The Risky Game of Real Estate Development in NYC

The audience for this article is active real estate developers in NYC. I am a big fan of this group, not only because it is my livelihood to sell land to them, but because they have unmatched vision and optimism on the market they are buying and building in. Their business is the definition of extremely high risk, but high reward. The problem is that risk can wipe them out. (i.e. personal guarantees...)

Real estate development, especially in New York City, is not for the thin skinned. It is a high-stakes game, loaded with uncertainties that can turn even the most promising project into a financial disaster. (I recommend reading “Billionaires Row” by Katherine Clarke for a few interesting examples...) From changing market conditions to regulatory shifts, developers face an array of challenges that can jeopardize their investments. However, with meticulous planning and rigorous due diligence, these risks can be managed or even alleviated.

At my firm, Development Site Advisors®, we specialize in reducing these risks using our comprehensive Due Diligence Accelerator Package®, team of in-house zoning focused architects, local zoning expert brokers and our Sitestimate, our proprietary zoning, massing & feasibility study + developer proforma valuation.

In recent months we have met with dozens of developers who are currently “stuck” with their development projects. Whether this is because of neighboring property problems (demolition, access agreements, underpinning, damage, etc.), environmental clean-up issues, investors/capital partners fleeing, financing challenges, market changes, incorrect zoning interpretations, among other reasons. I believe a lot of this, not all, could have been eliminated or eased with more proper risk planning.

Time: The Ultimate Risk Factor

The most formidable risk in real estate development is the passage of time. A typical project in the 5 boroughs of NYC can take anywhere from 2 to 4 years+, from inception to completion. In that period, the economic and regulatory landscape can shift dramatically. Personal health emergencies, loss of key members of the development team, escalating hard costs, material shortages, wars, and changes in tax laws can all pose significant risks.

Consider the volatility of the past few years. Political changes, the pandemic and now a high interest rate environment highlight how quickly market conditions can change. Developers who began projects in a bullish market suddenly found themselves dealing with unprecedented challenges. The cost of construction materials soared, supply chains were disrupted, and labor shortages and rising costs became the norm. Such unpredictability points out the necessity of thorough planning and risk management.

Delayed Income Gratification

This is the “Creating Buildings” business, not the “Existing Buildings” business, and creation is risky. Development projects do not yield immediate returns. Unlike existing properties that generate rental income, new developments require several years of planning and investment before any revenue is realized. This period of delayed income gratification can strain even the most robust financial plans.

Developers must also contend with substantial upfront costs. Banks typically require at least 20% equity, meaning developers need significant capital to secure financing. This financial burden is compounded by the inherent risks of the project. With no income during the construction phase, developers must manage cash flow strictly to avoid liquidity issues.

Due Diligence: The Key to Risk Mitigation

At Development Site Advisors®, we provide a curated Due Diligence Accelerator Package® (DDAP®) for every development site we sell. This package includes necessary reports and studies—a title report, surveys, environmental assessments, zoning, massing and feasibility studies, developer proformas, development pipeline reports, land-use attorney opinion letters, market data metrics and trends, soil reports, etc. These documents are crucial for identifying potential risks early in the process that will help in making informed decisions. Our DDAP® ensures that developers have a comprehensive understanding of the site’s potential pitfalls and opportunities.

Financial Dynamics of Development

The profit margin for a typical development project usually ranges from 20% to 25%+. For instance, a project that costs $80 million to develop might be worth $100 million upon completion. Banks typically finance 70% to 80% of these costs, including land acquisition, leaving developers to cover the remaining 20% to 30%. This often involves using land equity or additional cash investment. The rule of thumb is that land is valued at 20% to 30% of total costs; this is higher and lower in certain markets.

Buying the land right

What you can afford to pay for a development site is a function of the market and environment you are in, as well as your expected returns. You can determine the maximum amount you are able to pay for any given development site by making land cost the unknown variable and solving for the maximum you can pay and still receive your targeted return on total development costs. This is known as residual land valuation. Our Sitestimate® valuation will guarantee you understand not only what can be built based on the zoning, but what the neighborhood metrics, soft & hard costs and loan costs are and what land value truly is.

Eliminating risk is very expensive.

Why? Because to eliminate risks, you must bring on simply the best professionals: from land-use, construction and access agreement attorneys to environmental consultants, structural engineers, zoning experts and architects to name a few, and to bring on these best-in-class professionals, you will be paying top dollar. A good developer knows that mitigating risk requires hiring the best professionals in the industry. Poor decisions at the planning stage can lead to costly delays and overruns during construction.

Real estate development in New York City is undeniably risky. The goal is to minimize these risks through comprehensive due diligence, strategic planning, and a commitment to quality and buying the right land in the right location at the right price.

At Development Site Advisors®, we help our clients navigate these challenges using a combination of our team of in-house architects, local zoning expert brokers, our zoning, massing and feasibility plus developer proforma valuations we call a Sitestimate® and finally our Due Diligence Accelerator Package®, (DDAP), ensuring every development site we sell is thoroughly vetted and primed for success. By understanding and managing the inherent risks, developers can transform high-stakes projects into profitable projects.

Recent Building Filings - Focus: Manhattan

1. 66 University Place, Greenwich Village, MN - Zoned R7-2/C1-7. Plans filed to build an 11-Story, 125’ Tall, 54,604 ZFA Mixed-use Building with 28 Units and ground floor commercial on a 8,809 sf lot.
2. 539 West 54th Street, Hells Kitchen, MN - Zoned R8 - Plans filed to build a 21-Story, 81,567 ZFA Apartment Building with 68 Dwelling Units + Ground Floor Facility & Commercial space on a 12,549 sf lot. The property was purchased on 12/28/2021 for $25,000,000, equating to $306/ZFA.
3. 1578 Lexington Avenue, East Harlem, MN - Zoned R7-2, C1-5. Plans filed to build a 13-Story, 133,811 ZFA Community Facility building
4. 508 East 118th Street, East Harlem, MN - Zoned R7B. Plans filed to build a 6-Story, 14,473 ZFA Apartment Building with 18 Dwelling Units on a 4,827 sf lot.

Financial Market Snapshot:

• Federal Prime Rate: 8.5%
• Secured Overnight Financing Rate (SOFR): 5.34%
• United States Federal Funds Rate: 5.5%
• United States Annual Inflation Rate: 2.97% (down from 3.27% last month)
• US 1-Year Treasury Rate: 4.86%
• US 2-Year Treasury Rate: 4.49%
• US 10-Year Treasury Rate: 4.22%
• Treasury Bill Auction Rates:
• 4-Week Term: 5.27%
• 8-Week Term: 5.26%
• 17-Week Term: 5.195%
• 26-Week Term: 5.080%
• 52-Week Term: 4.775%
• US Bonds:
• 20-Year Bond: 4.625%
• 30-Year Bond: 4.625%
• Mortgage Rates:
• 30-Year Fixed Rate: 6.8%
• 15-Year Fixed Rate: 6.3%
• 5-Year ARM: 6.75%
• Ground Up Construction Rates: 8.5%+
• Hard Money Lending Rates: 12%+
• Highest Interest Rate for Bank Savings Account: 5.55%

Construction Costs in NYC

What does it cost to build in NYC on average? Below you will find the ranges from a recent RLB report, based on the type of project being built:

Residential:

Multi-family: From $235/sf to $460/sf

Condo: From $340/sf to $675/sf

Office Buildings:

Prime Market: From $320/sf to $905/sf

Secondary Market: From $225/sf to $565/sf

Retail:

Shopping Center: $340/sf to $675/sf

Strip Center: $360/sf to $710/sf

Hotels:

5-Star Hotel: $485/sf to $730/sf

3-Star Hotel: $360/sf to $485/sf

Industrial:

Warehouse: $135/sf to $225/sf

Parking:

Below Grade: $155/sf to $235/sf