Prestige/Vanity Developments - Are They Worth It?

Used to work at a firm with one- no. Unless you’re huge the entire firm gets cannibalized and really can’t do anything else.

Cool to change a neighborhood, I think they end up as net positive to society too. but imo you want to be 2nd/3rd buyer of these things.

At a developer that is currently doing a “mega project” in a T2 city. Nothing like Hudson yards but Ph 1 (already underway) is ~1Bn and by the end of all phases a whole district will have been redone and likely ends up in the ~3Bn range (Multi, Office, Hotel, Retail all included).

Fee stream to “keep the lights on” is definitely the biggest financial benefit on our end. Yes we will make money on the backend from promote and our coinvest, but in theory the time and human capital would be better spend on industrial/MF projects etc in terms of pure $. However it acts as a trophy project within that projects market and more broadly across the US that showcases our capabilities to do a type of project we hadn’t done before. We are a “go to” developer for standalone industrial and office developments (less so MF, but we also do that), but this is our first time undertaking a huge mixed use multi-tower project like this.  
 

Also selfishly I love when developers do massive place making projects like this as it helps develop cities in a cohesive way rather than just one block at a time in a hodgepodge manner. 

They are “worth it” when the feds artificially hold rates down for a decade.

It's not worth it. It helps establish a name and markets the people or partners behind the project because no one else would do it but people understand the economies of scale involved. Every part of the process is more and more challenging that ends having a smaller net value in the end. It's just like when cities bid to host the Olympics, it's really just a way to help market a city's name and marginally stimulate the local economy.

No direct experience on this but I’m guessing massive fee income on OPM… even if you don’t hit your promote. Curious what a “market” developer fee is on a 10 figure project.

Some make money. Others don’t. Project dependent. The hard part on these projects is the complexity from different uses, the time they take (7-15 years) & finally - internal turnover. Every time someone leaves you lose so much project knowledge making it even more risky. 
 

Developers do these deals because they believe they can make money but usually…fees. You can get rich off the fees and get your money back with profit even if the equity is a $0.

Absolutely not worth it. Have had experience on a large-scale, transformative project and would have much rather been focused on capitalizing and developing singular product. There are layers of complexity around design, entitlement, personalities layered with aggregated risk. You also tend not to become a product expert in any one use relative to focused developers churning (3x) the product over a 10 year period (more limited optionality for other job opportunities). Once you start working, no one cares about "prestige", etc.

Sure, you can grind it out over decades to build something potentially unique (if it doesn't blow up), but would rather get paid via career growth. Big issue for the large-scale, long developments is you start at some position (analyst, associate, vice president) and your equity (if any) is fixed so your equity does not grow as you move up and the project matures. Big no for anyone with a brain. A lot of large-scale developments also give a fake user experience (very easy to execute incorrectly on the many I've seen internally and externally evidenced by muted lease up).

I've worked on a few of these projects and the best justification I've seen was the ability to contribute land at a marked-up basis in a risk-on environment.

Most of these mega dev sites were programmed prior to 2020 when LPs were underwriting developments and solving for return hurdles using trended rents. The combination of lower YOC requirements with the ability to trend income faster than expenses created a spread where land owners and developers could mark up their land basis and still have a project pencil. E.g.) Using actual land basis, the project might solve to a 7.0% YOC but LPs only required a 6.5% yield (risk-free rate was sub 3%) so the land costs could be marked up to solve for 6.75% and everyone is happy. 

Also, in this pre-2020 development utopian higher yielding asset classes such as office and life science were being developed on a spec basis with low to no pre-leasing requirements (think NINJA loans but for development). Today, LPs won't risk their careers by brining an office development to IC even if there is 60% pre-leasing. This asset class reallocation has forced the developers to reprogram these site to lower NOI/FAR asset classes such as multi-family which algebraically requires a lower cost basis to meet LP returns. Multi-family doesn't solve their problem which is why you've seen more farfetched ideas on these sites such as casinos, massive hotels/condos, and sporting arenas. 

Tie in the construction inflation, lower loan proceeds, higher YOC requirements, a shift to untrended YOC hurdles, and higher debt service costs and that land value contribution mark-up that made these projects worth it 4-5 years ago are gone. Not only that but the land value contribution is now zero just to get these deals to pencil.     

Economically, these deals made a TON of sense (haven't even mentioned the fee stream yet) and made money day-one when they were first programmed pre-2020. Subsequently, they've become a necessary brain drain because if you're unable to contribute the land value at or above your cash basis, those development fees might become a break-even.  

I worked at a global developer (Hines, Tishman etc) which was underbidder on two notable $1-3BN GDV mixed-use projects. I was only an Analyst doing the underwrite at the time but thought both were terrible investments. The processes for projects of these scale are generally always market and get very competitive. Underwriting gets sloppier / more aggressive as people want to win the deal as time goes on and they become more emotionally tied into to the project. My concerns were mainly around timeframe to get entitlements, cost inflation in this time, and sustainability of the rental growth projected. All of these points have played out now for the purchaser, combine this with yields blowing out and I doubt there’s much if any profit in these projects now. Fees are great, but if you’re a top firm like these and looking at doing many of these projects, you need to show your LPs they were actually successful rather than a low single digit IRR which generated $40-60 million in fees for the firm.

Are they worth it? Don’t think I am qualified enough to answer but I am curious on what in the hell happens to these projects when one begins to view buildings as outdated. Does the whole mega development become old and uncool at once? eventually, tenants will move out to the next bigger and better spot. Master-planned projects typically have not had great success, as they tend to build what they think people want/what will make money, rather than what is needed. The best neighborhoods evolve organically, and some random billionaire typically does not know what's best to grow and sustain a community. To further add to that community aspect, this involves working with government which takes YEARS in Chicago. I would say definitely not worth it. 

This displays a shocking lack of understanding about how this industry works.

First off, every project pencils to some degree; very few firms take on a "vanity project" that they know is destined to fail.  They may not make money at the end of the day, but when all you've got is an underwriting model, every deal is a home run!

Second, how exactly do you think these projects make money?  I mean that seriously - you don't really seem to have considered the multiple revenue streams available to a developer doing a massive project.  Related, for example, manufactured their own windows for Hudson Yards.  Nominally that was to avoid supply chain bottlenecks, but you don't think they monetized that to some extent?  These are billion+ dollar projects; don't you think they're asking GCs for a piece of their fee to give them a job?

Third, think about it from the non-financial perspective.  Maybe you've got a construction team, or a development team, and you want to keep them busy.  After all, even in a breakeven project, you still retain all that institutional knowledge and experience, and simply keeping them on board and working is accretive for a firm, rather than having to lay people off in every cycle just because you're being super picky about only doing deals with a 20%+ IRR.

Fourth, reputation matters.  As an aside, do you know the first megaproject Related did?  Columbus Circle, which was a fucking grand slam.  But the point is, historically Related is an affordable housing developer, which basically no one remembers anymore outside of the industry, but you know how you make that jump in the public eye?  By taking on huge projects.  When you talk about Related, no one thinks about their affordable housing portfolio, even that's what made Mr Ross wealthy and keeps the company running - you talk about Hudson Yards, about the Shops at Columbus Circle, about the Grand LA.  That may not be "worth" anything to you, but if the oodles of posts on this site about prestige dick measuring are any indication, having that reputation is important to a lot of people, and may actually be an asset in attracting top talent.

Real Estate Developers are problem solvers and these are just really big problems so some developers are going to try. 

Personally, I wouldn't want to live in Lakeshore East in Chicago but it's pretty hard to say that it hasn't been successful. 

Also, usually there is some aspect of capital preservation as it relates to the money behind some of these deals.