Helping architects conquer the world. And here is your host Enoch Sears.

>> I want to welcome everyone out to Business of Architecture today. Today we have the honor

and privilege of having Jonathan Segal, FAIA. Heís an architect whoís found remarkable

zest developing and building his own projects. Heís considered San Diegoís downtown most

successful in pioneering Architectural Development Company. In 2006 ñ and this is plastered

all over the magazines so Iím sure most people have heard about it if theyíre architects

ñ I think itís 2006 ñ Jonathan sold a portion of his portfolio for $45 million. His companies

currently manage over $50 million worth of properties. Heís also received multiple honors

and awards for his design and recently he received California AIAís highest honor,

the Distinguished Architect Award. So congratulations Jonathan and welcome to Business of Architecture!

>> Thank you and Iím happy to be here.

>> Great. So what our audience would like to know is they say, ìI want to do what Jonathanís

done.î I want to be an Architect as Developer. They look at the success youíve had and I

know from the outside it seems Ö itís hard to see the struggle youíve gone through to

get where youíre at. So Iím hoping that through our conversation right now we can

deconstruct a lot of your early struggles to map out a path for those people who want

to develop their own projects.

>> Well, the funny thing is that the early struggles donít go away. They continue. Each

project has what I consider three problems and then every project has its own three individual

problems. So itís not like youíve done so many of these buildings, everything is easy.

There is always a new twist, a new turn and itís a constant struggle. What Iíd suggest

if someone wants to do what I do is to build your own house. That would be the simplest,

easiest thing to do and/or start a very small project. You can do a remodel. You can take

a single unit and add three more units to it and get a loan that actually allows you

to do that. Thereís some magic out there right now. I

think itís called the 203K loan that actually allows you to borrow almost all the money

back so you can acquire the property and do the construction and the remodel to add the

three more units and I think you only have to put 5% down. So thatís another way of

doing it. Or focus on what you do. If youíre an architect that builds and designs 20 unit

projects and you feel comfortable doing it because thatís your niche, focus on that.

But the key to success is picking it small and slowly working up the food chain. Donít

start big because things will go wrong and when they go wrong you better have a check

book to figure out how youíre going to rectify your problems and theyíre always out there.

>> Yeah. So if the problems always continue, why should we get into this Jonathan? Whatís

in it for us?

>> My first development project I did in 1988. I think I was 25 or 26 years old. I had worked

for two architecture firms in San Diego, got the experience that I wanted, went out on

my own. The first project we won a State of California Honor award that was published

in Architecture Magazine and I made $500,000. So money isnít the key to success. It sure

helps and the fact that we got published and the fact that we got that top honor award

at the age 25 is solidifying my point that this will help you achieve what you should

be achieving 10 years or 20 years earlier than the traditional architecture law will

allow you to.

>> Excellent. So letís break it down. You mentioned I think about three prototypes right

now for people who are just starting out and one of them was a single family residence.

You said build your own house. The second one was Ö well, you did mention the 203k

loan which is a rehab loan I believe through FHA.

>> Correct.

>> Where they can actually borrow money on top of what they used to buy the property

to fix it up

>> Right and I believe itís up to four units, which also is great because to take out money

for and up to four units is 30 year fixed money whereby or whereas when I do my larger

projects their funding may fund and take out loans but theyíre only for 10 years. So if

you can actually lock in, which todayís rate is still on 3.5% multifamily project of four

units for 30 years is something you look back on in 10 years and think wow, I canít believe

that actually happened. Itís pretty remarkable.

>> Interestingly enough your son Matthew is just completing his first project I believe

and heís using that scenario. Heís developing a Fourplex, right?

>> Correct, but heís not doing a 203K loan. He did a traditional loan with a bank and

then weíll do a takeout loan after the fact, but heís done quite well. People can do it

and people should do it and now is the time to do it. The part that I fear most in the

cycle of this world, the first part that goes wrong is the cost of land goes up. The second

part is the cost of construction goes up. The third part is the interest rates go up

and the fourth part is the value of the property starts to drop as the interest rates go up

and the capital rates go with it and weíre moving into the second phase, the construction

costs going up. Weíre starting a project in 30 to 60 days

thatís 27 units and 9,000 feet of retail and Iím going to be hoping and praying that

weíre not going to get caught with the prices just spiraling out of control and contractors

being too busy. Weíre just getting into that phase. The landís already gone up outrageously,

really. Weíre past that phase.

>> Yeah. Are you hearing the same thing from other architects and other areas of the country

that the construction costs are starting to go up?

>> No. This is just my prediction that it would be this summer and I think itís not

here yet. Iím hoping and praying to get in. As I tell everybody on my weekly blog on the

Architectureís Developer website, itís coming. You better get in. You better get in now.

You better lock in your prices. Youíll be happy that you did it. The next phase would

be making sure that the actual contractors will be there to perform because sometimes

theyíll bid on certain projects and then the project will languish and then all come

up at the same time and then they canít even stop it. Itís just more problems and itís

all problem management that you do as a regular architect.

>> Sure. So one thing that you mention in your course is the importance of relationships

and for anyone starting out, Iím thinking thatís going to be the first thing they start

with is those relationships. Do you have any suggestions for how to find the people that

are going to be able to help someone starting out do they need to do?

>> Well, the first relationship you want would be a realtor to help you find property if

you canít find it yourself. So thereís a real timeline between overpaying for services

to keep relationships intact and being fair. So just make sure you take care of that broker

and they are a strange crowd. They seem to be apparently on the outside doing little

and getting a lot. Iím not sure thatís exactly the case. I think youíre paying for their

experience. The next thing is the general contractor that you should probably use your

first time out just so you understand the lay of the land there.

Then the subcontractors and treat them right because you want to be that guy at the front

of the bus, not the back of the bus. So you want to pay these guys on time. You want to

make sure they feel like theyíre treated properly because if theyíre not youíll be

at the back of the bus, youíll be hating life.

>> One thing that you talked about in your Architect as Developer seminar too is that

thereís a lot of older towns that have the bungalow with the long lots, alley access

and I know that youíve done a lot of different designs and played with things for that kind

of scenario. One thing that you mentioned talking about was an [air rights] condo, something

about air rights. What opportunities might exist for an alleys access scenario if someone

has a bungalow?

>> Well, the specific example I cited was when I was in an area called Hillcrest where

they do have the alleys. They do have the bungalows and there is room for one to four

units in the back of it. You potentially could take a bungalow on the front, purchase that

with that with a conventional loan and then do a lot, split whereby you get a free lot

in the back. You could live in the front while you build the one in the back. You move into

the back and sell the one in the front and hopefully the sale on the front significantly

subsidizes the one in the back. If you start off with the free land, clearly thatís a

massive subsidy. Also you have the ability to live in the property in the front while

the constructions going on the back.

>> Got you. Now I know a lot of communities have limitations on the accessory dwelling

unit. For instance, if you have one property theyíre going to limit what you can with

the little house you build behind your house. Are there any tricks to tweak that and get

around that and make that happen?

>> It depends on where you are and what the zoning is. What I was suggesting is you buy

a lot that actually allows the zoning for two units. I believe in Los Angeles they actually

let you subdivide a lot. Letís say that the lots are able to build four legitimate apartment

units on it. You can actually subdivide that into four lots. Fee simple lots and when I

mean fee you actually own the dirt instead of being a condo and then you can build four

houses on it. I donít really want to suggest people go into the fore sale housing product.

I want them to be in apartments from a sustainability standpoint.

Be green to yourself and develop a sustainable lifestyle so that you have apartment rental

income. If you do for sale, youíve got to pay ordinary income on it. If you do for rent

you have offsetting depreciation which typically counteracts the profit you make. So you basically

get free income for the term of the depreciation of your property.

>> Okay. Could you explain that to us real quick in laymanís terms how that depreciation

works?

>> Well, basically, to make it very simple, if you take a property that costs you letís

say $270,000 to develop the actual building itself all in, not including the land, the

government allows you to depreciate the residential portion over 27 years. So every year $10,000

ñ letís say the $10,000 of the building is wearing out. So letís say that you have

$10,000 of income. You have the $10,000 of depreciation thatís offsetting the income.

So basically the government said thereís no profit on that. So youíre basically deferring

the tax liability to the end of the road. So if youíve got $10,000 coming in and you

have a depreciation of $10,000 you donít pay any income tax legitimately on that property.

>> As opposed to fee income like you mentioned which Ö

>> Youíre getting whacked by the government. I donít know what the rates are. I tend to

be on the non-ordinary income part of the equation. So I donít pay attention to much

of that. My business model is actually that my architectural company, letís call it my

development company which has letís say four to six people in it, the rental income pays

for that. So I donít try to make any money whatsoever. I make enough money to live on

an annual basis and then the money thatís in excess of that actually pays for the development

end of the project. So even in a project where thereís fees,

the fees would be architectural. We do the landscape drawings, electrical drawings, mechanical

drawings and plumbing drawings. Those are all fees that we get. I donít take those

fees. So I donít have to pay ó basically Iíll have to make a whole bunch of money,

pay off a whole bunch of tax on it then pay myself the fees and then pay tax on the balance

of that. I use those, what I call Jonny bucks which

are capital that goes straight into the project. Development fees also come into that equation.

So in order to do that and not make any money off the development, I have to have supplemental

income and thatís the apartment income. So the apartment income actually pays for letís

call it the machine that actually builds the building. So Iím trying to make a balance

sheet increase in my net worth. I donít want a bunch of cash from fees. I want the balance

sheet to increase with the real estate. Hopefully I wasnít too complicated.

>> Well, Iíll try to rephrase it here and see if at least I understood a thing or two.

But so you take your ó the fees that an architect would normally get in a consultancy is obviously

theyíre upfront in the project. So just to rephrase, it sounds like what youíre saying

is instead of submitting a drawer order to the bank, getting paid those funds, youíre

leaving those funds and basically not taking them out and then that money is still part

of the construction line I would imagine. Do you then just use that to upgrade the project

or what happens to that extra cash that you didnít take out?

>> Let me even make it simpler. If the bank says that your project costs $100,000, they

want you to bring in $20,000. They want to lend you $80,000 or they want to lend you

$75,000 and they want you to bring $25,000 cash in. Typically in my deals $11,000 of

that $25,000 are fees that Iím going to get. So the bank says fine, only bring in $14,000

and bring in letís say your drawings. Letís say your drawings here are worth $11,000 because

youíve done those services. They acknowledge that. Itís not like future earnings. Youíve

already done the work. So you hand them the drawings which are worth

$11,000 oversimplifying and then you bring in a $14,000 check. So if you look at that

$11,000, you didnít have to make $14,000, pay $3000 in tax for the government to then

give the $11,000, to pay yourself the $11,000 and pay another $3,000 in tax. So if you made

$14,000, you give the bank $11,000, youíve got six in tax. Itís just insane. So if you