"Nothing ventured, nothing gained."

"A penny saved is a penny earned."

These could be mottoes that profit-motivated developers might proclaim as guides to successful building.

What are the risks and rewards expected by developers and investors who erect office buildings and other commercial properties in D.C.'s business and governmental core?

Before construction, any one of the following occurrences could stop a project and result in a loss of all funds expended up to the point of termination:

* The site proves technically unfeasible for building because of unforeseen subsurface conditions too costly to remedy. Unstable soils, excessive rock or poor drainage and ground-water conditions may be discovered only after extensive testing, and sometimes even after construction begins.

* When land is being acquired, unclear titles, recalcitrant sellers, lingering claims or easements not previously revealed can stall or prevent development.

* Governing authorities may refuse to approve requested zoning variances, exceptions or changes required to build the project as designed. The project might not meet building code criteria.

* Public utilities may become unavailable, particularly sewer hookup authorizations. Many people still recall the necessary but costly sewer moratoria of the 1970s that delayed or stopped millions of dollars of new construction in the D.C. area.

* Unacceptably high construction bids can result from uncontrollable general increases in labor and material costs, material and labor shortages, overdesign by architects and engineers, an insufficiently competitive bidding climate (when contractors are busy and not "hungry" enough), or an increase in construction work caused by additional government regulatory requirements or market needs.

* Project financing may be inadequate to cover all costs. Investors might back off, perhaps because of excessive risk or insufficient return. Lenders might refuse to provide permanent and construction loans on acceptable terms, demanding interest rates, loan fees and other provisions that a developer could not live with economically. Or there might not be any offers to provide financing if lenders question the project's soundness.

Once construction is under way, new risks appear. Unforeseen construction cost overruns, those annoying extras caused by factors cited earlier, can precipitate serious cash-flow problems requiring the investment of more money, either out of pocket or borrowed. Without offsetting increases in income, investment return may disappear altogether. In some cases, developers run out of funds before project completion, ultimately burdening project lenders with finishing and marketing the project.

Delays, for whatever reasons, can add significantly to administrative and financing costs. Time is literally money when the loan interest clock is running. If delays are substantial, a developer may miss crucial leasing or selling opportunities while experiencing unanticipated development cost increases for interest and overhead.

However, even after all these risks are run, commercial developers still must pass the market test. Two basic questions must be answered affirmatively: Are there enough tenants looking for space at the location where it's being provided? And are those tenants willing to pay at least enough rent to cover operating expenses (real estate taxes, utilities, management and maintenance, housekeeping, insurance) and debt service (loan interest and amortization)?

If the development fails the market test by not attracting tenants, the developer obviously must make up the deficit, because those expenses and debts have to be paid regularly. When funds are exhausted, default and foreclosure may ensue.

Poor market absorption and intolerable vacancy rates may be caused by mistaken assumptions and projections arising from erroneous market analysis data, underestimation of competition or questionable location. Contrary to popular real estate lore asserting that the three most critical factors for success are "location, location and location," having a great site, although necessary, is not sufficient.

Timing is a major factor. Conditions may have changed rapidly during the development period, which easily can last three to four years or more. Interest rates may have risen or a general economic recession may have set in. Rents that looked realistic 30 months ago may be unrealistic today.

Now you may ask: Why take all these risks? The economic rationale is profit. The economic technique is leverage.

Leverage allows developers and investors to own and control an asset of great value with a relatively small amount of equity. Thus, even a small percentage return on the total asset value can represent a large percentage return on the invested equity.

Real estate investment returns consist of several components. Cash revenue from a project may exceed cash expenditures, leaving a distributable cash surplus at year's end.

Tax laws permit noncash depreciation deductions. For tax accounting purposes, these may result in net losses being generated by projects yielding cash surpluses. Paper losses mean not only nontaxable cash benefits flowing from the project, but also reduction of taxes on other income that otherwise would be taxed in the absence of such losses. On top of all this shelter, investment tax credits may reduce tax liability further and augment the net worth of developers and investors.

Appreciation in the value of real estate over time, amortization of project debt and the conversion of current ordinary income into future capital-gain income represent another form of potential return. But this can backfire. A sale at the wrong moment can produce enormous negative tax consequences and cash outlays, not bankable profit.

Real estate often is owned by limited partnerships consisting of a managing general partner backed up financially by passive, limited-partner investors. Such limited partners may be more interested in tax shelter benefits than in additional cash income. Nevertheless, their ultimate motive for investing is to become wealthier by keeping more of their income.

This risk-and-reward system shapes cities and buildings by influencing decisions about how, where and when money is invested. Today, in cities such as Washington or Houston, office space remains vacant because investors, developers and lenders overestimated the market. Some misjudged the strength of tenants' locational preferences and persisting competition from other parts of the city and suburbs.

Buildings exhibit more amenities as developers struggle to compete with each other for choice occupants. But greater architectural amenities -- better finishes, high-tech security systems, increased landscaping, interior atria, sophisticated environmental controls -- imply higher capital costs. With high interest rates and land costs, extraordinarily high rentals and occupancy levels are required just to break even.

Moreover, recent years have witnessed the inflow of foreign investment capital attracted by the security of American real estate. Thus, projects have been built as capital repositories without necessarily being sound economic performers. Coupled with aggressive, tax-motivated investment, this has distorted the office building market.

Eventually, marginal locations in the city become desirable locations. Empty buildings fill up. If the current owner doesn't make money, perhaps the next one will. However discouraging today's outlook may be, things will improve tomorrow. For developers, it's in the blood.

NEXT WEEK: Not-for-Profit Building