Business Insider

Treasure Valley developers get back in the commercial-building game

Almost all developers build projects whose bottom line isn’t the bottom line.

Sometimes, they go into a project knowing they will make less money than normal. They do it, they say, because it’s good for the neighborhood, because it will help a young company take root, because they’re have an emotional investment.

“Eighth & Main is a prime example. That was a total stretch,” says Tommy Ahlquist, chief operating officer of the Gardner Co. A parapet atop the building made Eighth & Main the tallest in Idaho – topping the kitty-cornered U.S. Bank Building, which has more floors – when it opened last year. Eighth & Main filled a lot in Downtown Boise that had been empty so long that people called it the Boise Hole.

So what was Gardner’s reason for accepting the risk on Eighth & Main?

“It was going to be cool.”

Adds David Wali, Gardner’s executive vice president: “How many times do you get to build the tallest building in the state? If you claim to build community, then sometimes you just do things to make the place better.”

“Building community” is Gardner’s slogan.

Clay Carley, a longtime Downtown Boise developer who owns much of the property near the corner of 6th and Main streets, says he looks at Downtown as a whole when he considers new projects. That helps him assess their potential profitability over the long run, instead of trying to make money right away.

“By adding to the neighborhood, I’m adding to the value of my other properties,” Carley says. “So my perception of return on investment is probably different than an outside developer coming in, buying a single parcel that’s his only project in Boise, and his only measure is that project. For me, the measure is my neighborhood. Every time I improve my neighborhood, I get a long-term value that’s hard to calculate and quantify.”

Making money matters, of course.Never let pride be the reason you take on a project, Treasure Valley developers say.

“Everything’s got to work on the financial side or nothing works,” says Jared Smith, a Boise native who plans to build a 10-story, 180-room hotel where Dunkley Music now stands on the southeast corner of Capitol Boulevard and Broad Street in Downtown Boise.

For Smith, the hotel project is a happy combination of homecoming and opportunity. He has worked on hotel projects much of his career, and he always wanted to do one in Boise. With Boise hotels’ room occupancy and nightly rental rates soaring in recent years, Smith jumped at his chance.

Local Construct:

Urban homebuilders

The methods developers rely on when they do new projects varies as much as their favorite product types.

The Los Angeles-based developer Local Construct teamed with Carley to turn Downtown Boise’s historic Owyhee Hotel into office space and apartments and plans to build a seven-story, 160-apartment building in Boise’s Central Addition neighborhood on the west side of 5th Street between Myrtle and Broad streets.

The company starts every project with a simple question: “Why are we in the markets we’re in?” co-founder Mike Brown says.

Brown says he and partner Casey Lynch found mostly positive signs in Boise’s traditional market fundamentals. Those include job growth, housing growth, population growth and average median income. .

“People are moving here. People love living here,” he says. “Every single person you talk to, for the most part, in Boise is basically a proselytizer for Boise. They’re just very happy to live here. As a developer, that’s a no-brainer. If you’ve got a place where that’s going on, that’s a market we’d like to be in.”

LocalConstruct also examines less traditional criteria, such as Internet access, walkability scores, long-term water supply and how progressive the local governments are when it comes to planning, building and issuing permits for new projects. Downtown gets high scores, Brown says.

LocalConstruct is a numbers- and process-oriented firm. Before it moves forward, the company develops detailed pro formas – spreadsheets that calculate and compare every cost and expected return. The developers know how much land is likely to cost and how much they will spend on contractors, lawyers, accountants, local-impact fees, permit fees and recording fees. Brown says LocalConstruct calculates expenses as small as the expected cost of a telephone line in the manager’s office of a new building and of planting flowers in spring.

He memorizes statistics like the local market’s vacancy and lease rates. But as much as he finds comfort in the process, Brown acknowledges his way isn’t the only way.

“I know people who invest totally with their own money who essentially shoot from the hip,” he says. “I mean, they’ve been doing it long enough that they’re pretty accurate shooting from the hip. They don’t have a 10-page Excel model. And a lot of those guys are very successful.”

Ron Van Auker: Industrialist

Ron Van Auker doesn’t exactly shoot from the hip, but he’s a lot less process-oriented than Brown.

“Generally, when we get short on space, we build more spec buildings,” Van Auker says.

The co-owner of Meridian’s Van Auker Cos. builds industrial space for manufacturers. His business owns, manages and leases more than 2 million square feet of office and industrial buildings in the Valley, including the Emerald Tech Center in Boise. It also owns ready-to-develop land in Meridian and Nampa.

Van Auker says he pays attention to broad indicators, such as average rental and vacancy rates for industrial space, though he doesn’t put too much stock in them.

“The problem that most real estate people, particularly the real estate firms themselves, have is that they lump everything together,” he says. “One of the distinctions people really should make when they come up with vacancy rates is, it’s no different than office buildings. You have class C, class A and class B. Well, there’s no reason that industrial space shouldn’t be rated the same.”

Clay Carley: Old Town

Carley’s roots run deep in Downtown Boise. Downtown has the Carley family and forebears to thank for much of the way it looks today.

Before Carley got into development, his mother, Joan Carley, was buying some of Boise’s oldest buildings and promoting preservation of the city’s historic treasures.

Carley’s great-great-grandfather was C.W. Moore, one of Boise’s most prominent early residents. Moore established the First National Bank of Idaho in 1867. He donated the quarter-acre on the northeast corner of 5th and Grove streets to the city just before he died in 1916. It is now a small city park that bears his name.

On the data-instinct spectrum, Carley falls somewhere in the middle. He has his process, but he has so much local experience that sizing up possibilities has become second nature to him.

“You do a pro forma, you look at the returns, you evaluate the risk, and you say, ‘This return, given the risk, is worth it.’ And then, as a developer, you decide, ‘I’m ready to go,’” he says. “And then you have to go get financing. And that can change everything. Because the bank’s assessment of all of those issues is different than yours.”

Carley is making plans to build a five-story apartment complex with 84 units on the southwest corner of Fifth and Idaho streets Downtown, replacing Gibson Funeral Home.

He says he wants a long-term investment, not a quick buck.

“Many projects in Downtown Boise and across the country get developed and for two, three, four, sometimes five years, may not make money,” he says. “But 20 years later, when looking back, it looks brilliant, and they’re extremely successful and making big money.”

David Hale:

Downtown homes

David Hale specializes in urban development that mixes commercial and residential uses, especially infill housing such as the Hyde Park Rowhouses on 13th Street and a group of live-work homes on the southwest corner of Iowa Street and Longmont Avenue near Broadway. Before the Great Recession, he redeveloped a six-block area on Grove Street in Downtown’s west side and named it the Linen District.

Now he plans a 15-townhome project near the Linen District on a vacant lot on the south side of Idaho Street between 15th and 16th streets.

In the beginning, his approach is similar to LocalConstruct’s. “I think every developer starts with some vision as to how they could best utilize a property, whether it’s vacant land or an existing structure,” Hale says. “And then, that vision and that product type — or, the project — has to make sense from an economic formula standpoint.”

Hale, who moved here from Portland 18 years ago, likes urban settings, but instead of analyzing whether a market will support his product type – as Local Construct does – he adapts his projects to the market. The Idaho Street townhome project illustrates this nuance.

When he announced the townhomes, Hale said the units “will be priced under any of the Downtown competition on a price-per-square-foot basis.”

He made a point of including garages in his plans for the townhomes. “We live in a very active city where outdoor recreation is a pastime of many,” Hale says. “It appears everyone owns bikes, skis and recreational equipment, whether motorized or not. Offering a garage not only provides for safe and secure off-street parking, but also meets the storage needs of future buyers’ toys ... I wish I had completed product available today.”

Gardner Co:

Today’s alphas

In the past five years, no developer has changed the face of Boise more than Gardner, founded in Salt Lake City by Kem Gardner.

Eighth & Main marked Gardner’s first big move in Idaho. When that was done, the company moved quickly to a project that is, in some ways, more ambitious: City Center Plaza, a mixed-use development in the northeast quadrant of the Grove Plaza that will include office space, restaurants, an underground public transportation hub and an expansion of Boise Centre, the convention venue in the southwest quadrant of the Grove.

Gardner is also preparing a third project: a hotel-anchored mixed-use development on five undeveloped acres between 11th, 13th, Front and Myrtle streets.

Like LocalConstruct, Gardner worships in the temple of process, details and data. The whole point, says Tommy Ahlquist, the chief operating officer, is to narrow the margins of variability — in other words, reduce the unknowns as much as possible.

“Absorption is the big unknown. And that’s where people get burned,” Ahlquist says. “Well, you can get burned a few ways. If your costs get out of whack, if you’re over budget, if you get into something and it costs you a lot more, that can really foul your pro forma.”

Predictability is one reason Gardner likes to work with Engineered Structures Inc., the commercial construction company that built Eighth & Main.

“If you can take a big chunk of risk down, and you’ve got a partner that you know that they’re going to come in on time, on budget, that eliminates a huge amount of risk for you,” Ahlquist says. “You’re not going to get into any legal issues with them. They always deliver.”

The numbers: Cool vs. highly profitable

Another way developers differ is the way they calculate success financially.

Most of them have numbers in mind, but the formulas behind those number vary. For example, Brown and Casey watch the capitalization rate on LocalConstruct’s projects. The “cap rate” is the ratio of a project’s income from rent minus operating expenses to its total cost.

Brown says LocalConstruct likes to keep the rate at 6 percent or higher for Boise projects.

Gardner calculates return in a similar way, but Wali and Ahlquist look for a rate of 8 to 12 percent.

“And 5 if it’s just such a cool project,” Wali says.

But Ahlquist says Gardner won’t compromise its numbers on a residential project.

Gardner is also wary of projects that offer unrealistically high returns. High returns usually signal high risk.

“If someone’s willing to pay you a rent that allows you to have a return that’s too high, then the reason they’re doing it is because no one else will do something for them,” Ahlquist says.

Carley thinks about his investments from a different angle. Instead of focusing on year-to-year revenue, he considers how long it takes for a new project to go “cash-positive,” to bring in more money than it costs to maintain. Carley says he wants his projects to be cash-positive within two years of completing them.

“It takes a lot of tenants and a lot of months before you are paying your debt and getting a return on your investment from that income,” he says.

Hale, whose urban residential projects are the same kind Carley plans to do, says he wants them to produce a return right away. He looks for 8 to 15 percent.

Smith, the hotelier, and Van Auker say they have target ranges for return on investment, but they decline to disclose them.

The future: Constraints of competition

Across the board, Treasure Valley developers are busier and more aggressive these days than they have been for almost a decade.

Van Auker says he is looking at building 75,000 square feet of prime industrial space for specific customer. He thinks he will build another 75,000 square feet of spec space in the same development.

A hot market brings complications, and some are reminders of why the economy got into trouble last time.

“It’s crazy out there again. You’ve seen what’s happening. It just gets nutty,” Ahlquist says. “You’ve got subs in an already shallow market just saying, ‘Hey, it’s heyday now. I’m going to make my money.’ And tripling, quadrupling their prices ... And you can’t blame them. They’re in demand. They’re just a market-driven community, too.”

Ahlquist says Gardner “will probably slow a little bit” after several years of ideal circumstances: low construction costs, plentiful labor and subcontractors, and low interest rates.

Developers aren’t just competing for subcontractors. They’re competing against each other.

Smith’s plans for a Downtown hotel were the first publicly announced. Since then, Gardner has announced its own plans for a major one. And Eugene, Ore.-based Obie Cos. announced plans to build a hotel just south of where Smith wants to put his.

Smith worries the other hotels will drive down demand for his rooms. But he is not backing off his own plans.

A similar competition could be lurking in the multifamily residential sector, which is considered part of the commercial real estate industry. Brown says he is wary of a sudden burst of supply on the local market that would reduce demand for LocalConstruct’s projects, even though the housing he offers tenants — high-end apartments within a short walk of the urban core — is fairly rare in Boise.

“When rents rise and fall in a market, you may be protected to a certain extent by being the newest or otherwise somehow the best — the best-located within the market, or having the nicest product,” Brown says. “But if the market is going down, you’re going down with it.”

On the other hand, demand seems to be strong enough, at least in the multifamily sector, to absorb a glut of apartment projects either under construction or in the planning phases across the valley.

More than three years ago, Brown and Lynch bought the empty, 1.8-acre block between 15th, 16th, Idaho and Bannock streets. They do not have plans for developing it yet, but they’re willing to keep paying taxes without getting a return for now. They believe Downtown development will push westward enough to put their property into the Downtown-walkability zone they crave.

“Now it’s just starting to reach the realm of possibility that perhaps someone would consider walking from there all the way down to 10th Street, where you start encountering restaurants,” Brown says.