In today’s build-and-flip, institutional merchant apartment development world, keeping an asset for decades is no easy task. For these companies, it’s the goal.
Last year, The Bozzuto Group celebrated its 30th anniversary in business.
The milestone marked a new mindset for President and CEO Toby Bozzuto, whose father Tom, along with Richard L. Mostyn and John Slidell, founded the business in 1988.
“When a company is in its infancy, its primary focus tends to be survival,” Bozzuto says. “I am privileged to be a steward of this company in our second generation. As the company begins our 30th year, it is far more mature. We are therefore able to leverage great long-term relationships, as well as an increasingly robust brand. We believe that our communities are unique, so we would ideally like to hold them for the long term. Our projects feel too precious to us to sell them immediately.”
The story is similar at other companies. When Bob Kettler, Founder of Kettler, was younger, his father, a successful home builder in Maryland, would tell him the “key to making money in real estate is, ‘don’t die.’ ”
Kettler says, “The difference between the billionaires in the industry and millionaires in the industry is the billionaires are generally ‘buy-and-hold guys.’ ”
Kettler has real estate investments of all types as part of its diversified, vertically-integrated platform.
For a certain number of projects (roughly one-third), Bozzuto wants to build “legacy” deals that it can hold for years and even decades.
“We build communities that are thoughtfully designed with a focus on creating extraordinary experiences for our residents,” Bozzuto says. “We pour our heart and soul into the development, construction and management of these assets, and would therefore like to enjoy owning them for the long term. With this longer duration in mind, we can focus on cash flow versus a quick turn of the asset.”
Bozzuto is not alone. Around the country, a handful of developers specialize in building complex projects that they can hold for the long term. But in today’s build-and-flip, institutional merchant development world, keeping an asset for decades is no easy task.
These developers’ pockets must be deep enough to invest the upfront capital without needing to recycle it a couple of years later. Finding willing equity and land partners is an even bigger challenge. Being able to secure those partners, whether they are landowners or cities, takes a long track record of success—something a second-generation company, such as Bozzuto, is more apt to have.
The Capital Chase
During the past few decades, apartments have evolved into an institutional asset class. And Bozzuto says that is not a bad thing.
“My father and his partners were fortunate to have institutional equity and debt partners from the beginning.
To do this day, these institutional partners have been our largest clients in our management business,” Bozzuto says. “These institutions allow a company like ours to grow in reputation and geographic reach.”
They also provide the opportunity for a developer to do what it does best—build. With institutional capital, a developer can build, sell and move on to the next project.
“Many developers are not fortunate enough to be able to invest for the long term because they need to be able to free their equity for future transactions,” Bozzuto says. “Due to the relative maturity of our company, we are not as reliant on deals that turn quickly. Nor are we dependent on using institutional equity alone. We are therefore not only interested in doing institutional transactions but are now also undertaking deals with equity that is more interested in a long-term horizon.”
Finding the right equity partner to develop an apartment that will be held for generations is not easy. This generally eliminates institutional investors.
“Understandably, institutional capital needs to evidence returns for their investors, and therefore has a more finite holding period,” Bozzuto says.
So where does that leave a developer who needs an equity partner and wants to hold an apartment for a generation—or longer? Bozzuto goes to high-net-worth individuals through their family offices, which are private wealth advisory firms that serve high-net-worth investors.
“They often view real estate as an alternative asset class,” Bozzuto says.
Putting together the debt for legacy deals is easier than finding the equity. But if the wrong debt structure is chosen, the hold time may be limited.
West Coast developer Prometheus will typically fund 35 percent to 40 percent in equity and get 60 percent to 65 percent in debt.
“We typically don’t try to get more aggressive in the capital stack with mezzanine financing or preferred equity as one might see in a quick-turnaround-and-sell strategy,” says its President, John Millham. “We do have a large stable of debt providers in agency debt, life insurance companies, debt funds and traditional banks.”
There are many long-term financing options that make long-term holds attractive, including The HUD 221(d)(4) loan, which is fixed for 40 years plus up to an additional three years during the construction period. Although it’s an open secret these loans require a lot of patience because of the complicated and protracted approvals process. Nonetheless, these programs have advantages because these products lower the equity requirements and they are great for the balance sheet because they are non-recourse,” Kettler says.
“As long as those options are out there, we will use it,” he says.
As this apartment market cycle matures, the land market for any type of apartment assets—not just legacy ones—has grown to be exceptionally fierce. Fortunately for some developers, the partner who wants a long-term hold can also be the landowner.
“In virtually every market we operate in, we have multiple competitors on every opportunity,” Millham says. “We have become less focused on ‘acquisitions’ and more focused on opportunities for estate plans or tax efficiencies from our land sellers. This has resulted in very different deal structures and timelines than some of our competitors.”
For Prometheus, these deal structures could transform the land seller into a tenant-in-common owner, ground lessor, installment seller or a joint-venture partner.
Bozzuto also develops joint-venture partnerships with land owners. Instead of cashing out, these land holders decide to hold their land and partner with a developer to create a family annuity or to generate a cash-flowing entity for a trust or foundation.
“In general, land owners can put some or all of their land value into the deal as equity,” Bozzuto says. “They are looking for a long-term partnership, and we, therefore, utilize financing tools such as HUD’s 221 (d)(4) program to effectuate these mutual goals.”
Bozzuto, has a lot of experience piecing these deals together. In Reston, Va., it built 241 apartments next to the Metro station on land owned by Charles A. Veatch. It also is building 279 apartment units and 86,500 square feet of retail with The Chevy Chase Land Company next to the Bethesda Metro Station in Montgomery County, Md. The Chevy Chase Land Company remains in the hands of the descendants of Sen. Francis Newlands, who founded it in 1890.
“The Land Company wanted to continue to keep the property within their family,” Bozzuto says. “Whereas countless developers wanted to buy it from the Land Company, we were instead able to combine the Bozzuto and Land Company families to form a long-term beneficial partnership.”
Institutions can’t entirely be counted out as partners on generational projects either. Ronald Witten, Founder of Witten Advisors, says he believes there are more deals this cycle where a developer builds a project with the eventual owner (who typically provides at least the equity capital for the project).
“It seems that most of those are with institutional partners rather than high-net-worth individuals [family offices],” Witten says. “However, high-net-worth investors are often reported to be the winning bidders on high-quality new developments being sold, a pattern over maybe the last two years.”
A good partner is not always an individual (or family) who owns the land. Kettler has successfully partnered with Santa Monica, Calif.-based Macerich on large deals such as Tysons Corner Center, which included 1.4 million square feet of residential, office, hotel and retail space adjacent to a new Metro station.
“Macerich’s Chairman looked at Reston Town Center [a mixed-use development featuring offices, retail stores and restaurants in Reston] and said, ‘I want to build with those guys. I like the way that they captured placemaking,’” Kettler says.
Kettler is also working on Market Terminal at Union Market (1.3 million square feet) and The Boro (1.7 million square feet in Phase I)—two other ambitious mixed-use projects in the Washington area. Even though the company may sell its portions of the projects in the future, Kettler considers them legacy-building projects.
There are times when the local government owns the land.
“We have a lot of experience doing public-private partnerships where a public entity controls a large swath of land,” Naparstek says.
Holland Partners, a large developer based in Vancouver, Wash., also has a strong record of working with local governments. At the Platform District at Orenco Station, it built three rental mixed-use buildings with 609 units and a public plaza on 5.25 acres in the suburban Portland neighborhood of Hillsboro, Ore.
Holland patched the deal together with multiple sources of financing, including a vertical housing tax exemption, system development charges financing, a transit-oriented development grant, development agreement with City of Hillsboro and a disposition and development agreement with TriMed (the Tri-County Metropolitan Transportation District of Oregon).
In a way, building a legacy-defining, generational-type asset is like the proverbial chicken-and-egg dilemma. Producing these buildings can help a developer forge a strong local, and even national, reputation. But to be able to access land that they can hold long term, they first need a strong reputation.
Prometheus has been in business for more than 50 years, which makes it an attractive partner.
“We hope people recognize that we will be here through the highs and lows of the cycles,” Millham says.
But how does a developer cement that reputation if it has not been around for a half-century? It starts by building a high-quality product regardless of hold time.
“At Bozzuto, we build every project as if we will be holding for the long term,” Bozzuto says. “We are trying to create sanctuary for our residents. We want our business and our reputation to be that of a company that builds high-quality projects that are beneficial to the surrounding community.”
At the Platform District, Holland included high-quality, durable materials, including Nichiha cladding, masonry, terra cotta, arris clading and pre-cast concrete.
“Long term” also is an important phrase to Prometheus. The company approaches every development decision with one goal—the project needs to stand the test of time.
“We invest deeply in every detail of the design, focused on building a quality and enduring product,” Millham says. “We also invest deeply in maintaining our projects.”
For Toby Bozzuto, building an apartment that he can hold for decades does not just add to his company’s legacy. There’s also a much more immediate advantage—it can help him get things through the approval process.
“It is difficult to go into neighborhoods and say ‘I want to be a guest in your neighborhood. Here is what we are going to build and how we are going to sell it,’” he says.
Bozzuto finds localities to be much more amenable to a developer’s pitch when the company wants to stay.
“I prefer to say we are making a sincere long-term investment and commitment to their community. We have every intention of being good neighbors and active participants in the neighborhood for the long term,” he says.
At the beginning of the development process, Prometheus engages local stakeholders and city politicians to better understand their concerns about land use, densities or overall design.
“We often hear about needs for open space, additional retail space or better traffic patterns,” Millham says. “We attempt to incorporate these elements into the project. In today’s world, we believe the neighbors and larger community need to be a part of the process.”