Land Development Primer

This primer is to share some of my experience with land development in Central Texas – by no means does this apply in every case or region.

Begin with the end in mind
In order to be successful in land development, you first need to know what you’re going to use the land for, how soon you want to do it, and how long it will take. This is especially important if you are borrowing to buy the land. While you are contemplating the land and what to do with it, make sure you know what the ‘compelling reason’ is for the consumer to live/shop/work there. Price, amenities, product, location, and schools are obvious considerations.

Make sure you love it
Most developers have a limited amount of capital to purchase and develop, even if they own the land outright. Before you invest your hard earned capital, make sure you like everything and there aren’t any reasons you wouldn’t want to buy. Talk to the seller, ask how long they have had the property and why they are willing to sell. What were their plans for the future of the parcel? The seller knows the property the best at this point and is a great source of information. Treat them as such, not as an opponent. Visit the neighbors, I assure you that they know something that you don’t. Doing this will allow you to determine what they like and dislike about the property and area and if they will be easy to work with as you develop your parcel in the future. They can help a lot or be a pain. It is nice to know this early on in the process.

Calculate the total cost of your purchase
The cost of your raw land in an undeveloped state won’t be the same as the sale price. As you develop your raw land, it should increase in value as you approach entitlement. In Austin it takes around 2 ½ to 3 years for entitlement to be complete. Other regions of the country can be much longer. This cost is something you need to take into consideration when calculating your total cost. Developing raw land will increase its value, typically multiple times the original price. Know that this isn’t a quick flip, but a long-term investment of time and money. Following are some basic tips for developing your raw land. These guidelines are not absolutes; each parcel has its own unique opportunities and problems.

Consider the factors that affect value, a few of which are location, schools, amenities, water front, parks, and trails. Value is sometimes hard to determine, although there are some sure factors that affect it. For example, an irregularly shaped parcel that makes development challenging can be a detriment. You could be paying extra for land that you won’t be able to fully utilize. So be careful to review the exact size, shape, width and depth of the property you are considering. Location is a top factor. Easy or dwindling access to utilities, drinking water, natural gas, electricity and telephone service should also be considered when selecting the location of your raw land purchase.

Location and nearby transportation infrastructure could add value. Trees add value to your land, as do streams. Waterfront always adds value. Good drainage is important, as well as contour and grading. A good view adds value but can be a double-edged sword. Elevated parcels will be more expensive to develop, with up to a 30% premium for roads, utilities, water, sewer and building foundations. And of course the environment affects value. Climate, soil, air quality, water supply, and the presence of hazardous materials can add or diminish value.

In calculating the cost and profit you’ll want to determine the maximum yield of units and profit for the developed property. That will require additional outlays of money for property surveys, environmental impact studies, fees, permits, engineering services, market studies, soil tests, etc. Depending on the results of these tests and the local regulations in your area, you may not be able to develop the land in the way you originally envisioned.

And once you’ve determined what your property potential worth is, you’ll also have the actual development costs. These can include tree and rock removal, grading and clearing, environmental protection and stoppage, the building of access roads, payments to bring utilities to your land, and expenses involved with or having utilities on site.

Know the right time to develop
Timing is everything when developing land (and pretty much everything else in life). Realize that recessions can be a great opportunity for real estate development. Clyde Copus (he once co-owned the nation’s largest private construction company) told me early on in my career that recessions were when he and his partner Nash Phillips liked to expand. He said that when times are good, they were swimming alongside everyone else, not gaining much ground. When times were bad is when they would hire the right personnel, expand into markets they couldn’t get into before and lock up parcels at a discount. DR Horton has done an excellent job putting this principal into practice. They tied up more land in Texas than any other builder/developer at rock bottom prices, setting them on a strong path for years to come.

Changing demographics, economics, or government can affect your development. A shaky local, regional, or national economy or other factors out of your control must be weighed. Building a new apartment complex or residential development when there is surplus inventory doesn’t make sense. If you already own or control the land, it might be best to wait until there are significant changes in the local market before developing. Real estate is local, so local economics are more important than national. National financial economics does affect you though. If you haven’t made your raw land purchase, be willing to walk away if the timing isn’t right. Don’t get so emotionally attached to your land parcel that you make the wrong decision. Run the numbers first, because once you walk the land it can be easy to fall in love. If the numbers don’t work, it’s a waste of time. There will be other days and parcels available.

Understand the drawbacks
Although investing in raw land can be lucrative, there can also be a downside. Raw land cannot be depreciated and once slated for development you lose most tax advantages associated with it.

When financing raw land, understand that it is considered a long-term, illiquid investment by lenders. Even if you begin developing it immediately, it may take a long time before you reap any profits. Selling it fast is usually not an option. There is also a risk of losing money on the resale of raw land. This is particularly true if you choose poorly or fail to fully evaluate the parcel. Unforeseen events such as a slowing economy can also affect the selling price, and how fast you can sell. Negative cash flow can be a problem. Investors sometimes find that they owe more for the land than they are able to generate as income. Others plunge in head first, not weighing costs vs. profit yields, spending more than they can possibly get in the resale.

Banks and equity consider raw land purchases to be speculative investments. They often generate little income and the cost of development can be high. It is often better to see if you can get financing through the property seller. Typically they will accept a lower down payment and provide financing at a lower interest rate.

What experts do you want on your team?
You need experts on your team, from financing to management. All are absolutely critical if you are going to have any success. Expertise is more important than price. If you don’t know, hire someone that does.

Buying or selling raw land can be an expensive process, and going it alone isn’t for everyone. It’s more of a team sport. An experienced broker will know the region, owners, potential issues outside of the engineering, etc. as well as the appropriate pricing. They should be one of your first stops in helping you find a suitable parcel, negotiate a reasonable price and help make arrangement for the transfer of the property.

So real estate attorneys, engineers, a title company, and marketers will all need a spot on your team. When in foreign markets (outside of Texas) that I am not familiar with, the top engineer, title company, and land broker are who I call. All have knowledge of the area I will not.

Where is your equity coming from?
If you’re getting a loan, most lenders will ask for ‘skin in the game’. Some might ask for as much as 50 percent down, although 20 percent is ideal. In today’s market, north of 30% is normal. What are the terms? Finding an equity partner that you are comfortable with is like a marriage. You need to know their history, desires, goals, and what could ‘kill’ a deal for them.

Decide where you want to buy
This is a tough step. Buying land is a big commitment — especially when you plan on developing it. It is a multiyear process. Depending on the size and density, it can be as little as 3 to 5 years for a small development in a good market, to decades for a larger development. If you don’t already know where you want to be or what the focus of the development will be, you need to figure that out first.

Look at the land
Nothing will clear up your ideas about a site or area better than looking at the property at all times of day. This will give you the best idea of the daily rhythm of the area, the neighbors, and the traffic. If after 24 hours your enthusiasm for the place has waned, imagine being stuck there for 24 years. You’ve got to be absolutely in love with it, and then some, before you’re ready to buy. You will immediately realize what appeals to you and what you don’t want. Look at egress and ingress. Most customer’s first impression of your community will be affected by the area around your development. Going through industrial or rental properties tends to scare away potential homeowners and clients. Walk the property, find the property boundaries, and investigate things like structures, creeks, lakes, and ponds. Soon you will need to hire environmental and civil engineers to map all geographic features as well as survey.

Research the property. Get the tax ID number and see what the land is appraised at by the state. Look into the history. If the land was once used for farming, there may be pesticides or leaking fuel storage tanks in the soil. This assessment needs to be done by an environmental engineer. If there is water of any type, you will need surveys and engineers to check flood plains, etc. Look up the plat for the area (it’s a county map showing all property boundaries) – are there large parcels around you, which will mean minimal / maximum development, or lots of subdivisions? What is the competition and potential competition? Call the county courthouse and find out about building codes, and whether any development is planned for the area. Find out everything you can about the area’s climate, economy, and history. There’s an astonishing amount of such information online.

Research the area
Is the area growing or losing population? Who are the major employers? What is their long term strategy? If the local economy is based on one company or industry, beware. Remember the 80’s energy bust in Texas? The 2001 ‘tech bust’ in Austin? AT&T moving from San Antonio to Dallas 2004? Talk to regional economists and analysts and the regional development agencies to get as much information about employment forecasts, planned roads, utility extensions, and preferred growth corridors. Besides your parcel, what other parcels are planning future development? What are their strengths / negatives? How do they stack up against yours?

Zoning and density
Research your land. How is it zoned? What is the maximum density? Height? How much of the total can you develop? Will you need to change the zoning? How long and what expenses are involved? If it already is zoned, how long is that zoning good for? Can you extend the time? What other restrictions may the local government have?

Have your engineers and entitlement lawyers visit with city and regional zoning and planning to ensure that all local guidelines and regulations are met.

Feasibility studies
Equity at some point will require an impartial third party to do a market study. School ratings, employment, demographics, competition now and in the future are all important criteria. They will want the engineering reports of all issues at this point. Where are utilities? How much will it cost to run utilities? If public utilities are not close and affordable, one of the most important things to ask about first is whether there is a proven source of water on the land. You’ll also want to know if the land can support a septic system, and if it can be placed far enough away from the intended structure to avoid contaminating drinking water. Usually you’re paying by the acre, so if the acreage is overstated by 20 percent you’re paying 20 percent more than needed.

Who is your market?
Sit down with your staff and look at what you are offering and look around at who you think would be perfect for your community. What makes it unique? Who is your competition? Who will be your competition two years from now? Twenty years from now?

Geographic, demographic and psychographic (the study of personality, values, attitudes, interests, and lifestyles) are the three main ways you can define your target market. You need to know exactly who your customers are. It’s called demographics. It’s part of the research you need to do before going into business. It may not go well if you have no idea who you are going to be telling about your product and community.

Once you know who it is you are going after, you can begin to design a plan around how you will market to them. If you try to blanket everyone with one marketing message, you will lose over half of your audience simply because it does not apply to them. Tailor your message, and you will be more effective. You will be more focused, more effective in your marketing strategies and long term plans and be able to get a greater return on your marketing investment.