When New York City-based Hugo Neu Corp. began the $1 billion, multiyear Kearny Point project in 2014 — redeveloping the 130-acre former Kearny shipyard as a center for office, co-working and retail space — “the common wisdom was that there was already too much office space in New Jersey and no need for office space in…

When New York City-based Hugo Neu Corp. began the $1 billion, multiyear Kearny Point project in 2014 — redeveloping the 130-acre former Kearny shipyard as a center for office, co-working and retail space — “the common wisdom was that there was already too much office space in New Jersey and no need for office space in Kearny,” according to Steve Nislick, the company’s CFO. “So, the idea of attracting new office tenants to Kearny was inherently very risky.”

Real estate developers routinely invest millions of dollars or more in their developments and constantly weigh short- and long-term issues, from the cost of borrowing money to shifts in market demand. Careful market studies, supplemented by sound planning and execution, can reduce the risks and increase the chances of a profitable project, according to experts.

A flexible approach

“Our investment strategy is very long term, but we’re unique in that we take on long-term risk as real estate owners in order to allow our tenants maximum flexibility through short-term lease options at Kearny Point,” said Nislick.

“Essentially, we take on the market risk in exchange for having more control over rent prices in the near term,” he added. “Additionally, we borrow a very limited amount of capital. We limit our borrowings to less than 30 percent of total construction costs so that any short-term risk is mitigated by the lack of debt.”

The company further reduces market risk at Kearny Point by leasing “primarily to short-term tenants, mainly entrepreneurs and small businesses that have short-term office-flex space needs and are unable to commit to the cost or terms associated with a traditional office lease,” he said. “Therefore, we’re closely and continuously tracking how deep the demand is from tenants in the 25-mile concentric circle around Kearny Point that are looking for an office space of 3,000 square feet or less.”

Hugo Neu Corp. executives also keep a close eye on the broader office and industrial market. “What we understood from the beginning — and what the broader market is now coming to terms with — is that there is an unquenchable demand for well-located flexible office space for short-term tenants in New Jersey and in the Greater New York City region,” according to Nislick. “As an owner, we were willing to make a long-term investment and take on risk to attract short-term tenants, and we were correct in doing so. We’ve been extremely successful in leasing up our available flex spaces at Kearny Point.”

He projected continuing demand from smaller tenants, “including startups and small businesses, that want to relocate to a creative work environment that is close to New York City. They need quality space, a great location and flexible lease options in order to attract the best-in-class talent that is needed to make their businesses successful.”

Trend spotting

The magic sauce at Mack-Cali Realty Corp. involves looking “for long-term sustainable trends in the market,” and then “we lean into those trends when making decisions,” according to CEO Michael DeMarco. “Examples of factors that are at play right now in the New Jersey commercial real estate market include millennial marriage and family patterns, income growth and housing preferences, to name a few. Once we’re able to identify the most prominent trends, we then strategize and develop our capital plan around them. While basing a real estate strategy around market preferences does involve some risk, anything that is worth obtaining is worth the risk.”

DeMarco pointed to Jersey City Urby — a 69-story residential tower with 765 apartments in downtown Jersey City — as a “perfect example of a risky but successful project. The building has a very unique design, with a cantilever structure, and it has a very different amenity package and different program offerings than the typical residential buildings in the area. Urby has been a huge success, and has become a flagship building for Mack-Cali and is a widely recognized icon of downtown Jersey City.”

The detail work begins long before shovels hit the ground. “Before starting a project, we’re consistently and diligently monitoring both market trends and economic conditions to ensure that we’re making informed decisions,” reported DeMarco. “We consider whether a recession could be around the corner. We consider household and workspace preferences. Striking a balance between all of the factors at play is key. Once a project is started, it’s very difficult to bail. However, we have postponed projects in certain cases to take a step back before launching to ensure that we are successful.”

DeMarco and his team continue to examine the market. “More people want to live in urban areas with major transportation hubs, or within less-urban areas that still mimic the live-work-play environment found in cities,” he said. “On the New Jersey waterfront, this includes Jersey City, Hoboken, Weehawken, West New York and Edgewater. In New Jersey’s suburbs, this includes locations with thriving downtown areas, such as Montclair, Westfield, Ridgewood, Red Bank, Morristown, Short Hills and Princeton, among others.”

A sense of balance

The Jersey City-based developer Hoboken Brownstone Co. has generally focused on two municipalities — Hoboken and Jersey City — and almost exclusively concentrates on brownfield sites that require extensive environmental remediation.

HBCo co-founder George Vallone was a state champion pole vaulter when he was in high school, and that might help explain his appetite for risk. Then again, it may have also influenced his sense of balance.

“We have a formal risk-management process designed to reduce the chance of engaging in the wrong of kind of project,” he said. “First, we consider entitlement. Is the property already zoned for the kinds of mixed-use developments we usually do, or if not, is it likely to gain approval?”

Then Vallone and co-founder Daniel Gans consider economic feasibility. “Jersey City and Hoboken each hosted significant industrial developments,” Vallone noted. “So there’s pervasive land contamination in many sites. Cleanup costs can be very expensive, so we have to determine if there’s going to be room for profit after the cleanup.”

The third issue is market demand, he add ed. “Will the market pay a rent or sales price that will cover our costs and still leave a profit for us and our investors?”

Construction costs make up another concern. “Can we build it for a price that leaves a profit?” he asked. “In addition to land and hard construction expenses, you’ve got to consider soft costs like architects, administration, project management and others that can add up.”

Finally, he said, “we have to examine the financing costs. It’s not just the equity, bank debt and investors’ money, including my own. We also have to consider the cost of capital over time. You may turn a profit, but how long will you have to finance the project, from pre-construction to absorption, or selling and renting the units? For a high-rise with a couple hundred units, you could be talking four years.”

Besides employing risk-management techniques that can help convince lenders to reduce their interest and equity requirements, HBCo also reduces its exposure by getting control of properties — without a costly outright purchase — while it engages in due diligence. “We may pay for an option to control the property for a year or two, while going though the permitting process,” he noted. “Or, we may sign a contract that gives us a year or two before we have to close on the deal.”

Right now, “there’s a huge, sustainable surge in demand for housing in Jersey City,” added Vallone. “Many of the positions will be middle management and won’t pay enough to cover Manhattan rents. But Jersey City offers an easy commute into Manhattan, and at lower apartment prices.”