Are some of the best projects ones that were never built?
By Michael R. Brown
I have an idea for a new celebration… “The Construction Due Diligence Awards: Projects That Never Happened!”
With all of the successful and exciting building development occurring in northern Michigan, it’s easy to forget that we have also seen our share of ill-fated projects over the last 20 years. Some of the most visible evidence of this would be the three unfinished construction projects in the downtowns of Traverse City and Petoskey. The sites were marked for years by large excavated holes in the ground. Of these three downtown “holes,” only one eventually saw a building successfully erected on the site. The other two are still…well…holes.
With more attention to due diligence, perhaps the developers could have avoided throwing money out the window (so to speak) and adding a blight to our community landscape.
These examples reinforce the need for a comprehensive due diligence approach in any prospective development. Whether it be a small doctor’s office or a larger multi-story building, every project can be better served by putting extra attention into the evaluation process.
All projects have their own unique issues and require a customized due diligence process. But after 40 years in the construction industry, I have observed that certain evaluation criteria should be mandatory before embarking on any project.
Due diligence should include a legal, physical, and economic evaluation.
A legal investigation evaluates such things as zoning requirements and other regulatory issues. It is a relatively straightforward effort for an initial screening of a prospective site.
A physical investigation utilizes site engineering information like surveys, soil borings etc. to determine a site’s physical limitations, This data generally confirms the type and size of building that can be accommodated on a particular site.
The physical investigation can also bring to light what I call the “true cost” of the property. This true cost is not just the purchase price, but also any extraordinary expenses that would be required to make the property “build ready.” For example, you might uncover grade issues that necessitate an expensive retaining wall. This physical assessment allows you to more accurately compare one site to another. Perhaps you’ll discover that spot with the low price and just “a few” challenges isn’t such a good deal after all.
An economic evaluation is where the fun really begins. This part of the due diligence process contains two criteria:
1.) What are the projected costs of the development?
2.) What kind of revenue can the development generate?
Both of these calculations include detailed financial projections. The projections can include objective data, like what the utility company will charge to provide power. However, it also includes subjective data – for instance, a projection of how many people are going to buy a condominium and at what sales price.
The rub here is if you are “in love” with the project (i.e. the developer) and you are responsible for deciding on a projection, then trouble could be brewing. When “in love,” you are more likely to use optimistic projections which, if repeated in multiple categories, can have a devastating effect on the accuracy of the projections. Could being “in love” with a project explain how we ended up with three holes in northern Michigan?
A veteran real estate agent once told me that “someone developing property will almost always end up performing a thorough due diligence investigation. The only question is whether they do it before developing the property or after.”
When confronted with financial projections that don’t quite work, how easy is it to justify to yourself that tweaking a few formulas to get a more desirable result is a good idea. This is why you’ll want to include a steely-eyed realist as part of your development team. Certainly they aren’t as much fun at a birthday party, but they sure can be valuable when you need a pragmatic perspective to keep those numbers real. It could save your rear end in the long run.
I think it is great that we celebrate successful developments. They are exciting and help make our region such a fantastic place to live and run our businesses. But maybe… just maybe… we need to celebrate the people who performed excellent due diligence and decided NOT to proceed with a flawed development. I’ll see you at the next awards event!
Michael R. Brown is owner/president of Burdco Inc., an award-winning design/build firm located in Traverse City. Visit Burdco.com for more about due diligence and Burdco’s design/build capabilities.