By Alison Rice. Part two of a two-part series on building homes while protecting limited natural resources.
With its hip repu-tation and resource-efficient sensibility, urban infill represents one of the solutions to the land and resource crunch that we at Builder covered in our January issue ("Material World"). But as smart an answer as infill seems to be, infill builders know that the obstacles to this type of development never seem to end. "Everything's designed to stop you," says Chris Branch, president of The Boulevard Co., an infill developer in Charlotte, N.C. "It takes a tremendous amount of drive and persistence."
At the same time, Branch and others are making it work, generating buzz and profits in cities around the country.
For some, infill represents the only pragmatic option for the markets they serve. "Eventually, [infill] will be 100 percent of what everyone does," predicts Lance Waite, president for Western Pacific Housing in San Diego, a division of D.R. Horton. "There has been so much acreage set aside for environmental habitat that soon there will be no more rural subdivisions left unless there is some relief."
Others see the infill challenge in more personal terms. "I want to build 100-year buildings in 100-year locations," says Branch, who's done projects such as 715 North Church, a 85-unit condo building just steps away from Charlotte's uptown arts community, and Gateway Plaza, the for-sale condo component of a $300-million Bank of America development in urban Charlotte.
But infill is more than a mission: It's a niche market with less competition than traditional suburban development and potentially higher profitability--for those who know how to work the system.
"I grew up in the city. I've lived in the city my whole life, and I understand the value and economics of city development," says Jim Letchinger, president of Chicago-based JDL Development, which does high-end townhomes and condominiums in affluent neighborhoods of the Windy City. "Other people look at a piece of land on the Gold Coast and say, 'The price of land is so high. The price per square foot will be so high.' I appreciate the value on the sales side."
After all, infill developers live by the law of supply and demand. "The great locations aren't getting any greater," Letchinger says. "You can fudge the boundaries, but the Gold Coast is the Gold Coast. It's four blocks wide and eight blocks long, and that's it."
Much has been made of the "urban revival" revealed in the 2000 U.S. Census. That research found that a surprising number of people were moving not into the suburbs, but downtown, increasing the density of cities such as Houston, Portland, Ore., Philadelphia, San Diego, and Baltimore.
Such numbers confirm what infill developers already knew--that there is a market for empty-nesters and for what Branch, borrowing from The Economist, calls "the Bridget Joneses of the world."
"They're 25 to 40, they're not married yet, and their life centers around their job and going out," Branch says. "These buyers just did not exist 25 years ago. It's a real demographic shift."
And they like to live downtown. In San Diego, demand has been so hot for downtown condos that would-be buyers can't even get on interest lists. "There's nothing available," says Waite.
That's sweet news to Steve Scarborough, chairman of Irvine, Calif.-based Standard Pacific Corp., which recently completed its first urban infill project, an 82-townhouse development called Providence, in the western part of San Francisco. "One of the things that is very attractive in an infill location is the lack of competition," he says. "There's very good pricing elasticity in projects and potentially greater profitability."
Breaking the mold
In many ways, infill is a natural for big builders, who have the capital, the resources, and the staying power to invest as much as $65 million in a single building, as Western Pacific has done with Union Square, the first of four downtown buildings the company is doing in San Diego.
"We have access to equity that smaller builders don't," Waite says. "Lots of times, they have to have 50 percent of units sold before they can start construction. We don't have those requirements."
But the nationals never really had the motivation to do infill that their local counterparts--seeking refuge from their competitors--did. Until now. Faced with rising development and environmental constraints in key markets, the public builders are returning to the city themselves.
K. Hovnanian, already known for brownfield and infill developments on the East Coast, hired a "director of infill opportunities" for its Northeast region last January and has been scouting parcels for mid-rise condos in San Diego and Pasadena, Calif. Toll Brothers recently started work on a luxury condo community in Providence, R.I., which recently underwent its own urban renaissance.
Beazer Homes USA recently formed Beazer Metro, which will do urban developments in Baltimore and other cities. And Standard Pacific is involved in two more Bay area infill projects as well as condominiums at Playa Vista, a massive infill community in Los Angeles.
"I think everyone's looking at it," says Waite. He adds that the increasing availability of larger infill parcels has made the approach more viable for companies like Horton. "In the past, infill parcels were 10,000 square feet, but once infill pieces get to be four, five, six acres, the big builders are always interested," he says. "And, when you can hit 75 to 100 units per acre, all of a sudden there is enough density to attract a large company like ours."
At the same time, infill represents a very different type of development for big builders, who are so accustomed to replication, standardization, and ultra-efficient production. Product and pricing decisions must be made without the benefits of comps or competition.
Plans must be created anew for each project, making costs and construction schedules less predictable. Buildings take a year to complete, not four months, slowing the inventory turns for the entire company.
As a result, infill wreaks havoc with the steady results Wall Street seeks. "Your returns on investment are negative for three years, and then they're 150 percent," Waite says. "The industry, as we move toward this type of construction, may want to reconsider how the larger builders are valued in the marketplace."
Whether a builder closes 5,000 homes a year or 50, in-town, new-home construction presents similar challenges to those who brave it. "Most of the infill sites you work with really have a lot of unknowns about them," says Steve Delva, the Standard Pacific division president responsible for the company's Bay area infill projects.
Those unknowns can include the very basics that conventional suburban builders and developers take for granted, such as the location and working condition of infrastructure essentials such as water, sewers, and other utilities.
"Urban planners like to tout urban infill as a way to take advantage of the existing infrastructure," Delva says. "What happens is you get in there and the infrastructure needs to be replaced. It's not as simple as going in and taking advantage of what's there. The water line [at a past south San Francisco project with another builder] was so old, we had to make custom-made fittings to tap into the line."
Utility connections represent only one of the land mines lurking beneath ground level. At Daly City, a hillside infill community south of San Francisco, Standard Pacific discovered buried trash pits while doing routine grading. "You try to do your homework, but you get surprised," Delva says.
Building codes provide another quick trip to infill's dark side for those who design mixed-use buildings. "The code is Byzantine," says Branch, noting that inspectors--and builders--must somehow find a balance between residential and commercial codes on buildings to which both apply. Why not scrap the retail? Because ground-floor units can be a challenge to sell in the city. Retail solves the sales problem and creates the sidewalk buzz urban dwellers seek.
Choosing a site in a redevelopment area can help. "The city of San Diego was a huge help to us," says Waite. "Not so much in the way of dollars, but in terms of time and understanding the process. They really hold your hand through the redevelopment process."
And one mustn't forget the neighbors. "You always have to deal with the neighborhood factor, but in suburban development, it's more the planning staff and the city councils. Once [the land] is zoned and generally planned, you're just going through the process," Delva says. "With infill, it's not quite that way. The neighbors have a huge influence on what the project looks like."
His fellow infillers agree. "The one thing we tend to study more [in infill projects vs. traditional suburban developments] are the surrounding uses," says Waite. Union Square, for example, was bordered by a college, a police department, a print shop, a coffeehouse, and a boxing gym.
A few blocks away, Park Boulevard East, another building by Western Pacific, found itself next to a rescue mission for down-and-out San Diegoans. "There are more different types of ownership, which makes it more difficult to work with the community and give them what they want," Waite says.
Doing that can require a full spectrum of developer accommodations. At Park Boulevard East, Western Pacific purchased the rescue mission's property early in the process so the group had the funds to find another location. And, until it moved, the group stayed rent free, thanks to the developer. "You have to be really flexible," Waite says. "You have to go in there and help them with what they really need."
Finding the flow
For smaller builders, though, infill's greatest challenge comes not from vocal opposition or infrastructure discoveries, but from managing a niche business with unpredictable cash flow and extreme demands on time and capital.
"Anybody with a lot can get a construction loan on a single-family house, because that is what the system is set up to do," says Branch. But those approvals don't come so easily on infill buildings, because of both any retail they may incorporate and their size.
"People are willing to take the risk on a single-family home because it's so liquid. They know they can sell it even if the builder can't," Branch says. "The very nature of infill means you are building a large number of units on spec."
JDL Development's Letchinger agrees. "The environment has gotten tougher. Banks are very nervous about saturation," says the Chicago developer, who says lenders' equity requirements have climbed from 10 percent to 15 percent of project costs to 25 percent to 30 percent.
As a result, many infill developers are turning to mezzanine debt, which covers the shortfall between equity and bank debt. This gap funding comes at a high price--at CIG International, a Washington-based mezzanine debt firm, interest rates run 20 percent to 25 percent, depending on the project, the developer, and other factors--but with a fixed rate, short term, and no profit-taking.
Small builders typically must meet presale requirements, as well, selling 20 percent to 60 percent of projects before they can begin construction. The benefits of presales are obvious: They confirm a market for the product and open the flow of funds for the builder. But they also limit a builder's profits, particularly on those early sales. If construction costs rise--or demand for your hip product soars--those prices remain the same.
Still, infill profits can be high. JDL, which builds $385,000 duplexes as well as million-dollar high-rise condos, makes a margin on its projects that many a home builder would sell his hammer for: 20 percent net profit. And those numbers are down compared with previous years.
"Our buildings used to have stronger margins, but they eroded because land prices are so high," says Letchinger, who consciously avoids less-profitable opportunities. "There is too much slippage in these deals to take a chance on a slim margin deal."
Even if a builder did want to take that sort of chance, lenders probably wouldn't let him. "[A project is] not financeable if you can't make 15 percent," Branch says.
Infill builders can't afford to let high profit margins translate into high overhead, because the pipeline is just too unpredictable. That's what Branch learned a few years ago. Flush with business, The Boulevard Co. grew to 20 employees--only to have idle staffers after those projects ended and before new ones began.
Today, the company has eight workers, including Branch. "You almost have to be a virtual company," he says. "You have to maintain your overhead and rely on consultants to handle the volume."
Letchinger, who expects to do $150 million to $200 million in business during the next two years with just 12 employees, agrees. "The way to run a good, small, private infill development company is to have good people in critical places," he says.
What are these essential areas? For Letchinger, it's finance and accounting, construction management, architecture, marketing, administration, and definitely not construction itself. "The construction side is extremely draining on resources," he says. "You need a lot of people. It's not a good place to use our resources--there are other people who can do it better and cheaper than us."
Of course, all these difficulties also represent part of infill's attraction for determined and creative developers and builders. "You'll never do the same project twice," Branch says.
For all the challenges, though, infill can work. At JDL's Columbia Place, a five-acre urban community of duplexes, townhomes, row homes, and single-family product, 70 percent of the first two phases sold out in three weeks, surprising even the developer.
Western Pacific was also surprised in San Diego--by the number of buyers willing to pay $60,000 more to get a two-bedroom condo at Union Square vs. the more affordable, but less flexible, $179,000 one-bedroom. "People really want a two-bedroom," says Waite, who reconfigured the project to provide more two-bedroom units. The same goes for the condos with winding iron staircases that lead to rooftop decks. They're being snapped up as soon as they become available.
But such demand for a unique living space--a home with a view of the city lights--shouldn't come as a surprise. After all, features like that capture the central advantage to going urban for buyers and builders alike. "The major amenity is the location--where the building sits," says Branch, "and that's as good for the first home as for the last."
Weave your infill project into the streets of the city with the following seven tips.