Quantity over Quality - America's Problem. Part 2

Last time around I began a discussion of America's seeming obsession with quantity over quality and its impact on real estate development. I'll wrap up those thoughts this time.

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This is not to say all homes and buildings need to be exquisitely handcrafted by master craftsmen using only the finest materials. That's great if you're a billionaire but the average person is certainly not that..

I believe much of the source of the problem lies in the current business school / MBA philosophy that the manager/executive is ultimately beholden solely to the shareholder to maximize returns. I get it. I went to business school and got my MBA but have never been comfortable with that position. Just as a real, live person is a member of his/her community and should act as a good citizen, a corporation, legally a person, should do so as well. 

This is not to say that profits are not important - they are. But I don't believe they are the be-all/end-all, especially "immediate quarterly profits" (and this belief is one reason I am a signer of the MBA Oath). The primary purpose of the oath is to encourage MBAs and businesses to "create value responsibly and ethically". A business needs to look to the long term health of the company, not just upcoming quarterly profits. And of course the compensation structure of C-level execs has long been a subject of debate and continues to be.

I worked for a company that was private when I started and went public during my tenure there. There was a major shift in corporate culture (and not for the better) and the company slowly went downhill as it chased quarterly profits, eventually going bankrupt (of course a major factor in its downfall was the Great Recession, but still...).

You might say "So what? A company is there to make money. Who cares if the employees are happy? The company is not there to serve them." I'd have to strongly disagree. Happy employees (but not so fat and happy they aren't striving to be better) make for happy customers and happy customers make for a successful, profitable company. 

So how do we tie this back into real estate development? Builders and developers need to once again take pride in their work. Almost more than any other product, ours is visible to the general public. We have chosen to create the built space the human race lives its lives in. Think about that. It's a fairly awesome responsibility. 

I won't berate the point. Long story short is that those of us in real estate development and construction need to stand up for providing profits AND value AND quality.

Whither Goes the Gated Community?...Part 3 - Wrap Up

In part 3, I wrap up my discussion of the golf course community and suggest alternate approaches.

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What should the Industry do to Survive?

First, let’s decide which industry we are – Homebuilders? Golf Course Managers? Hospitality? The remains of companies that tried to expand too far outside their core business litter the history of commerce. 

Regardless of how we define ourselves, community residents will continue to spend a large portion of their discretionary income outside the gates of their communities and look for a variety of activities that do not get

stale. Recognize and accept it. The opportunity to increase resident spending inside the gates is limited – people simply do not want to spend all their time and money in one place. Instead, look for opportunities to capture more of the residents’ “discretionary wallet” by providing services to residents outside the gates and maintain flexibility with respect to the offerings inside the gates.

For example, assume the typical couple eats out twice a week. It is highly unlikely they will want to eat at their club twice a week, every week. Accept it and move on; after you have done all you can with special events, dinner specials, and the like residents will still want to go downtown to stroll around and sample other fare. What to do? Establish a dining program with some of the better restaurants in town. Develop value-added

programs that cost you little-to-nothing but are highly valued by club members like preferred reservations and other special services. In return for directing traffic their way, ask the restaurants for a finder’s fee or an in-kind exchange. 

A big, luxurious clubhouse can be a major trophy and selling point, but it is also a money pit requiring a tremendous upfront capital expenditure as well as ongoing maintenance costs (Typically in order to sell the community the clubhouse has to be built prior to most of the homes being built and memberships sold. Thus it operates saturated by red ink in the first few years. One option among others is to provide a temporary clubhouse until a certain home sales goal is reached). They often have highly specialized spaces that cannot be easily reconfigured such as commercial kitchens, theatres, locker rooms and spas. And once spent, that money is, for all intents-and-purposes, illiquid. It is locked up tight by more than just the physical

gates surrounding it.

There is an option to spend just as much, or maybe less, on hard amenities like this albeit in a somewhat more liquid fashion. Purchase existing “one-off” facilities in various locations for use by members when they vacation and travel outside of the community.

For example, instead of building a large clubhouse buy

• An apartment in NYC
• A flat in London
• A chalet in Vail
• A cabin in the Smoky Mountains, and
• A beachfront home on the Outer Banks.

Should any particular property not prove popular, it is far easier to sell a single ski chalet in Vail than an entire gated community….and it would seem far easier to sell (to the homebuyer) a community with an international presence over one with only what is right in front of them. There are of course operational challenges to overcome with respect to maintenance, guest services and how reservation priorities are set. Companies that

provide this type of service are out there, like Abercrombie & Kent, so a model to deal with these operational issues exists.

However, there is a basic level of facilities your buyer will expect, depending on your target market. A modest clubhouse with flex space is a minimum with a well-equipped fitness center (and not the afterthought, hotel-type that no one really seems to use). A pool helps too but save money and go for a standard shape without all the bells and whistles like waterfalls and fountains (and a regularly shaped pool can be covered at

night, resulting in tremendous savings in water, heating and chemical costs).

Forego the theatre (most people have large-screen flat TV’s with surround sound at home anyway), the billiards room, luxury spa, business center, and other highly specialized spaces unless you are trying to offer a particular angle for your community. Do not offer them simply because everyone else is…it only becomes an expense that does not set you apart from your competition. Think very hard before providing a full-blown restaurant as opposed to a grill room or even snack bar. The kitchen equipment alone can cost $500,000 or more, not to mention the headaches involved with maintenance and inspections. Also not cheap is the cost of an executive chef whose salary (excluding benefits) will run close to $100,000/year.

Look to build space which can be used for a variety of activities and provide plenty of storage to put away equipment and furniture not used at the moment. Operable folding partitions offer a sound way to easily reconfigure a large space into multiple smaller rooms or vice versa.

The big-ticket item to reconsider is what, during the Boom, seemed to be almost sacrosanct – the golf course. The outlook for golf has already been discussed and plenty of those course-side homebuyers spent their extra funds on a lot premium for a view of open space instead of a golf membership. An 18-hole golf course at the low end is going to cost at least $10 million to build and $500,000 a year to maintain (in  warm-weather climates). Move up the scale in quality and bump the construction price to $20 million and annual maintenance easily to $1 million +. Even an executive course takes a significant amount of capital and land to build and operate.

If you open up the course to semi-public play to help with revenues, the ability to market it as a private course goes out the window. And despite their lush, green look, golf courses are an environmental challenge due to the amount of fertilizers, pesticides, fungicides, herbicides and huge quantities of water they require. Finally, you purchased a large amount of land that is only actively useable by a relatively small portion of the community.

What do you offer your community members instead? Simply preserve multiple-use open space with pathways, water features, and other amenities that take up far less space like tennis and basketball courts. Even a driving range is an option since it does not require that much land or maintenance relative to 18-

holes. Consider “soft amenities” like travel clubs or a cooperative agreement with a local university so residents can take non-matriculated classes, bring in guest speakers on a wide variety of topics. Bringing in a full-time coordinator to keep things lively and their finger on the pulse of the community is far less costly than a golf pro, assistant pro and the pro shop staff. Should a particular program be more popular than planned for, it is easy enough to scale it up – or eliminate it altogether if necessary. Taking advantage of the latest trend is also simple with a soft amenity program. And because people like to stay involved, having members organize and run many of the clubs is another way to keep operating costs down.

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Long story short...the gated golf course community crowd (i.e. Boomers), while they may still retire to FL, NC or wherever, have a lot more options at their fingertips when it comes to how they will spend their discretionary income. This is why the gated highly amenitized, golf course community as we now know is

doomed to go the way of the dinosaur. A few will continue to exist for those that want that lifestyle, but expect their number to be far fewer than has been planned for. In order to compete, country club-style gated communities are going to need to start thinking very creatively with respect to the amenities and services they offer.

Sources:

National Golf Foundation. Golf Participation in the United States, 2010 Edition.

National Golf Foundation, Minority Golf Participation in the United States, 2010 Edition.

National Golf Foundation, Minority Golf Participation in the United States, 2010 Edition.

National Golf Foundation – Golf Participation in America, 2010-2020.

US Census – Table 4. Projections of the Population by Sex, Race and Hispanic Origin for the United

                States: 2010 to 2050 (population numbers have been used by author to calculate %).

Whither Goes the Gated Community? ...Part 1 - The Problem and Supply

The Real Estate Boom which gained steam after 9/11 was the high-water mark for gated, amenity-rich McMansion communities. Developers bulldozed acres of open space to create enclaves where, for the right price, you could live on a private golf course, eat at your private club, exercise at your private gym and relax at your private spa. Property values were skyrocketing; everyone was fat and happy. Then, a funny thing happened on the way to the bank…

It may seem like a fundamentally sound model, but there were some serious problems with the concept of these gated communities from both the supply and demand sides. While the current economic climate means the model is on the shelf for now, this article suggests that for the wise developer it should stay there – forever – even when real estate finally turns around.

In today’s world, a highly-amenitized community faces dual challenges. First, too many communities vying for too few members which requires they must offer ever better and better amenities and services at ever-lower price points. Second, the internet and commonplace jet travel are taking their toll on the traditional country  club model.

Supply

Even before the absolute and utter disaster of the real estate crash, the amenity-rich gated community was an unsustainable model. It was a cash generator for the developer in that it helped to sell lots of rooftops. The problem came once once the developer turned the community over to the homeowner’s association (HOA) 5-7 years later. The HOA received a rude awakening to how much the community really cost to operate. 

Often, in the very amenity-rich communities, those attractions were loss-leaders for the developers who kept them afloat using profits from the sale of homes and memberships. While it was feasible for the HOA to continue to operate post-turnover, it was often only at diminished service levels from those provided when the developer ran it. Alternately, it required the HOA to jack up annual dues and fees.

Adding fuel to the fire was the problem that the developers’ pro forma models were based on a certain absorption rate of homebuyers opting to buy a club membership. However, the rampant level of speculation during the Boom threw that model out the window as speculators typically do not buy memberships. So, operations that run in the red by nature and only show in the black due to membership sales and dues are seriously behind the eight ball from the get-go.

Why do they run in the red? Because the quality and level of goods and services that members expect is expensive, especially when combined with the low membership levels you have to have (even with a full roster) to provide that personalized service. Moreover, in order to attract good staff members capable of high-end service you have to pay well and provide excellent benefits in order to make up the difference from what they can make at a commercial restaurant or public golf course with high volume. Finally, the volume at most clubs is simply not that high with respect to both the variable and (especially) fixed costs.

Compounding the problem is that many of the “hard amenities” – golf courses, clubhouses, fitness centers, restaurants, and spas – are too specialized in their construction and use to be easily adaptable should the winds of change blow in terms of what activities the members want. Offering a community based almost entirely on these hard amenities, instead of one focused more on “soft amenities” (travel clubs, programs, classes, etc) requires a tremendous amount of up-front capital investment that may or may not provide a suitable ROI. It is not unheard of for a developer to spend $20, $30 or even more than $40 million on a clubhouse…and maybe double that if you add a high-end golf course.

The gated golf course community so prevalent during the boom is essentially based on the country club model of a generation or two ago when there were only one or two clubs in town that anyone of means belonged to, and this was pretty much the extent of your social life and spending of discretionary income [You didn't live there - you joined and then played golf every weekend and ate dinner there a couple times a week]. During that era, there were not as many luxuries competing for your dollars or other places to spend your free time.

Financial models for recent gated communities were based on residents acting like those club members of 40 years ago. However, most people today are not willing to eat and spend that much time at their club given the choices they have outside the gates. Yet members still expect the same level of personalized service even if they only eat there once a fortnight instead of twice a week. Unfortunately, the club has a legal obligation to

provide that service because of what was marketed and sold. This is compounded by the fact that many members bought homes in the community based on the “lifestyle” and not just the house.

The other challenge is that with the old country club model, membership was somewhat fungible in that anyone could join. It was a simple decision to make – you paid your dues and joined. Alternately, you could decide not to renew your membership and leave. In today’s gated community, you first have to buy a house before you can even decide to become a member or not. That’s a really strong barrier-to-entry…in reverse. Or, God forbid you want to sell your house, you have to put your name at the bottom of an often long resignation list.

For some reason, it was thought the old country club model would be just dandy when mixed it with actual real estate sales. What they were marketing was a “lifestyle”, not just homes. This is not terribly different from how many companies pitch their products – they sell the benefit not the product – but an odd pairing when combined with someone’s home, especially the added cost associated with it. (The business model was not  merged into the marketing of a comprehensive lifestyle product. Home development plus country club management does not easily add up to twice the profit. Residential for-sale development is based on one-time, fast and high profits, while successful country clubs and other hospitality ventures are typically mid- to long-terms holds with steady returns based on superior customer service.)

Compare it, for example, with Coke™ whose marketing rarely pushes the actual product. Instead, you see advertising showing youth, action, and good times while drinking their product. Therefore, by extension, if you buy Coke™ you might somehow enjoy those things too (although it is never implicitly said you will). The Coca-Cola Company does not offer the option of adding an extra $0.50 to your purchase of a bottle of Coke™ to gain entry to this non-existent clubhouse of eternal youth and vitality. Pretty absurd when

you think about it – but this is exactly what real estate developers did when selling a lifestyle…except they spent real money building that good-times clubhouse. A lot of them in fact.

In Part 2....Demand