The Architect as Developer, is the approach where the architect is also the developer (and sometimes the contractor), which leads to more control of the overall development process. Assuming the role of architect, developer, and contractor requires taking on more risk, but can result in more financial reward. It also gives the architect more control over the development process resulting in a better built environment. The downside to this approach is that the real estate development industry is an intricate and risky business, relying on the expertise of many business services and consultants that the architect has little to no experience working with, including real estate brokers, title and escrow, insurance, marketing, and bankers.
What if the Architect were able to partner with a Developer to creating building projects? The Architect would provide services to permit a project in return for an equity stake, or ownership in the project. This means development/project management fees, cash flow from rental income and the profits from the sale of real estate. The Developer would have significantly less upfront costs before acquiring a building permit and starting construction, which means less risk.
I’ve been bouncing this idea around in my head and would like to hear people’s opinions and questions.
It aint new, and generally the fee for planning consent would not be worth it from the developers perspective.
It is easier to simply pay a fee for services rendered tied to a particular development/funding stage rather than have some other instrument set up to record those services and then translate that into an equity stake into a property where the market valuation is not yet known, or subject to change.
Having said that, it has been done before, but usually by architects that are very well connected. Got connections?
i mean what you're saying isnt really new its just that we need the organizations that supposedly support architects (ahem ahem aia) to encourage this behavior more often. The only reason that architects are in such a $#Itty situation is that you dont need an architect to make a building happen. everyone that gets sick needs a doctor, everyone that goes to court (more or less) needs a lawyer but everyone that needs a building doesn't necessarily need to hire an architect. they can go to any draftsman that took two autocad classes at a local junior college, hire a contractor from the yellow pages and get their drawings stamped by a PE for 1500 bucks. if more building types needed a RA on board to get a building permit then we would all be rolling in dough. my pro practice teacher in undergrad showed us a very interesting graph of the number of people attempting to become registered architects since 1950, its a steep and steady exponential DECLINE, the profession of architecture as we know it is entirely in danger and no one really cares. who the hell in their right mind goes into a field were you work harder and longer than many other equivalent degrees with a lot less return. obviously me and you do it because we genuinely enjoy it, but when push comes to shove (esp in this economy) less and less seniors coming out of high school are opting into the risk of becoming a starving architect when they can apply the same skills towards becoming some other kind of professional making 6 figures coming out of graduate or professional school. most degree programs dont publish their admission stats but i was told from sources at both of my institutions that since the beginning of the recession especially less and less people are applying to architecture school.
It would do architects a lot of good to take the time to really understand why architectural fees are accounted as a capital cost in a developer's project pro forma, rather than an expense. Might change our outlook on a few things, including our relationship with our clients.
If less people are applying to arch school, that's a good thing. We have way too many people pursuing careers in architecture relative to demand.
I agree that the profession of architecture is profoundly endangered right now. The main reason for that is how profoundly risk averse architects started becoming a few decades ago, systematically and strategically shedding responsibility for anything that might bring liability so that we could focus on drawing our pretty pictures. But the problem with risk avoidance is it breeds irrelevance. If you've got no skin in the game, you are unnecessary to that game. The reason developers and contractors reap such large financial rewards relative to architects, even though we are the ones who typically bring the most value to the table in terms of project definition, is risk. They assume a lot of it, and it pays off handsomely for them when things go right. Of course, if things go wrong, they can be financially ruined too. But it's foolish to think we can insulate ourselves from that downside risk when we're still dependent on the risk-takers for our income stream. Now we have the worst of both worlds: high financial risk-sensitivity combined with lack of leverage in the marketplace. This is the primary source of the difficulties architects face moving forward.
Re-integrating the architectural practice model -- by becoming developers and builders as well as designers, and thus getting skin in the game again -- is the way forward.
The problem, of course, is that the ongoing de-leveraging of the credit bubble and ensuing deflationary economic environment will make it very difficult for cash-poor architects to re-enter those domains, which will likely remain very depressed for at least another decade. At the same time though, those same economic parameters will be clearing out a lot of the competition.
Until everyone stops talking about it and "walks the walk" its not going to happen. Assess the site develop, the marketing program and prepare to put your ass on the line like you never have before and calculate the risk and the potential reward then see if you have guts and ability to handle the stress and still make beautiful architecture all while spending your money. Its not easy, thats why so few architects have ventured into it.
It is rewarding, stressful, not so much fun, hardwork, but ultimately a testament to your ability to put it on the line and see if you can walk the walk ... no excuses! Your money, your design, your decision making ..... the perfect scenario right!
What people are missing is that to be a developer is not just some "choice". You cannot take on risk without something substantial to risk. Most architects, almost every single one I know, has very limited capital.
You can't just "get a loan" without the money to put on the line. Nowadays, even then it is extremely, if not downright impossible (not many for sale projects going up anywhere, that's all credit limitations).
So, to be a developer today you need TONS of money, or a background and connections to get funding from other sources (pension funds, etc.), but then you are not going to be more than a 'developer for hire'.
And as noted above numerous times, the "architecture" part of development is worth almost nothing. Nowadays you could even get someone to happily do everything for free. Nothing there for a developer to give you a place at the table for something that is not that valuable (monetarily speaking).
@gwharton: "The reason developers and contractors reap such large financial rewards relative to architects, even though we are the ones who typically bring the most value to the table in terms of project definition, is risk."
While I agree with much of what gwharton wrote in his 12:40 pm post, the italicized and bold portion of the above phrase literally made my jaw drop and demonstrates, once again, the disconnect between many members of our profession and the reality of our clients' world and the environment in which projects are delivered. Even the qualifier "in terms of project definition" doesn't make it better.
"Value" - while an elusive concept - is in the eye of the beholder, like beauty. The vast majority of owners and contractors simply can't see the full value of what we can contribute to the process because, in the vast majority of cases, we are wrapped up in our own little world and oblivious to the real requirements, and complexities, of the project development process.
The intrinsic value, which gwharton is referring to I believe, still holds much more importance, especially long term, than the monetary value related to development. The monetary value that is in the mindset of most developers and clients related to developers involves sort shortsightedness and little attention to contextual impact. gwharton is arguing that these two types of values should be tied together and equally addressed instead of the current situation where cheapness trumps all. Or I'm rather mistaken.
Rand - you are, perhaps, correct about ghwarton's intent. Nevertheless, I stand by my earlier post. What we view as "cheapness" the typical developer views as "economy". They are competing in an environment where their own customers (naturally) look for the best value at the lowest price - as I expect you do when purchasing clothing or automobiles. Developers must be market driven to be successful and many of our architectural notions about what a building should "be" simply don't (and cannot) support the competitive environment in which most developers operate.
This is not a situation unique to developers -- I suggest that it is pervasive in Western culture (at least) and penetrates virtually all business entities. And, until a large preponderance of society decides we want to approach our corporations, and out cities, in another way, I expect that pervasiveness to remain -- although I personally wish an alternative view of the future were more likely.
Rand is right in his read of my meaning, and I've ranted about that subject at length elsewhere here. Before you start making a lot of unwarranted assumptions about me and what I think, why don't you go read that stuff. Or maybe just ask me. As it turns out, I know rather a lot about real estate development and how the development business works.
Developers are not idiots, and the successful ones have a good appreciation for the value that good design brings to their project and differentiates in the marketplace. A good design can easily add 50% or more to the bottom line asset value, increases absorbtion rates, and allows pricing leverage at sale or lease over the competition. That's why most developers don't just hire the cheapest possible architect they can find. They'll happily beat you up all day long to try and intimidate you into cutting your fees, and odds are they'll be successful if you can't articulate the value you bring to the table, but that doesn't meant they don't understand that value themselves. They just want it cheap. Unfortunately, lots of architects are willing to give it to them cheap.
I happen to agree that our managerialist society has substituted quantification and optimization for value judgment, leading to rampant commoditization in the mass market, and that this has been a very negative trend. That mode of thinking is exactly what put us in the economic situation we're in now. You can only gain profit by substituting optimization and margin-cutting for value-creation for so long before you hit the frontier of diminishing returns.
@gwharton: "I've ranted about that subject at length elsewhere here. Before you start making a lot of unwarranted assumptions about me and what I think, why don't you go read that stuff."
So -- unlike you, maybe the rest of us have lives (as least, most of us). Are you really so arrogant as to think that we need to research all of your earlier posts before responding to your latest smelly gift to the forum. Maybe each post ought to stand on its own.
@gwharton: "It would do architects a lot of good to take the time to really understand why architectural fees are accounted as a capital cost in a developer's project pro forma, rather than an expense. Might change our outlook on a few things, including our relationship with our clients."
You can think of a typical development process separated into four (4) distinct stages:
(1) Feasibility/Due Diligence
(2) Pre-Development
(3) Construction
(4) Sale/Lease-Up
From the Developer's perspective, the most risk occurs during Stage 1 and Stage 2 of the development process. During Feasibility and Pre-Development stage, the Developer is spending their own money, investor's money, or lines-of-credit. If the project doesn't work out, then they stand to loose all this money without producing a "real" project. To mitigate against this risk, you want to spend as little money as possible before you get to Stage 3, Construction.
At Stage 3, Construction, you will need to have a building permit and can close on a Construction Loan that will finance approx. 70% to 80% of the total project cost. Or in other words, you're spending someone else's money and you are now producing a real project that has value (or collateral).
Now back to Stage 1, Feasibility and Stage 2, Pre-Development. A typical Architect's fee schedule might look like this:
Schematic Design: 15%
Design Development: 20%
Construction Documents: 35%
Construction Bidding: 5%
Construction Administration: 25%
This means the Architect will earn 75% of their fee before construction starts. In other words, the Developer will spend the most money on Architect Fees at the riskiest (or earliest) part of the development process. The Architect Fees is the highest line item in the budget, more than civil, structural, acoustical, landscape (if hired separately), geotechnical engineering, environmental consultants, surveyor, market study, appraisals, title and escrow). For the Developer to limit their risk, they will want to lower their upfront costs as low as possible before they can get a building permit. So how can the Developer lower their risk? Which budget line item do they look to squeeze? You guessed it! The Architect Fees.
Do you think Architect's would be willing to forgo their fees in the beginning of the project for an ownership stake? As an Owner, the Architect would be sharing in the development risk (as mentioned above), but would also share in the financial reward (if the project is successful) of a real estate development including rental cash flow, proceeds on sale, developer/project management fees, etc.
Great post, wikemoo. You've clearly identified one of the major sticking points on architectural fee structure as it relates to our clients' business model. We're one of the few players in the game that require payment out of at-risk capital (direct equity) up front. That means the dollars we have to be paid are unleveraged, where the dollars the contractor, developer, sales agents, et al. are all leveraged dollars. That makes us comparatively expensive (one un-leveraged dollar being roughly equal to five leveraged dollars on a typical pro forma at 80/20 LTV).
Obviously, pushing out payment of architectural fees to a later stage, when they can be paid with leveraged dollars, is much better for the developer and reduces his risk to equity significantly. But it does so by transferring that risk to the architect, who may never get paid at all if the project falls apart for some reason (most projects never make it out of feasibility). A cardinal rule of successful business practice is to always get paid for assuming risk. So if you negotiate a deferred fee deal, make sure it includes compensation for the risk you're taking by giving the developer a float on your fees.
You can also use bonuses and penalties as part of the fee structure as well. I particularly like to do this with the entitlement process, a major source of risk to the developer. Getting permits and entitlements in a timely fashion is very important, and though the architect doesn't have a lot of control over what the bureaucrats do when they're on the clock, there are lots of things the architect can do to expedite that process. An incentive structure which reward the architect for getting entitlements quickly is a good source of cash flow and is often attractive to developers as well. What's their carry on the site while the permit application is sitting at the city planning department? Each month you can cut off of that has a direct effect on the developer's up-front capital costs.
GCs regularly get bonuses for finishing projects ahead of schedule. We should too. But if you negotiate bonuses, be ready to accept penalties as well.
Equity participation can also be a good way to increase the architect's economic returns. I've done that on many projects. But be aware that most developers don't really want you as a partner, nor do they want to dilute their equity. This can be a very touchy subject and difficult to negotiate.
There are also other ways to gain residuals downstream. I know a couple of architects who write royalty clauses into the deeds or sale contracts for residential units they've designed. If it's a contractual term, then they get a percentage of the sale price of every unit sold, just like the RE agents do but as a royalty for having designed it. If it's a deed restriction (the holy grail of this sort of thing), that royalty is payable to the architect not just at the original sale, but every sale thereafter in perpetuity. Believe it or not, architects do ask for and get stuff like that as part our fee negotiations. You just have to take a value-pricing approach and really understand the developer's business model and goals to make it work. Everything is negotiable, and our clients know this better than almost anybody.
wouldn't it be interesting if the aia (just to, you know, name a name.....) would be able to offer feasibility/pre-development loans to qualified developers that could be rolled into a construction loan?
el jefffe: as a general statement, given the number of projects that die during the pre-development phase, I can't imagine any lender, of any sort, who would want to finance that sort of risk. To do so would require iron-clad personal guarantees from the borrower(s) -- and, if the borrower(s) can provide such guarantees, they probably don't need to borrow the funds required to cover pre-development costs, which generally represent a fairly small portion of the total project cost.
Moreover, I feel absolutely certain that even if this were a good idea, the AIA hasn't the sort of resources -- or the business acumen -- to evaluate and provide this sort of financing.
Realtor Commission = $15,600 (3900 to listing co. 3900 to listing broker 3900 to selling company 3900 to selling broker)
Developers Fee = $49,400 (minus transfer tax, home warranty, buyer concessions, etc)
GC Fee = $22,000
Carpentry L+M+Fee = $10,000 + $10,000 + $5000
Architects Fee = $5000
These numbers are pretty simplified, but you can see the relationship and ,hopefully, the risk associated with each. Development is way too general of a word to say it would be a good fit, but if you start with the lowest common denominator (residential housing). You can see how an architecture firm could start to take over more of the development process and capture more of the fees. I personally would rather control more of the process and be able to low ball my design fees in order to recapture that money at a later point in time. My current business model is Design + GC and Self Perform Carpentry (on select projects).
It seems like a no brainer to get my RE license to capture that profit, but in this market a good RE agent is worth the price. My goal, instead, is to grow capital to the point where I don't need a money partner to take the majority of the development fee.
I've heard carpenters say, "build two homes, the third is free" There's an even better saying, "If you want to be a carpenter, you have to move the wood."
Overlooking the fact that developers are some of the cheapest mofos on the planet (after banksters, of course). In New York, the developer cuts your throat on the way in AND on the way out.
@gwharton: "Equity participation can also be a good way to increase the architect's economic returns. I've done that on many projects. But be aware that most developers don't really want you as a partner, nor do they want to dilute their equity. This can be a very touchy subject and difficult to negotiate."
Assuming that an Architect's fee might be anywhere from 8% to 15% of total construction costs, if you where to defer your fee for an equity stake in a development project, what would you ask for? 20% project ownership maybe? How would it be structured?
I'm assuming that these projects might be small in size, maybe 2-8 units, stick-framed townhouses, or something like that. Smaller developers would be more accepting of this approach since it reduces their upfront risk and they might be short on equity. But it's also more risky to work with smaller developer since they are less seasoned.
Larger, more established developers will have lines of credit, mezz debt financing, and equity partners, so you're right, they probably would not be open to partnering with an architect.
You can easily find an architect that will risk everything for no increase in pay. Especially in this economy. Really, I see no way for an architect to "leverage" anything more. In the past few years, architects (that I know) have been working for free just hoping a job will happen.
Perhaps you can negotiate a little more if you do all the work and forgo payment until the developer makes money, but for such a small fraction of the risk and little monetary value, I don't see how it would be of great value to a developer (of course it depends on the scale, etc.).
It really comes down to who control's the dollars. Getting financing is the most essential part of development. Everything else is easy to get in place if you got the cash and architects (poor architects, after this mess) are on every corner.
When you state that an Architect's fees are 8-10% I'm assuming you are including structural and MEP engineering. Are you paying for their fees? I would imagine that would be a very bad move. You would have to structure it so that your consultant's are paid and your fee is the only part that is at risk. Unless of course, your consultant's agree to defer their fee.
I would guess that this would be much more attractive to a smaller developer, but then it has more risk, as mentioned above. Payment and return would depend on the developers exit strategy. Let's assume a sale at the end of construction, I would negotiate full payment of fees plus a percentage for risk. Using the example I outlined above, maybe your fee is $5000 and your return is 10% for an additional $5000. I'm not sure that is enough at the same time, your investment of $5000 is less than 5% of the total cost the developer has at risk. How much of a return should you get? Typically it's in direct relation to your percentage of money in the pot.
Regarding equity participation, remember that the developer gets to count anything he spends on the architect's (or other consultants') fees in his own equity column on the project balance sheet (it's a capital cost, not an expense, remember). That's one of the reasons arch/dev works as a lower-cash approach to development. If the developer IS the architect, then he can use his own architectural fees as equity in the project.
So if you suggest deferring part of your fee to equity participation, his equity position can drop substantially depending on how he's structured the project and how long he intends to hold it. Not only is he diluting his own ownership of the project, but he's losing part of the equity he would otherwise have had by just paying you up front. Sometimes that makes sense for developers, but often it does not.
You are talking about Steve Jobs territory here, where everything is vertically integrated. Difficult to do , but not impossible.
Being a developer, you need SOLID knowledge in Finance - A subject that architects don't really like to touch. They much rather draw and sketch and "make art". Hence the difficulty. This is on top of all the architectural knowledge you need to build a building. You really need to be mentally ambidextrous here.
Quite a lot of good comments... gwharton seems to know quite a bit.
I think even with the architect/developer route, there will be another issue:
Architects hired under the Archi-Developer will be a paid a wage under his Development company. That wage is also based also on an efficient competitive market rate, which depending on how the Developer runs his operations, the difference is still not much, because like any company, the owner is trying to maximize his return on investment.
The only true advantage is the seamless communication in value creation right from the start - just like automotive houses like BMW. They design a product with a particular target market in mind and since their designers are under their payroll, the communication of the brand value is much more easily imparted.
But when you outsource design to a third-party, a lot of that value creation intent gets lost in translation through the brief, although for some, the cost savings associated with the compromise is worth it.
Let's just say I have in my family who bought lands to build condos, and other kinds of developments. I think I am fortunate enough to see the game being played from both ends.
Back then, I was a young architecture student still in school then. I certainly was more interested in drawing, sketching and "making art".
Even when I was working in a commercial firm, everyone seemed more interested in the design jobs than the "boring" management ones. So lucky for me, I took those "boring" jobs and moved up fast and learned a great deal of things.
This sounds like a good idea, however, are there any legal restrictions which prevent architects from being developers? (Partnerships is a different criteria) But I am keen to learn which countries allow, and which don't allow architects to be developers?
Germany with the concept of the Baugruppens brought about a revolution, and a new financing model based on speculation, which makes the architect a developer; but some other countries don't permit the architects to carry out developments, eg. France, Belgium.
Does anyone have any thoughts on real estate development education in tandem with an M.Arch? I'm considering applying for my school's program for a certificate in real estate development, and have heard mixed opinions about the necessity of formal education to become a developer.
Architect + Developer: A Partnership
The Architect as Developer, is the approach where the architect is also the developer (and sometimes the contractor), which leads to more control of the overall development process. Assuming the role of architect, developer, and contractor requires taking on more risk, but can result in more financial reward. It also gives the architect more control over the development process resulting in a better built environment. The downside to this approach is that the real estate development industry is an intricate and risky business, relying on the expertise of many business services and consultants that the architect has little to no experience working with, including real estate brokers, title and escrow, insurance, marketing, and bankers.
What if the Architect were able to partner with a Developer to creating building projects? The Architect would provide services to permit a project in return for an equity stake, or ownership in the project. This means development/project management fees, cash flow from rental income and the profits from the sale of real estate. The Developer would have significantly less upfront costs before acquiring a building permit and starting construction, which means less risk.
I’ve been bouncing this idea around in my head and would like to hear people’s opinions and questions.
this aint a new idea, my friend...
It aint new, and generally the fee for planning consent would not be worth it from the developers perspective.
It is easier to simply pay a fee for services rendered tied to a particular development/funding stage rather than have some other instrument set up to record those services and then translate that into an equity stake into a property where the market valuation is not yet known, or subject to change.
Having said that, it has been done before, but usually by architects that are very well connected. Got connections?
i mean what you're saying isnt really new its just that we need the organizations that supposedly support architects (ahem ahem aia) to encourage this behavior more often. The only reason that architects are in such a $#Itty situation is that you dont need an architect to make a building happen. everyone that gets sick needs a doctor, everyone that goes to court (more or less) needs a lawyer but everyone that needs a building doesn't necessarily need to hire an architect. they can go to any draftsman that took two autocad classes at a local junior college, hire a contractor from the yellow pages and get their drawings stamped by a PE for 1500 bucks. if more building types needed a RA on board to get a building permit then we would all be rolling in dough. my pro practice teacher in undergrad showed us a very interesting graph of the number of people attempting to become registered architects since 1950, its a steep and steady exponential DECLINE, the profession of architecture as we know it is entirely in danger and no one really cares. who the hell in their right mind goes into a field were you work harder and longer than many other equivalent degrees with a lot less return. obviously me and you do it because we genuinely enjoy it, but when push comes to shove (esp in this economy) less and less seniors coming out of high school are opting into the risk of becoming a starving architect when they can apply the same skills towards becoming some other kind of professional making 6 figures coming out of graduate or professional school. most degree programs dont publish their admission stats but i was told from sources at both of my institutions that since the beginning of the recession especially less and less people are applying to architecture school.
It would do architects a lot of good to take the time to really understand why architectural fees are accounted as a capital cost in a developer's project pro forma, rather than an expense. Might change our outlook on a few things, including our relationship with our clients.
If less people are applying to arch school, that's a good thing. We have way too many people pursuing careers in architecture relative to demand.
I agree that the profession of architecture is profoundly endangered right now. The main reason for that is how profoundly risk averse architects started becoming a few decades ago, systematically and strategically shedding responsibility for anything that might bring liability so that we could focus on drawing our pretty pictures. But the problem with risk avoidance is it breeds irrelevance. If you've got no skin in the game, you are unnecessary to that game. The reason developers and contractors reap such large financial rewards relative to architects, even though we are the ones who typically bring the most value to the table in terms of project definition, is risk. They assume a lot of it, and it pays off handsomely for them when things go right. Of course, if things go wrong, they can be financially ruined too. But it's foolish to think we can insulate ourselves from that downside risk when we're still dependent on the risk-takers for our income stream. Now we have the worst of both worlds: high financial risk-sensitivity combined with lack of leverage in the marketplace. This is the primary source of the difficulties architects face moving forward.
Re-integrating the architectural practice model -- by becoming developers and builders as well as designers, and thus getting skin in the game again -- is the way forward.
The problem, of course, is that the ongoing de-leveraging of the credit bubble and ensuing deflationary economic environment will make it very difficult for cash-poor architects to re-enter those domains, which will likely remain very depressed for at least another decade. At the same time though, those same economic parameters will be clearing out a lot of the competition.
Until everyone stops talking about it and "walks the walk" its not going to happen. Assess the site develop, the marketing program and prepare to put your ass on the line like you never have before and calculate the risk and the potential reward then see if you have guts and ability to handle the stress and still make beautiful architecture all while spending your money. Its not easy, thats why so few architects have ventured into it.
It is rewarding, stressful, not so much fun, hardwork, but ultimately a testament to your ability to put it on the line and see if you can walk the walk ... no excuses! Your money, your design, your decision making ..... the perfect scenario right!
Enjoy!
What people are missing is that to be a developer is not just some "choice". You cannot take on risk without something substantial to risk. Most architects, almost every single one I know, has very limited capital.
You can't just "get a loan" without the money to put on the line. Nowadays, even then it is extremely, if not downright impossible (not many for sale projects going up anywhere, that's all credit limitations).
So, to be a developer today you need TONS of money, or a background and connections to get funding from other sources (pension funds, etc.), but then you are not going to be more than a 'developer for hire'.
And as noted above numerous times, the "architecture" part of development is worth almost nothing. Nowadays you could even get someone to happily do everything for free. Nothing there for a developer to give you a place at the table for something that is not that valuable (monetarily speaking).
@gwharton: "The reason developers and contractors reap such large financial rewards relative to architects, even though we are the ones who typically bring the most value to the table in terms of project definition, is risk."
While I agree with much of what gwharton wrote in his 12:40 pm post, the italicized and bold portion of the above phrase literally made my jaw drop and demonstrates, once again, the disconnect between many members of our profession and the reality of our clients' world and the environment in which projects are delivered. Even the qualifier "in terms of project definition" doesn't make it better.
"Value" - while an elusive concept - is in the eye of the beholder, like beauty. The vast majority of owners and contractors simply can't see the full value of what we can contribute to the process because, in the vast majority of cases, we are wrapped up in our own little world and oblivious to the real requirements, and complexities, of the project development process.
The intrinsic value, which gwharton is referring to I believe, still holds much more importance, especially long term, than the monetary value related to development. The monetary value that is in the mindset of most developers and clients related to developers involves sort shortsightedness and little attention to contextual impact. gwharton is arguing that these two types of values should be tied together and equally addressed instead of the current situation where cheapness trumps all. Or I'm rather mistaken.
Rand - you are, perhaps, correct about ghwarton's intent. Nevertheless, I stand by my earlier post. What we view as "cheapness" the typical developer views as "economy". They are competing in an environment where their own customers (naturally) look for the best value at the lowest price - as I expect you do when purchasing clothing or automobiles. Developers must be market driven to be successful and many of our architectural notions about what a building should "be" simply don't (and cannot) support the competitive environment in which most developers operate.
This is not a situation unique to developers -- I suggest that it is pervasive in Western culture (at least) and penetrates virtually all business entities. And, until a large preponderance of society decides we want to approach our corporations, and out cities, in another way, I expect that pervasiveness to remain -- although I personally wish an alternative view of the future were more likely.
Rand is right in his read of my meaning, and I've ranted about that subject at length elsewhere here. Before you start making a lot of unwarranted assumptions about me and what I think, why don't you go read that stuff. Or maybe just ask me. As it turns out, I know rather a lot about real estate development and how the development business works.
Developers are not idiots, and the successful ones have a good appreciation for the value that good design brings to their project and differentiates in the marketplace. A good design can easily add 50% or more to the bottom line asset value, increases absorbtion rates, and allows pricing leverage at sale or lease over the competition. That's why most developers don't just hire the cheapest possible architect they can find. They'll happily beat you up all day long to try and intimidate you into cutting your fees, and odds are they'll be successful if you can't articulate the value you bring to the table, but that doesn't meant they don't understand that value themselves. They just want it cheap. Unfortunately, lots of architects are willing to give it to them cheap.
I happen to agree that our managerialist society has substituted quantification and optimization for value judgment, leading to rampant commoditization in the mass market, and that this has been a very negative trend. That mode of thinking is exactly what put us in the economic situation we're in now. You can only gain profit by substituting optimization and margin-cutting for value-creation for so long before you hit the frontier of diminishing returns.
Well, I think it's a really great idea!
Haterz gonna hate, yo!
@gwharton: "I've ranted about that subject at length elsewhere here. Before you start making a lot of unwarranted assumptions about me and what I think, why don't you go read that stuff."
So -- unlike you, maybe the rest of us have lives (as least, most of us). Are you really so arrogant as to think that we need to research all of your earlier posts before responding to your latest smelly gift to the forum. Maybe each post ought to stand on its own.
What an arrogant ass!
http://archinect.com/forum/thread/52358745/why-are-the-vast-majority-of-architects-liberal/100
a little over half way down should be the gwharton school of economics and value for those interested, and it goes on for a bit after that.
@gwharton: "It would do architects a lot of good to take the time to really understand why architectural fees are accounted as a capital cost in a developer's project pro forma, rather than an expense. Might change our outlook on a few things, including our relationship with our clients."
You can think of a typical development process separated into four (4) distinct stages:
(1) Feasibility/Due Diligence
(2) Pre-Development
(3) Construction
(4) Sale/Lease-Up
From the Developer's perspective, the most risk occurs during Stage 1 and Stage 2 of the development process. During Feasibility and Pre-Development stage, the Developer is spending their own money, investor's money, or lines-of-credit. If the project doesn't work out, then they stand to loose all this money without producing a "real" project. To mitigate against this risk, you want to spend as little money as possible before you get to Stage 3, Construction.
At Stage 3, Construction, you will need to have a building permit and can close on a Construction Loan that will finance approx. 70% to 80% of the total project cost. Or in other words, you're spending someone else's money and you are now producing a real project that has value (or collateral).
Now back to Stage 1, Feasibility and Stage 2, Pre-Development. A typical Architect's fee schedule might look like this:
Schematic Design: 15%
Design Development: 20%
Construction Documents: 35%
Construction Bidding: 5%
Construction Administration: 25%
This means the Architect will earn 75% of their fee before construction starts. In other words, the Developer will spend the most money on Architect Fees at the riskiest (or earliest) part of the development process. The Architect Fees is the highest line item in the budget, more than civil, structural, acoustical, landscape (if hired separately), geotechnical engineering, environmental consultants, surveyor, market study, appraisals, title and escrow). For the Developer to limit their risk, they will want to lower their upfront costs as low as possible before they can get a building permit. So how can the Developer lower their risk? Which budget line item do they look to squeeze? You guessed it! The Architect Fees.
Do you think Architect's would be willing to forgo their fees in the beginning of the project for an ownership stake? As an Owner, the Architect would be sharing in the development risk (as mentioned above), but would also share in the financial reward (if the project is successful) of a real estate development including rental cash flow, proceeds on sale, developer/project management fees, etc.
Great post, wikemoo. You've clearly identified one of the major sticking points on architectural fee structure as it relates to our clients' business model. We're one of the few players in the game that require payment out of at-risk capital (direct equity) up front. That means the dollars we have to be paid are unleveraged, where the dollars the contractor, developer, sales agents, et al. are all leveraged dollars. That makes us comparatively expensive (one un-leveraged dollar being roughly equal to five leveraged dollars on a typical pro forma at 80/20 LTV).
Obviously, pushing out payment of architectural fees to a later stage, when they can be paid with leveraged dollars, is much better for the developer and reduces his risk to equity significantly. But it does so by transferring that risk to the architect, who may never get paid at all if the project falls apart for some reason (most projects never make it out of feasibility). A cardinal rule of successful business practice is to always get paid for assuming risk. So if you negotiate a deferred fee deal, make sure it includes compensation for the risk you're taking by giving the developer a float on your fees.
You can also use bonuses and penalties as part of the fee structure as well. I particularly like to do this with the entitlement process, a major source of risk to the developer. Getting permits and entitlements in a timely fashion is very important, and though the architect doesn't have a lot of control over what the bureaucrats do when they're on the clock, there are lots of things the architect can do to expedite that process. An incentive structure which reward the architect for getting entitlements quickly is a good source of cash flow and is often attractive to developers as well. What's their carry on the site while the permit application is sitting at the city planning department? Each month you can cut off of that has a direct effect on the developer's up-front capital costs.
GCs regularly get bonuses for finishing projects ahead of schedule. We should too. But if you negotiate bonuses, be ready to accept penalties as well.
Equity participation can also be a good way to increase the architect's economic returns. I've done that on many projects. But be aware that most developers don't really want you as a partner, nor do they want to dilute their equity. This can be a very touchy subject and difficult to negotiate.
There are also other ways to gain residuals downstream. I know a couple of architects who write royalty clauses into the deeds or sale contracts for residential units they've designed. If it's a contractual term, then they get a percentage of the sale price of every unit sold, just like the RE agents do but as a royalty for having designed it. If it's a deed restriction (the holy grail of this sort of thing), that royalty is payable to the architect not just at the original sale, but every sale thereafter in perpetuity. Believe it or not, architects do ask for and get stuff like that as part our fee negotiations. You just have to take a value-pricing approach and really understand the developer's business model and goals to make it work. Everything is negotiable, and our clients know this better than almost anybody.
wouldn't it be interesting if the aia (just to, you know, name a name.....) would be able to offer feasibility/pre-development loans to qualified developers that could be rolled into a construction loan?
@el jeffe - how would that work?
el jefffe: as a general statement, given the number of projects that die during the pre-development phase, I can't imagine any lender, of any sort, who would want to finance that sort of risk. To do so would require iron-clad personal guarantees from the borrower(s) -- and, if the borrower(s) can provide such guarantees, they probably don't need to borrow the funds required to cover pre-development costs, which generally represent a fairly small portion of the total project cost.
Moreover, I feel absolutely certain that even if this were a good idea, the AIA hasn't the sort of resources -- or the business acumen -- to evaluate and provide this sort of financing.
1500 sf new home construction @$110/sf = $165,000
Buildable Lot = $30,000
Sales Price = $260,000
Realtor Commission = $15,600 (3900 to listing co. 3900 to listing broker 3900 to selling company 3900 to selling broker)
Developers Fee = $49,400 (minus transfer tax, home warranty, buyer concessions, etc)
GC Fee = $22,000
Carpentry L+M+Fee = $10,000 + $10,000 + $5000
Architects Fee = $5000
These numbers are pretty simplified, but you can see the relationship and ,hopefully, the risk associated with each. Development is way too general of a word to say it would be a good fit, but if you start with the lowest common denominator (residential housing). You can see how an architecture firm could start to take over more of the development process and capture more of the fees. I personally would rather control more of the process and be able to low ball my design fees in order to recapture that money at a later point in time. My current business model is Design + GC and Self Perform Carpentry (on select projects).
It seems like a no brainer to get my RE license to capture that profit, but in this market a good RE agent is worth the price. My goal, instead, is to grow capital to the point where I don't need a money partner to take the majority of the development fee.
I've heard carpenters say, "build two homes, the third is free" There's an even better saying, "If you want to be a carpenter, you have to move the wood."
Magellan in Chicago would be an example of a similar approach at a very large scale.
http://www.magellandevelopment.com/
Overlooking the fact that developers are some of the cheapest mofos on the planet (after banksters, of course). In New York, the developer cuts your throat on the way in AND on the way out.
@gwharton: "Equity participation can also be a good way to increase the architect's economic returns. I've done that on many projects. But be aware that most developers don't really want you as a partner, nor do they want to dilute their equity. This can be a very touchy subject and difficult to negotiate."
Assuming that an Architect's fee might be anywhere from 8% to 15% of total construction costs, if you where to defer your fee for an equity stake in a development project, what would you ask for? 20% project ownership maybe? How would it be structured?
I'm assuming that these projects might be small in size, maybe 2-8 units, stick-framed townhouses, or something like that. Smaller developers would be more accepting of this approach since it reduces their upfront risk and they might be short on equity. But it's also more risky to work with smaller developer since they are less seasoned.
Larger, more established developers will have lines of credit, mezz debt financing, and equity partners, so you're right, they probably would not be open to partnering with an architect.
You can easily find an architect that will risk everything for no increase in pay. Especially in this economy. Really, I see no way for an architect to "leverage" anything more. In the past few years, architects (that I know) have been working for free just hoping a job will happen.
Perhaps you can negotiate a little more if you do all the work and forgo payment until the developer makes money, but for such a small fraction of the risk and little monetary value, I don't see how it would be of great value to a developer (of course it depends on the scale, etc.).
It really comes down to who control's the dollars. Getting financing is the most essential part of development. Everything else is easy to get in place if you got the cash and architects (poor architects, after this mess) are on every corner.
When you state that an Architect's fees are 8-10% I'm assuming you are including structural and MEP engineering. Are you paying for their fees? I would imagine that would be a very bad move. You would have to structure it so that your consultant's are paid and your fee is the only part that is at risk. Unless of course, your consultant's agree to defer their fee.
I would guess that this would be much more attractive to a smaller developer, but then it has more risk, as mentioned above. Payment and return would depend on the developers exit strategy. Let's assume a sale at the end of construction, I would negotiate full payment of fees plus a percentage for risk. Using the example I outlined above, maybe your fee is $5000 and your return is 10% for an additional $5000. I'm not sure that is enough at the same time, your investment of $5000 is less than 5% of the total cost the developer has at risk. How much of a return should you get? Typically it's in direct relation to your percentage of money in the pot.
Regarding equity participation, remember that the developer gets to count anything he spends on the architect's (or other consultants') fees in his own equity column on the project balance sheet (it's a capital cost, not an expense, remember). That's one of the reasons arch/dev works as a lower-cash approach to development. If the developer IS the architect, then he can use his own architectural fees as equity in the project.
So if you suggest deferring part of your fee to equity participation, his equity position can drop substantially depending on how he's structured the project and how long he intends to hold it. Not only is he diluting his own ownership of the project, but he's losing part of the equity he would otherwise have had by just paying you up front. Sometimes that makes sense for developers, but often it does not.
You are talking about Steve Jobs territory here, where everything is vertically integrated. Difficult to do , but not impossible.
Being a developer, you need SOLID knowledge in Finance - A subject that architects don't really like to touch. They much rather draw and sketch and "make art". Hence the difficulty. This is on top of all the architectural knowledge you need to build a building. You really need to be mentally ambidextrous here.
Quite a lot of good comments... gwharton seems to know quite a bit.
"They much rather draw and sketch and "make art"."
not offensive or ignorant sounding at all.
I think even with the architect/developer route, there will be another issue:
Architects hired under the Archi-Developer will be a paid a wage under his Development company. That wage is also based also on an efficient competitive market rate, which depending on how the Developer runs his operations, the difference is still not much, because like any company, the owner is trying to maximize his return on investment.
The only true advantage is the seamless communication in value creation right from the start - just like automotive houses like BMW. They design a product with a particular target market in mind and since their designers are under their payroll, the communication of the brand value is much more easily imparted.
But when you outsource design to a third-party, a lot of that value creation intent gets lost in translation through the brief, although for some, the cost savings associated with the compromise is worth it.
@ Rand H.
Let's just say I have in my family who bought lands to build condos, and other kinds of developments. I think I am fortunate enough to see the game being played from both ends.
Back then, I was a young architecture student still in school then. I certainly was more interested in drawing, sketching and "making art".
Even when I was working in a commercial firm, everyone seemed more interested in the design jobs than the "boring" management ones. So lucky for me, I took those "boring" jobs and moved up fast and learned a great deal of things.
My benefit. Other people's loss.
This sounds like a good idea, however, are there any legal restrictions which prevent architects from being developers? (Partnerships is a different criteria) But I am keen to learn which countries allow, and which don't allow architects to be developers?
Germany with the concept of the Baugruppens brought about a revolution, and a new financing model based on speculation, which makes the architect a developer; but some other countries don't permit the architects to carry out developments, eg. France, Belgium.
interesting thread, I think i've mentioned or asked some of theses questions before, esp. about equity in exchange for cash, glad to see some insight
Does anyone have any thoughts on real estate development education in tandem with an M.Arch? I'm considering applying for my school's program for a certificate in real estate development, and have heard mixed opinions about the necessity of formal education to become a developer.
Just in case you would be interested, I did interview 2 architects on how and why they did transform their service business into real estate business:
http://blog.archisnapper.com/punch-list-app-iPhone-iPad-Android/from-architects-to-real-estate-developers-with-alex-and-esther-from-barcelona/
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