DECISION MAKING IN THE PROPERTY DEVELOPMENT INDUSTRY DURING A BUSINESS CYCLE By JIMMY CARL WHITEHEAD M.Sc.(Planning), University of Toronto, 1971 M.A., The University of British Columbia, 1968 B.A., The University of British Columbia, 1962 A THESIS SUBMITTED IN PARTIAL FULFILMENT OF THE REQUIREMENTS FOR THE DEGREE OF DOCTOR OF PHILOSOPHY IN THE FACULTY OF GRADUATE STUDIES (DEPARTMENT OF GEOGRAPHY) We accept this thesis as conforming to the required standard THE UNIVERSITY OF BRITISH COLUMBIA May 1987 (c)Jimmy Carl Whitehead, 1987 In presenting this thesis in partial fulfilment of the requirements for an advanced degree at the University of British Columbia, I agree that the Library shall make it freely available for reference and study. I further agree that permission for extensive copying of this thesis for scholarly purposes may be granted by the head of my department or by his or her representatives. It is understood that copying or publication of this thesis for financial gain shall not be allowed without my written permission. Department of Geography The University of British Columbia 1956 Main Mall Vancouver, Canada V6T 1Y3 DE-6(3/81) Supervisor: Dr. Walter Hardwick ABSTRACT The property development industry in cities such as Calgary, Edmonton, Denver and Houston experienced a boom characterized by compulsive speculative growth in the 1970's and then a dramatic collapse in 1982. In the wake of the collapse came a crisis in the financial as well as the development sector, which to 1987 is nowhere near resolved. The expansion and decline in the property development industry is seen as a subset of a classical business cycle fueled by the world oil and gas economy, Canadian government regional and economic policies, and changes in money supply and interest rates. These factors are recognized as being contributory, but not a sufficient explanation for the property boom and bust. Additional understanding is offered by an analysis of the decision making process in the development industry. The research, focusing on key decision makers, revealed that repeated decision errors made by developers on strategies related to growth, diversification, and financing contributed significantly to the industry problems. The sources of strategic errors were found to be associated with the key developers' personalities and their perception of the business environment, as well as group and organizational behaviour. In 1976-77 opportunities to gain windfall profits in real estate development encouraged developers to travel from city to city continent wide in search of opportunities. Their fast-paced activity brought key developers stunning successes. Their perceived brilliance attracted followers from the rest of the industry and captured the imagination of the financial community. In 1979-80, as land values began increasing at rates far faster than interest rates, land banking superceded land development as a principal activity. Developers not only borrowed to the maximum under conventional project lending, but they also invented the concept of "appraisal surplus" (the difference between market value and debt) as a measure of their enormous "equity". This in turn permitted them to raise additional capital corporately through debentures and share offering to purchase even more land. By 1981 companies were highly levered financially making them extremely vulnerable to the slightest changes in the marketplace. Rather than recognizing that they were swept up in a property' boom developers, individually and as a group, chose to continue to believe that their "exceptional ability" to turn a profit was the basis for their successes. As the boom accelerated developers abandoned all caution committing to some of their largest and most daring acquisitions at the very peak of the boom. Then, in 1982 the inevitable happened, the bust in the property market. Those public companies with huge financially levered land banks, whose strategies were predicated on continuing inflation and ever increasing market share failed. Those companies, often private, with low debt to equity ratios,, conservative financial practices, and income property portfolios survived. Since both sets of companies operated in a similar environment, but one failed and the other survived, the argument that decision making was a crucial factor in understanding the boom-bust property cycle is strengthened. The understanding of change in the activity patterns and in the structure of the built environment is elucidated by the study of decision processes. Insights into decision making and business cycles create a new awareness of the development process. ii TABLE OF CONTENTS ABSTRACT i TABLE OF CONTENTS iii LIST OF TABLES vii LIST OF FIGURES viii ACKNOWLEDGEMENTS ix CHAPTER INTRODUCTION 1.1 SYNOPSIS: THE CALGARY PROPERTY MARKET 1976-85 1 1.2 THE THESIS 5 1.3 RESEARCH OBJECTIVE, METHODOLOGY AND STRUCTURE 9 PART A: THEORY: INTRODUCTION TO DECISION MAKING AND BUSINESS CYCLE 14 2 DECISION-MAKING THEORY 15 2.1 RATIONAL DECISION MAKING 19 2.2 BEHAVIOURAL DECISION MAKING 24 2.3 GROUP DECISION MAKING 29 2.4 ORGANIZATIONAL DECISION MAKING 32 2.5 THE DECISION ENVIRONMENT 36 2.6 SUMMARY 38 3 THE IMPLICATIONS OF BUSINESS CYCLES TO PROPERTY DEVELOPMENT 42 3.1 THE BUSINESS CYCLE 43 3.1.1 THE DEVELOPMENT CYCLE 47 3.1.2 THE HOUSING MARKET CYCLE: A DEVELOPMENT CYCLE SUBSET 48 iii 3.2 THE ROLE OF THE ENTREPRENEUR IN BUSINESS CYCLES 50 3.3 THE ROLE OF FINANCIAL CAPITAL IN BUSINESS CYCLES 51 3.4 THE ROLE OF GOVERNMENT IN BUSINESS CYCLES 53 3.5 IMPLICATIONS FOR PROPERTY DEVELOPMENT 56 4 PHASES OF A BUSINESS CYCLE AND DECISION MAKING BEHAVIOUR 58 4.1 THE DEVELOPMENT INDUSTRY DURING RECOVERY 59 4.2 THE DEVELOPMENT INDUSTRY DURING CREDIT-BASED EXPANSION 61 4.3 THE DEVELOPMENT INDUSTRY DURING SPECULATIVE FEVER 65 4.4 THE DEVELOPMENT INDUSTRY DURING THE CRASH 71 4.5 THE DEVELOPMENT INDUSTRY DURING STAGNATION 78 4.6 PROPERTY BOOMS AND BUSTS: IMPLICATIONS FOR CALGARY 81 PART B: CONTEXT 87 5 THE 1976-84 PROPERTY BOOM AND BUST IN CALGARY 87 5.1 ECONOMIC EVENTS LEADING TO THE PROPERTY BOOM 88 5.2 THE IMPLICATIONS OF FEDERAL GOVERNMENT POLICY FOR CALGARY 89 5.3 PROVINCIAL AND LOCAL GOVERNMENT INVOLVEMENT 90 5.4 SOME MEASURES OF THE BOOM AND BUST IN CALGARY (1976-84) 95 5.5 RESIDENTIAL LAND DEVELOPMENT IN CALGARY 99 5.6 THE CALGARY OFFICE MARKET (1976-84) 107 5.7 IMPACT ON CALGARY'S BUILT ENVIRONMENT 109 5.7.1 OFFICE DEVELOPMENT: THE DOWNTOWN CONTROVERSY 5.7.2 RESIDENTIAAND DECENTRALIZATIOL DEVELOPMENN T 1130 iv 5.7.3 COMMERCIAL DEVELOPMENT: RETAIL AND SERVICE 117 5.8 IMPACT OF THE BUST ON THE FINANCIAL INSTITUTIONS 118 5.9 SUMMARY 122 PART C: ANALYSIS AND FINDINGS 125 6 ANALYSIS OF CORPORATE STRATEGY 126 6.1 CORPORATE STRATEGY 131 6.1.1 CORPORATE STRATEGY: CARMA CASE STUDY 131 6.1.2 CORPORATE STRATEGY: NUWEST CASE STUDY 135 6.2 AN EVALUATION OF ASSET GROWTH AS AN OVERRIDING STRATEGY 137 6.2.1 THE UNMANAGEABLE RATE OF GROWTH DURING THE PROPERTY BOOM 137 6.2.2 LAND BANKING AND APPRAISAL SURPLUS 141 6.2.3 SALES VERSUS INCOME AS THE BASIC SOURCE OF REVENUE 145 6.2.4 SUCCESS BREEDS FAILURE 147 6.3 AN EVALUATION OF THE DIVERSIFICATION STRATEGY 150 6.4 AN EVALUATION OF THE FINANCIAL STRATEGY 156 6.4.1 THE PRESSURE OF STOCK MARKET PERFORMANCE 157 6.4.2 THE USE OF DEBT FINANCING -- THE LEVERAGE GAME 161 6.4.3 FROM DEVELOPMENT TO FINANCE: THE TRANSFORMATION 164 6.5 CORPORATE STRATEGIES: CONCLUSIONS 170 7 SOURCES OF ERRORS IN DECISION MAKING 177 7.1 THE DECISION MAKER 178 7.2 GROUP BEHAVIOUR 185 7.3 ORGANIZATIONAL DYNAMICS 189 7.4 THE CORPORATE DECISION ENVIRONMENT 195 v 7.4.1 THE DECISION MAKER AND HIS ENVIRONMENT: INTERFACE PROBLEMS 196 7.4.2 THE EXTERNAL ENVIRONMENT: THE FINANCIAL COMMUNITY 209 7.5 SOURCES OF DECISION ERRORS: CONCLUSIONS 216 PART D: CONCLUSIONS, EVALUATIONS AND IMPLICATIONS 221 8 BUSINESS CYCLES AND DEVELOPER BEHAVIOUR 222 8.1 SUMMARY OF FINDINGS 222 8.1.1 CORPORATE STRATEGIES: THE APPARENT CAUSE OF THE COLLAPSE 225 8.1.2 SOURCES OF DECISION ERRORS 228 8.2 EVALUATION AND POLICY IMPLICATIONS 237 8.3 CONGRUENCE AND RELEVANCE OF LITERATURE TO FINDINGS 242 8.4 RESEARCH IMPLICATIONS 247 8.5 A MODEL OF INDUSTRY BEHAVIOUR: TOWARDS A DECISION THEORY OF DEVELOPMENT 249 8.6 DECISION MAKING: CHOICE VERSUS DETERMINISM 254 BIBLIOGRAPHY 257 vi TABLES PAGE 1 KEY DECISION MAKING CONCEPTS 39 2 HOUSING AND LAND PRICES IN SYDNEY 68 3 PRODUCTION AND MARKET SHARE OF THE MAJOR DEVELOPERS 103 4 VACANT LOT INVENTORY MAY 1983 106 5 CORPORATE EARNINGS 1978-83 129 6 THE GROWTH OF DEVELOPMENT COMPANIES OVER 1977-81 BOOM 138 7 EARNINGS PER SHARE AND STOCK PRICE RANGE 1976-82 159 8 THE INCREASE IN LONG-TERM DEBT 1977-81 162 9 EQUITY TO ASSET RATIOS 1977 AND 1981 163 vii FIGURES PAGE 1 BOOM-BUST CYCLE IN CALGARY 3 2 THEORETICAL FRAMEWORK FOR BUSINESS CYCLES AND THE DEVELOPMENT PROCESS 8 3 THESIS STRUCTURE 10 4 MULTIPLE PERSPECTIVES IN DECISION MAKING 17 5 DECISION BEHAVIOUR UNDER STRESS 28 6 VALUE BUILDING PERMITS IN CALGARY 1979-84 96 7 RESIDENTIAL GROWTH 1946-84 IN CALGARY 100 8 LANDS CONTROLLED BY MAJOR DEVELOPERS 102 9 HOUSING PRODUCTION AND LOT INVENTORY (1973-83) 104 10 INDUSTRY BEHAVIOUR DURING A BOOM-BUST CYCLE 250 viii ACKNOWLEDGEMENT I would like to take this opportunity to thank the members of my committee for the advice and encouragement. I would especially like to thank Dr. Walter Hardwick for his critical comments and support. I am grateful to Canada Mortgage and Housing for the financial assistance provided through the C.M.H.C. Fellowship. I would also like to thank my wife, Pat, my sister, Julie, and my daughter Carla, and Liz Collins for their assistance in preparing the thesis.