Risky Business Many real estate investment trusts (REIT) shy away from development because of the inherent risks of overbuilt markets or markets changing in the middle of construction. But for Archstone, good risk management is part of the company’s success. “An enormous amount of value can be created through development,” says Hamilton. “Our feeling is, if you do it well, you can create value that you can’t otherwise create. … People think [development is] risky, but there are things you can do to make it less risky.”
To start with, Archstone always places land under contract with the understanding that the deal will go forward only if Archstone is able to get the necessary zoning and support from the community. “The price has to work for us,” says Sellers, “but, we’re also concerned with having sufficient time for the approval.”
“You never know what the political jurisdictions are going to say until you have that conversation,” Sellers explains. “Sometimes they’ll say, ?Yes, if you’ll do the following,’ and then we can work out what that means, or what it costs. Other times they’ll say, ?No way, we’ll fight you until the end,’ and very rarely is it worth doing at that point.”
The fact that Archstone only develops in high-barrier-to-entry markets also protects the company from risk. Because it’s so hard to build in these markets, they are much less exposed to the impact of a recession.
In fact, since Archstone builds in communities that also contain expensive single-family homes, the likelihood of people staying in the apartments during a recession is greater. For example, from 1991 to 1993, the Los Angeles County market was devastated by aerospace industry layoffs. The area lost 440,000 jobs in two years, but overall apartment occupancies were down only 1 percent – even though unemployment was 11 percent, says Sellers.
Archstone doesn’t have more than one or two communities under construction at one time in most of its markets. There also is minimal competition in those markets.
When Archstone walks away from a deal, it’s almost always in the early stages. The company would walk away from a transaction if things changed so dramatically that the numbers no longer made sense, says Sellers. “We just had a transaction in Southern California that we placed under contract in cooperation with the seller,” he explains. “When we went to meet with the city to discuss our interest in rezoning the site, we were told in no uncertain terms that there would be no support forthcoming from the elected officials that were responsible for that area. So, we went back to the seller and said it doesn’t make sense to [continue].”