Kevin Cavenaugh, owner of Portland-based Guerrilla Development, is challenging developers to look beyond the typical formula for creating the “highest and best use” for a site. Speaking at a ULI Minnesota event, he described how bigger is not necessarily better, and oftentimes it is worse, in terms of the complexity and risk.
Guerrilla Development has created several successful small-scale commercial and residential projects in Portland, and he recently shared his insights on how to successfully build “Not So Big Real Estate” at ULI Minnesota’s 2018 Young Leaders Group annual program in Minneapolis. Cavenaugh discussed case studies and strategies for building small and midsized infill projects, as well as insights on how those same ideas might be applied to Minneapolis and other markets around the country.
“We in the Twin Cities have seen an incredible amount of development over the last five years or so, but a lot of it is at a very large scale,” says Sara Joy Proppe, a project manager at Schafer Richardson and co-chair of the Young Leaders Group Executive Committee. “That’s great, but the places that we also gravitate towards are those neighborhood nodes and smaller infill places.” The question for many developers today is how to make those smaller projects work, she adds.
At the heart of Cavenaugh’s strategy is to A) take risks and B) find investment partners that understand and share the vision for a project. Guerrilla Development does not use any institutional money. Instead, it sources capital primarily from individual accredited and nonaccredited investors, and the six-person firm also has tested Reg A crowdfunding as another alternative. “No offense if you are institutional money. But, I don’t want you, and you probably don’t want me,” says Cavenaugh.
Institutional capital typically does not mesh with Cavenaugh’s unconventional approach and designs that are far outside the box. One of Guerrilla Development’s best-known projects is the Fair-Haired Dumbbell, a 56,000-square-foot (5,200 sq m) speculative office building with ground-floor retail in the heart of Portland’s Burnside Bridgehead neighborhood. The most striking feature is its colorful exterior with both six-story towers wrapped in a giant mural.
The project cost $11 million to build and the paint job alone was $500,000. “If you’re making decisions on a profit imperative, you would never spend a half million on a paint job if you were going to sell it the next week. It makes no sense at all,” says Cavenaugh. “If you’re going to keep it as a long-term hold, it makes all the sense in the world.” The project cost $11 million to build in 2017 and is now valued at $22 million. In addition to a bank loan, he raised $1.5 million in equity from 111 unaccredited investors and 18 accredited investors with a ten-year internal rate of return (IRR) of 15.3 percent.
Thinking Outside the Box
At its heart, Guerrilla Development is about creating some cool buildings—and driving social change in the process. In Portland, many of the neighborhoods are zoned for a maximum of six-story developments. So, what most developers are doing is building five over one mixed-use development to achieve maximum density on a site, notes Cavenaugh. “Not every building has to be the same thing. Office, retail, and housing can cluster together, but it doesn’t have to be this formulaic churn-it-out kind of project,” he says.
For example, the Zipper is an 8,000-square-foot (743 sq m) project that Guerrilla Development built on a 12,600-square-foot (1,200 sq m) site that features four micro restaurants, a punk rock nail salon, a coffee shop, and a whiskey bar with a common indoor seating area. The project is a single-story slab on grade with curved walls. The exterior of the triangular-shaped building features art that was created by street artists from L.A. and Tokyo that grabs the attention of the 28,000 cars that travel past the building every day. The property is also profitable, with a ten-year IRR of 22.9 percent, and institutional investors have since bought the land on either side to build bigger housing projects.
Cavenaugh attributes basic math to the financial success of his projects. He goes after cheap sites and works to keep construction costs down with what he refers to as “back of the pick-up truck,” nonunion labor.
Since 2016, Guerrilla Development also has adopted a bigger mission of using its projects to create “deep social repair” by supporting issues such as reverse gentrification and nonsubsidized affordable housing. One way the firm accomplishes that is by encouraging impact investing. For example, if a project will deliver a cash-on-cash preferred return to investors of 8 percent, he is asking them to accept 6 percent. He uses that extra 2 percent to create a private subsidy that can create reduced rent on a space or unit that he offers to people specifically who live or work near that project.
Certainly, many people agree that a desire and a need exist to create small, creative infill projects in urban and suburban communities. “I think there is a need for all kinds of development. That’s what makes a city a city,” says David Frank, director of community planning and economic development for the city of Minneapolis. “We have large buildings downtown. We have single-family homes, and we need everything in between,” he adds. Frank also served as moderator for the ULI event.
However, some of the hurdles that developers do have to overcome are zoning, ordinances, and neighborhood opposition. Portland changed its zoning code about ten years ago that eliminated parking requirements for any site that was within 500 feet (152 m) of a mass transit stop. “It was pretty gutsy and progressive, and I applaud them for doing that,” says Cavenaugh. Eliminating the parking obligation is what has made many of Guerrilla Development’s projects financially feasible, while in other cities, including Minneapolis, that remains a significant stumbling block.
“I do think the desire to encourage small to medium-sized developments is slowly increasing. City leaders are starting to recognize that if we are going to approach neighborhoods holistically, we have to address both the granular and the big picture,” says Proppe. This means empowering more people to develop those empty or underused infill lots within their neighborhoods, she adds. To that point, the city of Minneapolis does have some programs that are aimed at supporting new developers just starting out, such as its Developer Technical Assistance Program.
Cavenaugh has no intention of marching across the country to take on new projects in other cities. Instead, he is encouraging others to follow in his footsteps. What many firms would protect as proprietary, Guerrilla Development posts online—project photos, plans, and even spreadsheet proformas—so that others can see exactly how they tick and pencil out from a financial perspective.
Although it may be hard for big developers to take a step down to do small, creative infill projects, it is much easier for smaller guys to expand into small commercial and multifamily development, notes Cavenaugh. “Find those smaller men and women who are willing to take that step up,” he advises.