By Eric Domeier

There is a class of real estate investor who, with relatively modest financial leverage, seeks to capitalize on San Diego’s perpetual growth. Not a mass-scale developer, these individuals may want to consider a one- or two-parcel project with a 10-year vision. While not an easy course, small-project real estate development can still be a source of sustainable family wealth. And in our area, City Heights has the greatest potential.

The business of land development

The basic residential development equation has always been to convert under-utilized land into higher-density housing. Thirty years ago, this meant turning farmland into residential tracts and selling them. The land was inexpensive. And square-foot costs for labor and materials were competitive. In the end, where the project might cost $135 per square foot to develop, it was selling for $185 per square foot. Life was good for the mass-scale developers.

But two things happened in the last 10 years.

The first is the implementation of SB-375. In 2008, the Sustainable Communities and Climate Protection Act (SB-375) went into effect and changed the development game. With a clearer understanding of how sprawl leads to environmental degradation, SB-375 is putting an end to single-family tract development in California. The state has re-directed growth to existing urban communities.

The second thing that happened is that construction costs went up while sale values went down. The end result is that it often costs as much or slightly more to build than the project’s market value. Combined, these two changes in the market have made business very difficult for the mass-scale developer.

But for the modest investor with the long-view, opportunity remains. These are found in under-utilized city parcels. There are properties that currently have 1,500 square feet of structure on them, but are allowed to have as much as 10,000 square feet. This is a parcel ready for conversion from single-story, low-density to a multi-story, mixed-use, medium-density project.

And rather than building a project for sale, these projects can be built for retention and rental. The investor retains the project and allows the rent to pay for itself. In time, real estate values will rebound and the investor will own a very marketable piece of property.

Zoning

The city organizes every parcel of land in our community into zoning classes. Each class carries a designation and many are unique to the neighborhood. Areas such as City Heights and Normal Heights have some particularly attractive opportunities.

In particular, parcels designated as CUPD-CT-2-4 and CU-2-4 have excellent development opportunity. These zones are intended to accommodate medium-density, mixed-use projects. But these same lots are currently under-utilized as single-story residential and commercial.

In these zones, a standard 2,500-square-foot lot can accommodate a 10,000-square-foot project. This can include up to four residential units and as much as 7,500 square feet of commercial space. There is, of course, a many-paged laundry list of requirements by the city to achieve this opportunity, not the least of which is parking. But it is development-by-right, meaning the investor does not need to obtain any special approvals from the city. Which is a good thing. Because there are enough standard approvals required to keep the project in a planning phase for two years.

Property values

An additionally attractive quality of the Mid-City area is property values. Still considered an outlier to the urban elite, the neighborhoods maintain a seedier image. Nonetheless, these areas are not very different than the 1990s North Park.

According to broker and attorney Eric Townsend, “City Heights is poised to be a great area for investment based on gentrification trends.”

Current owners of parcels in the earlier-mentioned CT-2-4 and CU-2-4 zones are in the catbird seat. With such a property in the portfolio, they are in the best position to finance and convert the property into a lucrative long-term profit.

But where the owners of these lots seek to sell, they often overplay their advantage and fail to move the property. It is important to note that the as-is property has potential value only. And the potential is only realized after significant work and expertise to make it into a medium-density, mixed-use property. This includes additional investment equal or greater to property cost, sound decision making, and gritty determination to labor through the entitlement process. It is the buyer of the as-is property who takes on all of this risk, where the seller assumes no risk beyond what is typical to any real estate transaction.

Opportunity

While Wall Street investment markets bob and weave, the safest bet for long-term money may be in San Diego real estate. And Mid-City might be a good fit for the long-term investor. With under-utilized parcels and reasonable property values, opportunity exists. The buy-build-hold model of real estate development could reap strong margins in the 10-year picture. Buy small, build big, and hold for the return.

—Eric Domeier lives in North Park and practices architecture from his Grim Avenue office. Visit his website at dome-arch.com or call him at 619-531-0010.