yet it is always evolving. It takes a long time to get a real estate product to market—years and even decades can go by between the time a developer conceives of a project and the day the last unit is sold or the last lease is signed. During that time many things change, from market tastes and demographic trends to construction costs and the efforts of the competition. How, then, does a developer go about successfully conceiving, producing, and selling a real estate product? What are the steps and who are the actors?
The Five Stages of Development
Concept Stage
The real estate development process can be divided into five basic stages: concept, approvals, design, construction, and sales. First, during the concept development or “pursuit” phase, a developer must have an idea or a vision for a product that will serve a specific market, for which there will be adequate demand, and that can be built at a cost and sold at a price that will yield a minimum profit. This idea may start with a piece of land or a building in a good location, a product type for which there is demand, a real tenant or buyer, or an amount of investment capital under the developer’s control. The developer will take into account supply and demand for the product type and local, regional, and national business, technological, and population growth trends.
The developer will also begin assembling a skeletal team, starting with an architect whose job it will be to test what kind of project will fit on the property, including use, numbers of floors, and numbers and types of units. The developer may also ask a contractor to provide a simple cost estimate for the project, based on the architect’s preliminary sketches and an anticipated quality level. This cost estimate will serve as the basis for an economic model of the project or “pro forma” that summarizes project costs, financing, and potential profits based on anticipated prices. The developer will need access to capital to finance the project through to completion so she will begin to court potential investors, lenders, and other individuals and institutions that may be potential sources of funds. The developer rarely has a monopoly opportunity, so she must also scrutinize the marketplace and consider what her competitors are doing, what comparable products are already in the development pipeline, when they will hit the market, and the likely costs and prices of those products.
The developer must then consider the politics of obtaining approvals and whether or not she can generate the good will and support required from local elected officials and government staff, neighbors and members of the community, and other special interests. At the end of the concept phase the developer will have a team, a concept design, a pro forma, potential investors and lenders, a preliminary indication of support from the city and other relevant stakeholders, and a good idea of the market’s appetite for the product. The developer’s objective in this stage is to arrive at a politically and economically viable concept for the lowest possible cost. Next, the developer will advance the design to the level required to seek and obtain formal approvals from the city.
Approvals Stage
At this early stage of the project, from the viewpoint of the public, the developer is often a solitary individual attending neighborhood meetings with a staffperson or an architect in tow. Behind the scenes, however, the developer’s team is larger and will continue to grow. Developers are generalists and very knowledgeable but they lead as conductors and so, as Gerald Fogelson pointed out in Chapter 1, they must surround themselves with a wide array of specialists if they are to succeed. The design team will grow from that one architect to include landscape architects, land surveyors, geotechnical engineers, and structural, mechanical, electrical, and plumbing engineers. These different team members may be hired because they possess relevant expertise in the product type or because they have worked successfully with the developer in the past, or both.
As the design evolves, the developer will begin to consider which building systems—structural, heating and air conditioning, plumbing, and electrical—are most appropriate for the building and for the product type and how those systems will impact the economics of the project, including both costs and rents or sales prices. The marketing and sales team will help to improve elements of the design from the column bay spacing, window design, and ceiling heights for an office building to the unit plans, parking facilities, and common spaces for a residential building. Their combined efforts will be directed toward sharpening and differentiating the project’s image or brand to ensure a competitive edge in the marketplace. In the background, the developer’s real estate attorneys will assist with everything from executing real estate transactions—options, purchase agreements, and other contracts—to partnership agreements. Other attorneys will lobby local politicians and draft homeowners’ association documents or other covenants, conditions, restrictions, and easements that will be applied to the completed property.
Throughout all of this, the developer will continue to meet informally and formally with city staff, politicians, community groups, neighbors, investors, lenders, and many others. The developer will receive feedback on anything from the height, density, and massing of the building to the mix and sizes of units, design style, colors, materials, site layout, and parking arrangements. She will strive to integrate as much of this feedback as is reasonably possible into the design, with the goal of maximizing the attractiveness of the product to potential buyers. At the same time, the developer will seek the support of these various stakeholders and will strive to increase their commitment to the project. If successful, the developer will gradually broaden ownership of the project by ensuring that the issues of key constituencies are reflected in the developing design as much as is technically and economically feasible. The developer will incorporate this information into the design and will complete drawings to the level of detail required by the city to submit for approvals and to present at formal public planning and zoning commission meetings. If successful, this stage ends with the city granting the formal approvals or “entitlements” to the developer for the submitted design that are required for the project to be built.
Design Stage
With entitlements in hand, key team members in place, and the developer’s vision and project goals more clearly outlined, the team will begin to design the building in detail. More architects and engineers will join the team, along with a variety of other subconsultants specializing in everything from traffic engineering and parking structures to historic resources, lighting design, and interior design.
The contractor will use the approved concept design as the basis for a more detailed estimate of construction costs. These costs will include everything required to construct the building, from materials, labor, systems, and interior finishes to temporary heat, electricity, insurances, and fees to be paid to the city if a lane of the street must be closed or parking meters must be taken out of service. To this estimate the developer will add land costs, design fees, legal and other professional service fees, and all other “soft costs” to arrive at the “total project cost.” Next, the developer will add an amount or percentage for profit to determine final pricing for the product. Once all of this information has been assembled, the developer will begin to fine-tune the project, working back and forth to reduce costs, increase value, and simplify the design from a construction standpoint while maintaining a certain level of quality. The contractor’s input at this stage will influence everything from the architectural design and the selection of materials to the column grid, the locations of stairs, elevator and mechanical shafts, and the selection of structural, mechanical, electrical, and plumbing systems.
The developer will keep meeting with potential investors and lenders and will also commission a market study to help demonstrate the viability of the concept. This document will be based on national, regional, and local economic and demographic data as well as information about comparable products, or “comps,” in the market. It will summarize existing inventory, how the project compares to similar projects in terms of location, features, and price, and how competitive the product is likely to be in the marketplace. If the developer is planning to use cheap appliances in a “luxury” condominium or providing one parking space per apartment unit when competitors are providing two, the lender either may be unwilling to make a loan without very good explanations for these decisions or may offer less favorable terms.
The marketing and sales team will begin to shape the image of the project from its name and logo to the design of its website and how it will be positioned, represented, and sold based on the target market—the buyers whom the developer hopes to attract. Developers differentiate their products to reflect the wants and needs of different types of buyers, and they vary their sales and marketing approaches for the same reason. Selling condominiums to first-time homebuyers on a budget, for example, is different from selling them to wealthy, retired, empty nesters. Similarly, leasing office space to small professional services firms is different from leasing to a call center filled with low-wage hourly workers in cubicles or to a prominent law firm that requires many large, private offices.
While the detailed design is being completed, the contractor will continue to fine-tune construction cost estimates, and the developer and sales team will determine final pricing. Marketing materials will be prepared, the sales center constructed, and the sales agents will be hired. The marketing team will grow to include public relations and media consultants; branding, graphic design, and creative firms; and an event planner. They will design brochures, signage, and collateral materials. Stories, opinion pieces, and ads will be placed in the local news media. And together they all begin to create excitement and “buzz” around the big and carefully planned grand opening of the sales center when the product will go on the market.
Construction Stage
Construction loans for real estate projects are secured by the future value of the completed property. Before a bank will make a loan, the developer must demonstrate this value by obtaining a specified number of purchase agreements or leases at or above projected prices to give the bank confidence that the project will sell out or lease up. The developer may turn to a bank with which she has a good relationship or she may shop around for the best loan terms.
As soon as the developer has settled on terms with a bank and closed on the loan, she will acquire or “take down” the land and break ground, with the goal of completing construction as quickly as possible. Throughout the construction stage, the developer will be involved in a million little decisions from materials selections to construction details to the review of monthly construction payment applications. Until the building is finished she will be constantly rebalancing the project’s design, materials, systems, and costs.
Closing dates with tenants or buyers will drive the schedule. For large projects the developer may complete and sell or lease up a part of the project while the rest of the building is still under construction. High-rise residential and office towers are often completed and occupied from the top down, while horizontal developments like townhomes and office parks lend themselves more easily to phasing that matches market demand and absorption. Whether the first condo unit or an entire building, the completion of construction signals the beginning of sales.
Sales Stage
Once construction is complete and the building is ready for occupancy, the developer’s objective is to sell or lease it up for the highest prices possible as quickly as possible. The developer must repay the construction loan with proceeds from sales. The longer it takes to sell out or lease up, the higher the interest costs on that borrowed money—the carrying costs—and the lower the developer’s profit. During this stage the developer’s attention will be focused on ensuring that buyers or tenants who have signed purchase agreements or leases remain satisfied and show up to close on those contracts.
The developer’s involvement will not end until the building is completely sold out or, in the case of a rental property, leased up and then refinanced or sold. Some developers build to “hold” over a longer time frame and they will have ongoing responsibility for property ownership from maintenance to periodic capital improvements. When the developer does finally sell or “dispose of the asset,” whether it is as soon as it has been leased up to a “stabilized” level of occupancy (for example 90 percent) or decades later, she will return all funds to lenders and make distributions of equity and profits to investors.
An Iterative and Fluid Process
The five stages outlined above offer an idea of the breadth of knowledge and experience required to be a successful developer. Each stage contains many tasks and many of those tasks span across some or all stages of a project. Many of those tasks are also different in character from one another, from negotiating a land purchase and directing an architect to drafting a pro forma and seeking the support of an elected official. So while they are sometimes portrayed as generalists who are “a mile wide but only an inch deep,” developers must possess deep knowledge in a broad range of subjects—they must be a mile wide and a mile deep. They must also know when to bring in specialized expertise in those instances when they are less knowledgeable. And they must know how and when to approach these many different tasks. Pat Prendergast, a developer from Portland, Oregon, offers a different view of the real estate development process through his own detailed checklist:
REAL ESTATE DEVELOPMENT TASK LIST:
• Project Initiation
• Site Control: Option/Purchase/Venture
• Initial Development Entity
• Selection of Development Team
• Project Conception
• Alternative Development Concepts
• Development Program
• Market Evaluation
• Site Evaluation
• Economic Analysis (Pro Forma)
○ Gross Income
○ Operating Expenses
○ Net Operating Income (NOI)
■ Debt Coverage Ratio (DCR)
■ Debt Service Constant/Loan Constant
■ Mortgage Loan Amount
■ Total Development Cost (TDC)
■ Equity Investment
○ Debt Service
○ Net Cash Flow Before Taxes (CFBT)
○ Return Ratio
■ Economic: Return on Assets (ROA)/Return on Cost (ROC) (ROA/ROC = NOI/TDC)
■ Cash-on-Cash: Return on Equity (ROE)
■ Discounted: Net Present Value (NPV) or Internal Rate of Return (IRR)
• Socioeconomic Analysis
• Development Prospectus
• Development Proposals
• Development Planning
• Development Agreements/Deals
• Land Use Approval
• Private-Sector Commitments
• Public-Sector Commitments
• Equity Participation
• Permanent Loan Commitments
• Construction Loan Commitments
• Public Site Assembly
• Design Development
• Construction Drawings and Specifications
• Construction Bids and Awards
• Construction Management
• Preleasing Program
• Leasing Program
• Property Management
• Marketing Promotion
• Critiques and Evaluation
• Alternative Development
Other Tasks:
• Disposal/Sale of Asset
(Include Presale OR Prelease)
(Courtesy of Pat Prendergast.)
Prendergast’s list reveals the scope and magnitude of the developer’s job, but it is also important to recognize that while some tasks are shown on this list as one-time events in fact many of them are ongoing. These tasks span over some or all development stages and are messy and not easily confined to lists and frameworks. Indeed, the development process is an iterative and fluid one, as various ideas, constraints, different types of feedback, and new information are integrated into the process and the product comes into increasingly clearer focus.
For example, the original development budget will evolve from some numbers scribbled on the back of an envelope to a simple one-page spreadsheet to a spreadsheet with many tables. These tables will reflect increasingly finer assumptions and the accumulation of more information. Over a development timeline of five years or more, the pro forma will undergo many iterations and revisions that incorporate new and changing information and assumptions from land price and construction costs to unit size, mix, and price. Discussions with investors and lenders will also begin in the first stage and continue throughout the process until the last unit is sold or the last square foot is leased, the construction loan is repaid, and all investors have received their initial equity back, ideally with a return or profit. Political work—meetings and negotiations with neighbors, politicians, city staff, commissions, and other interests—will also be ongoing as will parallel public relations and marketing and sales efforts. The design will evolve continuously too, from a freehand sketch on a napkin or the back of an envelope to a big stack of detailed drawings and specifications that the contractor will use to determine the final costs of labor and materials and to construct the building.
It sometimes helps to view development this way—as a series of stages and as a list of tasks—but it can also be viewed as a process that is punctuated by a small number of important milestones. These include property acquisition, preliminary approvals, final approvals, achieving a predetermined percentage of presales or signing a lease with an anchor tenant, closing on financing, completion of construction, stabilized occupancy, and sale. Each of these is a required step on the way to a completed project and each requires the careful management of myriad tasks through multiple stages. While these lists of stages and tasks are easy enough to comprehend in the abstract, they are more fluid and messier in practice. Because no two development projects unfold in the same way, managing uncertainty and the “unknown unknowns” is just one more part of the business. Real estate development is a complex type of product development with high stakes. Minor mistakes or omissions in any of the stages, tasks, or milestones can derail or stop a project and cost the developer most if not all of his or her financial resources. And just one bad project can wipe a developer out.
If real estate development is a form of product development, what exactly is the finished product that developers make and how do they go about doing it? In the next section we will explore these questions by considering the careers of two Portland developers—Pat Prendergast and John Carroll. Each had a long and productive career spanning various product types, and together they were the first to see the potential in an abandoned railyard that has since become a neighborhood called the Pearl District. We will hear how they each think about both the product and the process of development, beginning with Prendergast, whose career story is a study in opportunism, adaptation, and product innovation over time.
Portland, Oregon: The Graveyard of the West
Pat Prendergast grew up in Dallas and attended Park City schools and the University of Maryland while he served in the U.S. Air Force. After he was discharged he returned home and took an entry-level position in a large bank. Three years later he moved to Houston to work in a smaller bank where he knew he could learn more about what the various departments did. The most profitable department in that bank was real estate construction lending, so Prendergast began to pay attention to the man who ran that department. “He was a darling of management and he brought in a lot of money so I gravitated away from the commercial lending side towards real estate construction lending.”6
At the time, a big developer headquartered in Dallas named Trammell Crow pressured the Los Angeles–based commercial broker Coldwell Banker to come east and open its first location outside of California, in Texas. “Crow, who had become Coldwell’s largest client in California, felt strongly that Texas was going to be the next Southern California and he ended up being right,” says Prendergast. Five people came from Los Angeles to open Coldwell’s Houston office and a year after meeting them Prendergast went to work for Coldwell Banker in commercial brokerage. “We were working with some of the largest national developers including Trammell Crow and Gerald Hines, who was based in Houston.”
When Coldwell opened an office in Dallas, Prendergast moved back to his hometown. “CB was representing Neiman Marcus, which was based in Dallas, and Neiman was on an expansion program at the time. CB was also doing a lot of regional shopping mall leasing around the Midwest at the time so I did that for a couple of years.” Then, in 1972, one of the original five CB people who had come from Los Angeles to Houston was asked to go up and open an office in Portland, Oregon. He recruited four other CB people from around the country to go with him and one of them was Prendergast. “My father-in-law had a lot of friends in Seattle and California, so when I told him I was planning on maybe moving to Portland he checked around. Back then, Oregon was known primarily for its poor, lumber-based economy. ‘Word I get,’ said my father-in-law, ‘is that Portland is the graveyard of the west.’”
Creating Capital to Do Other Things
Prendergast moved to Portland anyway. “Coldwell had a Seattle presence at the time and they were all over California, so when we arrived in Portland that was the catalyst for Crow, Hines, Don Koll out of Newport Beach, and some of the other larger players who wanted national brokerage representation if they were going to come into a relatively unknown market like Portland.” Soon, Prendergast wanted to get into the business on his own but, at the time, Coldwell wouldn’t allow its brokers to own real estate. “They thought it was a conflict of interest and that as listings would come in the brokers would cherry-pick the good ones.” If he wanted to own real estate, he would have to go out on his own, so a year after moving to Portland, in 1973, Prendergast left Coldwell and formed his own development company.
“I started out doing build-to-suit commercial buildings on twenty-year, triple-net leases for expanding companies like Denny’s and 7-Eleven.” These large, national “credit tenants” could guarantee that the rent would be paid, lowering Prendergast’s risk and virtually ensuring a dependable income for the duration of the leases, while leaving him with buildings that could be sold as assets in the future. “Some of the banks were doing branches and the savings and loans were still expanding so I did buildings for them too. Until 1979–1980, we basically concentrated on those small, low-risk, build-to-suits to create capital to do other things.”
Late in the 1970s, Prendergast started doing some of the early speculative office-building developments in Portland, fairly close in to the core. “Those went reasonably well considering there was nothing in the urban center at that time, so in 1981 I did my first office building in the central business district.” This was a 200,000-square-foot building near Portland State University that Prendergast did as a joint venture with New York–based Merrill Lynch Hubbard. Between 1973 and the early 1980s Prendergast developed several million square feet of office space in Portland, Seattle, and Denver. “Then, slowly but surely, the high-tech boom started taking off in the early 1980s so we had a fairly sustained market for about ten years. High interest rates in the early 1980s, however, followed by the 1986 tax act that closed a lot of loopholes and eliminated tax benefits as an equity source, and then the savings and loan crisis in 1987 combined to dampen the commercial office market throughout the United States for decades to come. The rest of the 1980s were a tough time nationally for office development,” says Prendergast. “So, since the 1980s, we have concentrated largely in the urban center with the exception that I participated in some fairly significant land development and land sales in the 1980s, mostly on the west side, where high-tech was growing.”
An Inkling of High Tech
As late as the 1980s, Oregon was still struggling to move beyond its historical, labor-based lumber economy, and real estate market cycles were short when compared to the rapidly growing Sun Belt. “A good market cycle in the commercial and industrial area would be eighteen months,” says Prendergast, “but you have to have growth to have a decent economy, so the question then was ‘How would Portland make the transition?’ ” The answer began to emerge when high-tech companies began to relocate to the region from California. “Growth started to occur in Portland metro with the advent of high-tech in the early 1980s.”
At the time a new real estate product called “flex space”—a variation on the traditional one-story suburban industrial building—had come on the market and started to supply space for these companies. Flex space started with a basic high-bay warehouse or light industrial building. The innovation was that a strip of office space was tacked onto the front, creating an assembly building with offices. Flex space provides lots of flexibility by allowing office and manufacturing functions to be colocated in a single facility, but because it can house many more employees in its office space than a typical warehouse it requires much more parking. Most warehouses have few employees and just a handful of parking stalls but flex space is half office space, so it requires a much larger parking ratio to serve the same sized building, “on the order of a 4:1 ratio of parking to building area—four parking spaces for every 1,000 square feet of building area—as opposed to 1:1 for a typical warehouse.”
New and growing tech companies in California needed lots of land, including room for expansion, and a good water supply. “But people had made a lot of mistakes in San Jose,” says Prendergast. “As land costs skyrocketed in Silicon Valley, young tech companies tried to keep their costs down by buying smaller amounts of land that did not provide enough capacity for expansion, so when it came time to grow, they had nowhere to go. We had reasonable land costs in Portland, however, lots of water, and good planning, and so up they came.”
Prendergast knew commercial office, which shared some similarities with flex space, so in the early 1980s Prendergast started doing flex space. “The land costs for flex space just took off because it is a suburban application that requires large land areas, so I went further west and bought undeveloped land that had just come into the growth boundary and just gotten utilities and urban services. Then, in 1984, the major users from Northern California started showing up—Epson, Fujitsu, NEC, Kyocera—it was a long list and we had a good run for the rest of the decade.” By 2000, Intel’s largest employment base was in Oregon, where it had between 16,000 and 18,000 employees—more than the headquarters in Santa Clara, California. “High-tech created a tremendous new economy that took the place of the timber-based economy of the early decades of the twentieth century so we capitalized on that and our major land development work on the west side led us to the Hoyt Street railyards.”
A Big Transaction
“We had been partners with the Burlington Northern Railroad for some land they owned on the west side and in 1990 I sold that land to Nike for a significant profit but then I needed to find an exchange property to buy.” Like many people who buy and sell real estate, Prendergast wanted to take advantage of section 1031 of the Internal Revenue Code, which allows sellers of property to avoid capital gains tax by using the proceeds of a sale to buy another property within 180 days. “So our company initiated the major acquisition of the Hoyt Street Yards, which was an obsolete railyard, from a former subsidiary of the Burlington Northern Railroad.” Freight traffic had abandoned the city and moved north to a new intermodal yard, so the only rail service going into downtown Portland by that time was a single freight line and Amtrak passenger service. “The board of the railroad had decided to liquidate all nonrail properties and we had developed a piece of land nearby and that got us interested in the railroad’s property.”
Portland’s Urban Growth Boundary (UGB) was created in the 1970s as a counter to sprawl and as a way to increase the use of transit and obtain the maximum value from other public infrastructure systems. “To a large extent it has served the city well,” says Prendergast. “The city had a strong interest in putting jobs and housing close together and close to transit, and the UGB had the effect of making the urban core the center of activity and a more interesting place as a real estate market.
“So in 1992 we took our master plan for the Hoyt Street Yards to the city council and proposed a public-private partnership.” The forty-plus acres that the railyards represented were made up of two big parcels and “it was a fairly risky deal at the time—there was a significant amount of environmental remediation required and the site needed planning and infrastructure.” When the railyard was first developed in the early 1990s the old street grid terminated at its edges, so there was no power, water, sewer, or streets. The old Lovejoy Viaduct—a big automobile bridge that spanned over the yards—also had to go, “and it was going to be a $10 million problem just to take that down.”
The railyard made up the northern end of a 100-block, 285-acre industrial area that was bounded by the Willamette River on the northeast and was filled with old factories, warehouses, and vacant lots. When the first urban pioneers began to move in, the buildings became home to numerous galleries and artists’ lofts that—legend has it—one gallery owner characterized as the pearls inside the crusty shells of the warehouses. Local business and property owners were searching for a name for the area and, despite a handful of other suggestions, it soon came to be known as the Pearl District.
