James Nelson of Massey Knakal sat down with David Von Spreckelsen of Toll Brothers, Ken Horn of Alchemy Properties and Michael Stern of JDS Development to discuss their current projects and the real estate landscape in New York City.
James Nelson: Please tell us about your recent projects and what you are currently working on.
Ken Horn: I’m currently working on three projects. In Brooklyn, we developed 32 residential condos and 11 townhouses on Sackett and Union Streets, off of Court Street. We’re completing the 35XV Condominium on West 15th Street, between 5th and 6th Avenues, which has Xavier High School on the bottom and 16 floors of residential on top. We’re also converting the upper 30 floors of the Woolworth Building, where we hope to start selling at the end of May.
David Von Spreckelsen: We are working on about eight projects now. We’re finishing sales at the Touraine at 65th Street and Lexington Avenue. On 22nd Street and Third Avenue we have sold 71 of the 81 units. We are about to open 400 Park Avenue South for sale, a joint development with Equity Residential, who will have the first 22 stories as rental and we’ll have the top 18 as condo. We just opened our Brooklyn Bridge Park project for sale, called Pierhouse. It’s a joint venture with Starwood Capital Group, with a 200 room hotel and 108 condos.
Michael Stern: We are finishing up at Walker Tower. There is one unit left, a penthouse. We are working on another conversion on West 50th and 9th Avenue called Stella Tower, a 51-unit, 120,000 square foot project. We just broke ground on a condo conversion and a new tower at 111 West 57th Street at 6th Avenue, the former Steinway Building. In Brooklyn, we are starting a new job on Baltic and 4th Avenues which will be about 65 units on the Park Slope side of 4th Avenue. Our big rental project on 1st Avenue and 35th Street is 800 units and just under one million square feet.
James Nelson: You have all been active in both Manhattan and Brooklyn. Are you shifting more of your focus to Brooklyn?
Ken Horn: The Brooklyn market is a very strong market. The building we just finished averaged around to $1,100 a foot, which is a real big number for Brooklyn, especially for large units. The idea that the Brooklyn market is propelled by people moving from Manhattan to Brooklyn is not necessarily true. Of our buyers, 55% were from Brooklyn. I’m very, very bullish on Brooklyn. It’s expanding, it’s moving, it’s not just Park Slope and Boerum Hill and Carroll Gardens and Williamsburg – it’s got wings.
James Nelson: The average price for a building in Manhattan last year was $1,000 a square foot versus Brooklyn’s $350 a square foot. Brooklyn rents are not 35 cents on the dollar, so there is definitely opportunity. David are you looking to do a lot more in Brooklyn? How about Queens?
David Von Sprekelsen: We started in Brooklyn. Our early projects were in Williamsburg and DUMBO. What we’re achieving now at Brooklyn Bridge Park just blows my mind. It has a relatively high carry cost because there is no tax abatement, yet we’re still averaging more than $1,500 a foot, which I never thought I would see this soon. We like Brooklyn a lot, but we like better neighborhoods, and we also want to have some economies of scale, some size. Therefore our choices in Brooklyn are really limited. I still think the Gowanus area is fantastic. At the right size and the right price, I would do something at Greenpoint and Williamsburg. We have done a project in Queens, in Hunter’s Point right after the district was rezoned. Clubs, restaurants – there’s stuff there, there’s just a limit because you start to get very close to the Queens Bridge, which is the largest housing project in the country. You also have a bunch of industrial zone areas over there, but just like with Greenpoint and Williamsburg, at the right size and the right price I’d probably do something in Long Island City.
James Nelson:Well we’ve talked about some of the sellouts in Brooklyn but can you talk about some of the numbers being achieved in Manhattan. Ken, can you talk about pricing at the Woolworth and what you were able to achieve on other projects?
Ken Horn: Well we think Woolworth is unique. We’re only doing 35 or 36 units. If we achieve in pricing what a lot of people think we are going to achieve, we’ll be good. The interesting thing is, we all build beautiful buildings, but there is only one Woolworth Building. The neighborhood down there is obviously changing, enormously, with Condé Nast moving down there and the World Trade Center being developed – it is quite unique. The views are phenomenal and the architecture is great. We have really given everything to respect the architecture in terms of the common areas and the lobby, and we’re trying to recycle a lot of things that were in the building. Do I think we’re going to hit numbers that were achieved at Walker Tower? I don’t know, maybe.
James Nelson: So let’s talk about land prices today. Where are they and are you still able to find things that make sense to buy?
Ken Horn: I think it’s probably the first time in our careers where the hard and soft costs to build are less than the potential land costs, which is totally backwards. That being said, if your average price is going to be $3,000 a foot, and you’re spending $800 a foot for land, then the deals make sense.
Michael Stern: It is backwards in Manhattan now but not backwards in Brooklyn.
James Nelson: David, how do you all feel about paying $800 a buildable if you’re confident that you can sell-out at an average of $3,000?
David Von Sprekelsen: We’ll do that any day, but like Ken said, not every site is going to get you $3,000 a foot. We’re also seeing some sites on the smaller side trading for more than $1,000 a foot, and then it starts to really get scary. When you’re talking about big numbers for land, and the break-even numbers get so high, it definitely gives us pause. We have not been competitive on the last half dozen things that we looked at where there was somebody willing to pay a number that didn’t make sense to us.
Michael Stern: My concern on that is identifying the sites that are really worth paying the $800 a foot. The problem is that people are convincing themselves that mediocre sites and mediocre locations are going to get $3,000+ a foot on the sellout, and those are the sites that are really going to run into a problem. You see a lot of sites that don’t deserve to be selling for $800 a foot. I have less of a problem with the premium sites, like the site that David just bought getting the premium dollars.
James Nelson: On that note, what about assemblages? Do you look to tie up a parcel and look for air rights, is that a way to make the numbers work?
Michael Stern: Sure, either you need to look for a fractured family situation, or find something that requires a lot of value-add and sometimes that means taking down a site and taking the chance that you’re going to be able to assemble something and make the sum worth greater than the parts. We’ve done that a couple of times. Steinway was an example of that.
James Nelson: David, would Toll Brothers ever do an assemblage with the air rights?
David Von Spreckelsen: We have bought sites that were big enough to develop and where we could add development rights, but it would be unlikely for us to do a traditional assemblage where we buy something that couldn’t be developed unless more was added to the piece.
Ken Horn: We just looked at a building and there were 25 apartments and retail, and then we were going to take air rights from the adjoining parcel. So we go to the adjoining parcel, and ask “will you sell your air rights?” Yes, they would sell, but the price of the air rights they were asking, because they realized that they were the only source, was more than the price of the land. Traditionally, you buy air rights to average down, but here it was averaging up. So it made no sense.
Michael Stern: It was just an inclusionary trade and James you’re the master of inclusionary. I don’t know if it’s public yet, but someone just bought inclusionary in CB5 for some astronomical sum, more than the land. It’s just an amazing trend we’re seeing.
James Nelson: Michael, what about rental projects? How do you find land today where rental even works? You said that you would not want to do 1,000 unit condos, but with the way land is priced and with the condo market wouldn’t you want to do condo on everything?
Michael Stern: I’d rather do rental on everything, assuming I can buy it at a basis that makes sense for rental. The other problem is land prices have escalated to the point where building a rental today is essentially impossible. We were fortunate enough to have a few sites that worked as a rental. We bought a site in Park Slope in 2008 and held onto it, which is why that one worked. We bought a broken deal in Williamsburg, 50 North 1st Street that worked as a rental, and were able to do another one in Prospect Heights. We bought a piece on 1st Ave right before land prices really escalated to where they are now. So we don’t think we’ll be able to do another rental project like that at today’s land prices. I don’t see it happening any time soon.
James Nelson: Ken, would you ever do a rental?
Ken Horn: We’d love to do a rental, but again the question, as Michael said, it’s very, very hard to make them work. Even making an 80/20 work in most cases does not fly. If the land were given for free and you take into account what you need to build the property, it would only throw off a 3.5% to 4% return because the rents are $31, $32 a foot. That’s at market, and then your 20% goes down to $12 or $13 a foot. So you couldn’t even build it under the affordable program with literally no taxes, because your operational expenses would just wipe out any kind of return. It would be wonderful to build rentals, but the price of land dictates that you just can’t.
David Von Spreckelsen: I am doing one rental that we had looked at as a co-op but half-way through, the land lessor informed us that they weren’t comfortable with ownership at that site. It’s in the West Village and we’re going through the landmarks process right now. We negotiated that land rent at a little bit of a different time, so we’re able to do it. It’s also a small boutique building, and in an incredible location where we’re going to get substantial rent numbers. The First Ave site that Michael’s doing is so big and it’s a little bit off the grid, but so big that no one’s doing a condo project there. The other way to get it done is to do rental for a portion of it and then condo at the top. That’s a way to take down sites and to be competitive on price when buying the site. I think you’ll continue to see rentals on really big sites that are a little bit off the grid.
James Nelson: We were talking a little bit before about hard costs, what are they today and how has that changed over the last couple of years?
Ken Horn: It’s hard to say. It’s really site-specific and it’s design-specific and what audience you’re building to as well. That being said, we have not seen a dramatic increase in hard costs, not dramatic by any means.
James Nelson: Michael, you’re building 1,300 feet high on 57th Street, what are the hard costs there?
Michael Stern: Around $800 a foot, because the building is pretty exotic and tall, but in other places it’s significantly less. On our 1st Avenue rental project, hard costs will be more like $400 a foot, and that’s a 50-story and a 40-story project. So as Ken said, it’s really very site-specific and design-specific.
James Nelson: Can you all talk about the capital stack today, how much are you borrowing, what is equity looking for, what are terms for construction financing?
Ken Horn: I think there are an enormous amount of equity players in the marketplace, probably five times as there were maybe six, seven months ago. It’s just astounding how many folks are looking to place money.
Michael Stern: We also haven’t seen leverage points rise anywhere above 65 to 70%.
Ken Horn: And I don’t know anyone who’s doing mezzanine because lenders are still mezzanine shy…
Michel Stern: Their doing pref’ equity instead.
Ken Horn: And people were burned before on things along those lines, so a typical capital stack that we’re seeing for a $100 million product is $35 million of equity, $65 million of debt and that’s traditionally the way they’ve been structured.
James Nelson: And what type of returns is equity looking for today?
Ken Horn: Ones shooting your 20% IRRs, I mean our Brooklyn project hit almost a 50, which was great. I think 15th Street will probably exceed that, but they’re not deals that you do all the time. The three of us were lucky, because we bought at the right time, we took the risk and we should point out we all risked in markets that a lot of people were not prepared to take risks in, 2009, 2010, and 2011.
Michael Stern: I always think it’s easier to make money in those markets than it is in this market. If the deal is small enough, then we’ll just do debt and we’ll write the GP side check; and if the deal is large enough, we’ll bring in a fund, an equity partner, or an insurance company. That’s the other player really putting equity out right now. We’ll borrow 65%, 35% will be the equity.
James Nelson: And what are the rates today for the construction loans?
Michael Stern: For condo or rental, it’s typically around L+300 for a conventional bank. For a very large loan, instead of putting a syndicate together you want to go to a one-stop shop like a Starwood, or it will be between 6 and 10%, depending on many variables.
James Nelson: David, you all have bought and built for cash before, is there an advantage when you’re competing for sites?
David Von Spreckelsen: Ken was talking about buying properties when people couldn’t get condo loans in 2008 to 2010. We didn’t have to get loans because we were all cash, so it was definitely an advantage. We not only buy, but we also build all cash. So we don’t do project-specific debt. We are now looking at maybe changing that formula, and when we do a joint venture we use debt because our partners are generally not capitalized the way we are. We haven’t gone outside for equity yet, but that maybe something that we look at in the future to leverage our dollars more to be able to do more projects in more locations. But on the debt side, we borrow about 70% and at the rates that Michael was talking about.