March, 2005

Minimizing Risk:
Managing risk in innovation

By Linda Andersen

Astoria, Oregon hardly seems like a good spot for an upscale housing development. The town of 10,000 where the Pacific Ocean meets the Columbia River had seen better days when the logging and fishing industries thrived. Add to that a Brownfields site where a sawmill once stood and you're talking about the kind of risk that would send many developers running.

Some builders are the first to push the envelope, to take risk and try something new.

Others are the last to try something new. In fact, homebuilders in general have a reputation for being the last kids on the block to step out on a limb.

Why? Because they're already involved in one of the riskiest businesses in the industry. And despite all the potential benefits of innovation--faster, better, cheaper, improved sales--the risks of the untested are high when you're talking about the kind of money involved in residential development.

How can a builder minimize the inherent risks in innovation? We talked with two developers who took risks to find out how they not only survived, but also thrived. Although the type of risks differed, in the end they both weighed the risk against the reward and the reward won.

Seeing potential in Brownfields

Art DeMuro, Venerable Properties, Portland, Ore., saw potential, not a contaminated Brownfields in Astoria, Ore. "I had loved Astoria for a long time," he says. "When I walked the Brownfields site I was impressed by 16 acres with substantial frontage on the Columbia. It provided an interesting challenge."

Challenge may be an understatement. The site with a small pond sat vacant for several years, contaminated with toxic chemicals before the city purchased it. After negotiating with the Oregon Department of Environmental Quality (DEQ) to pay for half of the clean-up costs, it issued a request for qualifications. Along came Venerable Properties, who agreed to purchase and develop the eyesore.

The largest risk to developing a Brownfields is uncertainty and delay, so the more investigation you do up front the better according to Deborah Schmall, partner with the law firm Farella, Braun and Martel, San Francisco. "There always will be some level of uncertainty," she says. "But if the developer gives himself enough time we can reduce the level of uncertainty before construction, to the level most clients would think is manageable."

DeMuro was careful. After the city and DEQ cleaned up the site, DeMuro spend about $200,000 as well in clean up before buying the property for $700,000. Remediation included restoring the south bank of the pond, building a weir where the pond flows into the Columbia River and adding a two-foot soil cap to hot spots. Venerable Properties agreed to not excavate certain areas and establish restrictions precluding any recreational use of the pond.

DeMuro hired an environmental consultant for technical assistance, but the greatest hedge against risk by far was gaining the prospective purchaser agreement (PPA) with the City and DEQ. The PPA limited Venerable Properties' liability exposure to contamination that occurred after acquiring ownership. "That made all the difference. There's no way we would have done it without it," DeMuro says.

To date, Venerable Properties is in the third phase of the project with more than 40 percent of the homes sold. However, developers should carefully pencil out cleanup costs to make sure the market for the project will support them. "Assess their impact on your purchase price," says Schmall, "because you'll have to disclose the contamination and figure its effect on your selling price."

She advises following a checklist when considering Brownfields development. "The first step is to assess the environmental situation and do a Phase 1 assessment, which requires checking government records, completing a site history and getting photographs, but doing no sampling. Depending upon the finding, you may need to do Phase II to determine contamination and at what levels."

DeMuro encourages others looking a Brownfields to take advantage of available incentives. "Getting the PPA was critical," he says. "Try to acquire a parcel that is handed to you clean, or at least has a high level of cleanliness. Reduce the list of remaining remediation you'll have to do." In this case, he says, the partnership between Venerable Properties, the city and the state was key. "The city and DEQ were completely committed to making sure we weren't buying into a can of worms," he says.

Attorney Schmall says cleanup costs vary greatly with a project of medium complexity costing between $5,000 and $7,000. "Phase II can easily reach $30,000 to $40,000. You don't want to skimp on the cost of an environmental consultant. That is penny wise but pound foolish."

Despite the risks, DeMuro says the Brownfields project is the most rewarding project he's ever completed. "We've done lots of building in Portland, but it's a thriving community. This is a major project in Astoria, proportionally it really contributed to the renaissance of the city."

As land becomes more scarce and cities encourage close-in development, Brownfields present a growing opportunity to builders. By doing one's homework, builders and developers can minimize the risks associated with them.

Going green on a large scale

It's one thing to increase the amount of insulation in the attic or install compact fluorescent lighting to appeal to the environmental green buyer. But how about creating a housing development that is green inside and out? Now that's risky business. Yet that's what Rancho Mission Viejo did in creating Terramor Village at Ladera Ranch in southern Orange County, Calif.

Terramor Village is one of the most aggressively eco-friendly housing developments in the country. It employs new site planning concepts to minimize auto traffic, uses ecological best practices and offers homes that are energy efficient and outfitted with environmentally safe products. Every home has a 110-volt outlet for charging the neighborhood electric vehicle, and home buyers have the option of purchases a photovoltaic package to provide the home's electricity--not exactly mainstream offerings in housing developments.

"From the beginning we took a risk management approach. We started with the market, not an altruistic goal of changing the world," says Steve Kellenberg, EDAW Consultant, Los Angles, who served on Terramor's master planning team.

That market, however, was only revealed after conducting some solid research. Research firm American Lives' findings uncovered an untapped market niche that they named the 'cultural creatives' Research showed this group of people value arts and culture, the environment, a sense of community and neighborhood, their home as a nest, and nature. "The research was critical in making the decision to 'go green,' and we took steps to consistently analyze and measure our research prior to the grand opening at Terramor," says Paul Johnson, senior vice president, Rancho Mission Viejo.

Kellenberg says a lot of homes were being built for traditionalists in southern Orange County, but there was a dearth of homes for the culturally creative person. "It's Economics 101. If you have a demand of 26 to 30 percent of the market, if you offer the supply, you'll be rewarded. It really was the least risky thing because it was in response to the market."

The next issue was getting builders willing to take the risk of using new materials and a new approach to meet a series of environmental requirements covering the home's site and landscape design, water and energy use, materials, indoor air quality and innovation.

It helped that the company had worked in the past with groups of builders with mutual success. "These builders had experienced or seen the incredible success in our past villages. We selected builders ready to take on the challenge with us, confident that it would be a win/win for everyone," Johnson said.

Still some builders were worried about complying with the green development standards. "The cost in time required to change logistics and subcontractor practices and retrain people was a concern," Kellenberg says.

To increase comfort levels, the company held a builder workshop. "After they got over their initial shock, we listened," Kellenberg says. "We knew we were pushing the envelope, but we eliminated those things that were 'over the top' such as using gray water for landscaping. On the other hand, Kellenberg said they were surprised by the receptivity to photovoltaics. "The economics are so that you can achieve a positive cash flow from day one. This will be the largest photvoltaic community in the country." William Lyon Homes had offered environmental features in the homes in the past, says Brian Doyle, director of sales and marketing, Newport Beach, Calif., but had never put them together as a package. "After looking at what other builders were doing around the country, we expanded our options program. We allowed people to choose more environmentally safe products, such as flooring or paint, or install more efficient heating and cooling systems, or more efficient windows," he says.

Participating homebuilders gave input into Terramor's environmental goals and were given flexibility in how to meet them. For instance by adjusting architectural guidelines, builders were able to reallocate the money saved to green building items. "The goal was that there would not be a net increase in costs to the builder," Kellenberg says. His research showed consumers would pay up to $4 per square foot more for a healthier home.

Communication and the sharing of information between builders also helped reduce builders' risks at Terramor, according to Doyle and he credits Rancho viejo with creating that open environment. "They and we wanted this village to have success. It wasn't about one of us having success over the other." Apparently that thinking paid off William Lyon Homes has sold 96 of the 109 homes it built at Terramor in little over a year.

Johnson believes there are always risks associated with developing new communities, but his company tends to look at calculated risk as an opportunity.

Doyle advises others to "do your homework," when trying something new. "In concept it may sound great and easy, but it's not always so," he says.

Kellenberg also supports risk-taking with a caution. "Know when enough is enough; don't gild the lily," he says. "Identify a threshold of distinction that gives you a perceivable difference to the buyer. That's where art and science meet."

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Mill Pond Village, Astoria, Ore., is a 16-acre master-planned riverfront community built on a designated Brownfields site. The City of Astoria and the Oregon DEQ shared clean up costs of 1.2 million and Venerable Properties, Portland, Ore., spend another $200,000 getting the site ready for construction. The project, which is 40 percent sold, will consist of 200 units of housing and about 30,000 sq ft of commercial space. Venerable established builder architectural requirements to capture a local coastal atmosphere that is similar to a fishing village and to ensure the project's compatibility with the historic town.

Photographer Bill Lind lives in Astoria, Ore., and specializes in location photography. He can be reach at bill@stillimages.com

More on Mill Pond Village residential lots for sale at www.millpondvillage.com