Transcript: Solutions for Developers Facing Supply Chain Issues
Speaker A: You’re listening to environmentally speaking, a weekly podcast diving into legal matters surrounding the environment, public utilities, energy, zoning, and permitting laws in Rhode Island and the surrounding areas, with your host, Marisa Desautel
Clarice: Good morning, everybody. Welcome to this week’s episode of environmentally speaking.
Kerin: Good morning, Clarice. How are you?
Clarice: I’m doing well. How are you? Good, good. I’m joined this week by Kerin, and today we’re talking about, oh, goodness. Navigating economic headwinds.
This podcast is for our commercial developers facing headwinds right now
Kerin: We are; this one’s for our commercial developers out there in 2024 m, facing a lot of headwinds.
Clarice: Yeah, I think headwinds are a very polite way of saying it’s tough.
Kerin: It is.
Clarice: And specifically, I love the fact that in your outline because, a little behind the curtain for everybody, Kerin gives me a beautiful outline every time we record. It’s very spoiling. You broke down into a couple of different categories that everybody’s facing. Do we want to just dig right into the first one?
Kerin: Yeah, I think so. I mean, I don’t think it’s any surprise if you know anything about commercial development, or even if you don’t and you watch the news. There’s a complex array of challenges out there. And, opportunities are getting more, and more scarce right now. So I think it’s important for our developers out there to, you know, understand the economic factors, to make informed decisions. And that’s true of any successful development. I think our more seasoned developers probably know this. This podcast will be below their experience level. But I do think it’s important to just go back and revisit some of the key ideas that have been successful in the past to get commercial development underway.
Interest rates have had a significant effect on commercial development.
So, obviously, the first one, easy, is interest rates. That’s always a guiding force of any development. My clients, I hear it all the time. I’m waiting to see what happens with rates. I think a lot of people that I’ve talked to are anticipating rates to come down in the next few months. Obviously, no one knows for sure, but we’re all hopeful. Hopefully, that’s true. But certainly, since 2022, there’s been a series of rate hikes to combat inflation. And, unfortunately, those increases have had a significant effect on commercial development. And what does that mean? So, basically, that means that a higher interest rate means to develop. It’s going to cost more money, meaning the cost of borrowing money is more. So when you’re considering building a building, going through the permitting process, getting the financing. The overall cost of the project just became more as soon as the rate went up. And that’s why I think we have seen a decline in commercial development.
You should be constantly evaluating supply chain interest rates, whether to do project.
So some of the things that typically, my clients look to, are exploring alternative financing, either private equity or mezzanine debt. And what does that mean? Private equity financing is where investors basically provide capital to a company in exchange for an ownership state. So it’s less like a loan; it’s more like trading a piece of the company for money to build, with the understanding that the project will get built. Yeah. Usually, investors are savvy enough in development, or you want an investor that’s savvy with development that they can use their experience to help the company grow, and increase its value, and then it becomes a win-win for both sides. And generally, usually after a couple of years, those investors sell their shares in the company for some sort of game. The other option, which is interesting, is called mezzanine financing.
Clarice: What?
Kerin: Mez. I never heard of them.
Clarice: Happy you included something about this.
Kerin: Yeah. So, mezzanine financing is where you combine debt and equity to help cover the cost of a project. So what does that mean? It’s complex, I’ll give you that. bButit basically lends capital in a combination way where you’re getting both, a debt loan and also money from the equity in the project and the property. So it’s straight capital and capital from the equity. Generally, it’s cheaper than just raising the funds. The equity yourself. iIt’susually long-term financing, and, generally, there’s no collateral. sSothat’s been a, that’s been a really popular one in the past. I don’t honestly know how much it’s used right now because we’ve slowed down so much, but that one has been used by quite a few of my clients in the past. So what else? You can also, once you explore different kinds of financing, see what’s out there and what’s going to work for you and your project. The other thing, honestly, is simple and it’s just adjusting your project timeline. Feel free to stretch it out or make it faster if you feel like there’s a rate change coming. mMaybeyou speed things up if you feel like you need to get started, but there are rate changes in your favor coming. Maybe you slow things down, and then you refinance
Clarice: I never thought about using or, yeah, using the schedule to your advantage. There was just a part of me that always thought the schedule was as it was. But sometimes those delays could be beneficial. That’s something I hadn’t considered.
Kerin: Yeah, they can be. And I think that’s really an interesting point because when you’re in when you’re doing a project, your work as a developer doesn’t stop when the shovels hit the ground. You should be constantly evaluating supply chain interest rates, everything that went into penciling, whether to do that project, to monitor changes, and to see if you can take advantage of changes in your favor. Also, can you mitigate changes that are happening against you? You know, do you know, do you have other suppliers out there if one can’t get you what you need? Can you diversify into somebody else? Just simple knowledge of the landscape and what went into the project, staying on top of things, and keeping everybody on the team up to date can go a long way to mitigating those risks.
Clarice: Yeah. It’s not a set-it-and-forget-it system.
Developers have to be cognizant of potential delays due to supply issues
And that kind of segues really nicely into another one. tThesupply chain woes. I thought it was getting better. Is it? Is it not?
Kerin: That’s a great question. I thought it was, too. But it’s just not; it’s just not clear. And I think, at this point, it depends on what the product is you’re looking for. And I think because we’re not quite 100% there where we were and maybe we never will be, I think developers have got to be cognizant of the fact that there could be delays. I think even forever, you’ve always got to understand that there’s going to be potential delays in products, and that can delay your project timeline. And what does that have? That means that the project is going to cost you more money. So being aware of that, making sure that you stay on top of things, that you’re monitoring these issues. And like I said before, going over to other suppliers, to mitigate, or maybe you switch the area of the project that you’re building to mitigate for the delay, you switch to some other area project.
Clarice: Yeah. And I think those sort of supply chain issues or, you know, depending on what the material is and how it kind of works within the project, I think it could lead for, and it’s probably, probably isn’t something that developers are excited about, but it could lead towards the idea of exploring alternative materials. If I can’t get x, yeah, I need to find something else. What does y look like? It might be a chance to try something new, maybe be a little bit creative, depending on what it was, just simply out of necessity just to get it done.
Kerin: Great point, great point. Even if that, different material costs a little bit more, you know, maybe, in the long run, you’re actually balancing out or saving money due to the fact that if you don’t go with that product, you’re going to have to wait and there’s going to be overrun in other areas. So again, that gets back to staying plugged into the project all the way through, not just at the beginning, and, being aware, doing your research, being aware of other products that you could switch to. But being flexible.
Clarice: Yeah. And I think it could end up being a time to try something new. It could be a thing, you know, if you’ve always used one brand or one type or one thing over and over again, now you’re being forced to pivot it. It could be a situation where you find your next favorite. You find something that’s a little bit more cost-effective. Maybe it’s, because it costs more, but the install day is shorter.
Kerin: That’s right. And not only does that go for materials, it also goes for process. There’s, we’re constantly evolving, in both areas, and just talking to people, doing research. There are constantly new products, new ways of doing things. you know, maybe they’re not, you know, tried and true, in terms of how long they’ve been on the market or how long they’ve been used. But it’s worth taking a look because countless, times I’ve encountered clients who have had to switch gears and they do a little research, or they talk to people they trust in the industry, and they learn about new processes, new ways of doing things, new products that they can implement, and it’s a lifesaver, it’s a project saver.
Clarice: Yeah. And I’m hoping that there might be some greener options in there. I mean, not that these, all of these projects are inherently not green, but like, if you can, you can wedge in a little.
Kerin: Yeah, again, great, great point. I think that there’s a lot of, the, there’s a paradigm shift going on, and not only in the industry, in terms of products and processes, but also we’re seeing, buyers, tenants, who want to be able to say that the building was constructed in, an environmentally conscious way there’s no doubt about it. That is something that not only the towns are looking to hear when you’re getting permits, but also the construction. the end tenant, Ian byer. it’s a value add.
Clarice: Absolutely. It’s becoming a question that people are asking more than about amenities. It’s being rolled into that conversation. I don’t necessarily care that this apartment complex has a common room, but I do care that this was consciously built. I mean, it’s definitely.
Kerin: I think you’re right. I think you’re right. And I also think if you can include amenities, rooftop gardens, increased landscaping, whatever it is, it’s what people are looking for. It’s where we’re headed. and we have a new generation that has full time jobs and is spending money and is buying property and leasing space. They are going to drive that conversation. And they are.
Clarice: Yeah. And I would say, a majority of those folks are working from home. So they want to know that the space that they’re in is aligning with their values more than they did in the past where there was that divide.
Kerin: Yeah, I agree. And they also want to be able to tell their visitors, their friends, their family.
Kerin: You know, it’s a sense of pride this building was built with whatever this building has. Ah, whatever. yeah, it is. It’s a sense of pride and it’s a value add.
Clarice: Absolutely.
There are some things you can do to hedge against inflation
shifting a little bit. I know we were talking originally about interest rates, but this kind of pairs with that inflation, folks, we know it’s an election year. We know you’ve heard inflation a thousand times, but welcome to the thousand and first time we’re going to talk about.
Kerin: How can you note I.
Clarice: You have.
Kerin: Right. We’re all trying to find that.
Karen: Silver bullet cure to inflation. None of us really has control over it. we’re not sitting in a seat to control it, certainly. but there are some things you can do to kind of wait out the storm. So, you know, just generally speaking, inflation, and I always have to go back to my definitions to make sure I understand. So generally speaking, inflation is just the rate at which prices increase over time. It’s really a measure that refers to the overall increase in prices or the cost of living. but that can translate into development when you’re trying to buy things like.
Kerin: Concrete, asphalt, sinks, toilets, all the stuff that goes into a building. and some things that people have.
Karen: Done, to hedge inflation, is really investing in products or things that have a set goal of protection. Meaning, the goal of that investment is to increase value over time, even if it’s not an aggressive ad. so that could be things like equities, bonds, gold, fixed rate mortgages. They’re traditionally thought of as safer, safer, investments. The other way that a lot of my clients do it, especially once they start transitioning into like that one off or smaller developers. And then the clients that kind of move into that mid range, developer kind of, they’ve got some properties under their belt, they also hold some properties, they’re looking at new opportunities to diversify. Right. And we’ve heard that before. and that idea in this context is to, to invest in different properties in different sectors. Maybe you did residential, maybe you want to move over into commercial or office, or maybe not office today, but, because nobody’s really office is down. But the point being is that find.
Kerin: A different sector, to hedge your.
Karen: Risk, and take advantage of the gain in one sector to offset a potential loss in another, and overall reduce your exposure.
Clarice: Yeah. And it’s, you know, it’s funny, I think in the, in the notes you had said it, it had a 2022 peak and I know it’s slowly making its way down. For some reason I thought the peak was 2020 and is steady. So there was good news in what, in my reading that, and I was like, oh, okay. I’ve just.
Kerin: Yeah, you know, and I’ll be honest.
Karen: That’s a tough one to nail down. I think if you go to different sources, you might get different information. And I think if you go out on the street and you ask ten people on the sidewalk, everybody’s going to have a different take. would be my opinion, just because it really depends on your personal reality. You know, if you’re going to the gas pump and it’s, you know, it’s, it’s hard to fill up that truck, or you have a fleet of vehicles, construction management vehicles, or whatever business you’re in and your gas prices are through the roof, how do you afford that? Do you pass it on to your customer? Do you absorb it to keep the customer? Yeah, I think, it’s really, it’s an important topic, but it feels like we’re all just waiting for something to happen, something to ease that pressure.
Clarice: Hundred percent.
Browning: You have to understand the different commercial sectors in their market cycles
And then the last thing that we have to talk about is the market cycles. And I know we were talking about that a little bit earlier when talking about initial investments and navigating the interest rates. Isn’t that the same idea, or is this something that’s a little different?
Kerin: It’s kind of that idea.
Karen: We talked about hedging and diversifying. You really have to understand the difference where the different commercial sectors are in their market cycle. For instance, offices might be low, post-pandemic, box stores might be low because more people are shopping online. That’s part of their cycle. But then you have other cycles that are coming into a high or at a high.
Karen: One of those, in my opinion, is quality, people want, if they’re going to go out and shop, and people still want to go out and shop to brick and mortar, but they want an experience. They want a high-quality, enjoyable experience. It’s not about going to a big box store.
Kerin: That’s usually just to go to get what you need.
Karen: If you’re going out to have an experience, it’s got to be higher quality, mixed-use, usually some sort of retail mixed with other uses, maybe entertainment, maybe a restaurant, people can go eat, play, shop, and do all of those things together. That does seem to be either at a peak or coming into a peak.
Clarice: Yeah. I think what’s interesting is that we’re shopping. You hit the nail on the head. We’re shopping and consuming differently now. So it’s something that I think is very smart for developers to keep an eye on. What’s that trend? What’s going to last? And then the difficult point of that is, is this space adaptable for when the cycle shifts and we consume differently again?
Kerin: That’s right.
Clarice: It’s a trend.
Kerin: That’s right. It’s always a trend. You’re always in that cycle. And that’s, you know, where you have to look at the project before you even start, you know, what is the down, what is the downside to this market look like? You know and can, can I get this project built, leased, and generating income before that market turns down? So there’s that consideration as well. The last thing you want to do is finish a project just as the market is in. That sector is tanking.
Clarice: Yeah. Oh, yeah. You don’t want to be the, you don’t want to buy bell bottoms the day everybody decides bell bottoms aren’t cool. Exactly.
Kerin: Apparently, I am doing all sorts of things like that now that I have a 15-year-old daughter.
Clarice: You now have an expert. Oh, well, I mean, hey, it’s important stuff to know. I think these are things that people should be consciously thinking of, especially if you’re, if you are a newer developer, things to keep in your back pocket as you’re planning and creating. Hopefully, some of these tips will save you money and help you strategize better.
Kerin: Yeah. You know, it’s a lot of vocabulary to know, and it’s a lot of research. But it’s not that difficult once you commit a little bit of time to understanding the process and what has worked in tough times. I’m also interested to know, for anybody listening out there, what other topics you want to hear about. What other things would you like someone to do that deep dive for you on and report back? Happy to do it.
Clarice: Oh, I love that. Yeah. And if they were going to send in their questions, they should send them in, too.
Kerin: Yeah, absolutely. So it’s Kerin desautelbrowning.com that first name is Kerin at Desautel D e s a u t e l browning. B r o w n i n g.com.
Clarice: Awesome. You can find us on the socials at desautelbrowning on Facebook, Instagram, and Twitter. Thank you so much.
Kerin: Thanks, Clarice.
Speaker A: Thank you for listening to this episode of environmentally speaking. If you’re in need of an environmental attorney, we are here to help. Call us at 401-477-0023 or visit our website at www.desautelbrowning.com that’s www. Dot desautelbrowning.com
