Thirty Suggestions On How To Make Money With Land
BATTLECALL GUEST EXPERT: Robert J. Abalos, Esq., InvestingInLand.com
A website visitor named Bryan from Toledo, Ohio asked if I would provide a "Tip of the Day" for land investors and real estate developers. In other words, just a short blurb or paragraph daily on how real estate investors can make some money, save some costs, or otherwise enrich themselves buying and selling land.
I thought it was a good idea but I would get bored by Tip of the Day #45,834. So I decided to do a Tip of the Day from June 16, 2005 through July 15, 2005, or thirty days of them.
So here they are, posted each day during that time. You can read the most recent posting by scrolling down this page.
June 16, 2005
Make absolutely sure there is a market for whatever type of property you are planning to develop. This is a CRUCIAL FIRST STEP in putting together a loan proposal or attracting equity investors. Just because a lot is zoned for an apartment building, for example, does not mean one should or can be built there profitably. The first question any banker or investor will ask when looking at your prospectus or application is whether you are attempting to build and sell a viable project. Does a community need or want it? Are tenants or retail buyers going to receive this new property in this location or how you plan to construct it? Are there too many similar properties already built or in the pipeline ahead of this one? You need more than gut intuition here. Gather MANY facts, figures, statistics, letters from supporters, everything you can to support your case. You will often find that when building a case for a property that you will learn it is not necessary or economically viable after all. A good percentage of spec construction falls into this category. Even great properties well built and in super locations sometimes do not have a market to support them. You might grill the best steaks in the world but if you live in a town of vegetarians your restaurant will fail there.
June 17, 2005
One crucial component of land valuations is pass-by traffic, or how many people pass a given piece of land in a given day. It doesn't matter if you are talking about people walking or driving by in cars, the more people, generally speaking, the more valuable the land. This is the reason why land in cities costs more than land in the middle of nowhere. Almost every type of business depends on visibility to prosper so the more visible some land is, the more development value it has and therefore the greater its value. So try to buy land where people have to pass in a concentrated fashion, the neck of a funnel, so to speak. A great suggestion is near public transportation stations, many of which are in marginal neighborhoods but still have thousands of people walking to and from them each day.
June 18, 2005
Don't be afraid to walk away from a land deal if the seller wants more than you are willing to pay. It is better to avoid one hundred marginal deals than buy into one of them. Land is often very slow to sell, even in today's overheated market, since there are many fewer buyers for raw land than improved real estate like single family homes. Sellers who need to sell will call you back with better terms if you walk away from the table when the deal does not suit you. Don't do deals for the sake of doing deals alone. Only do deals that instantly lock in your profits and showing a seller that you will not overpay is one great way of making this happen. Be sure to give such sellers your contact information like a business card and tell them you would like to buy their land but you need a better price or other arrangements. I've had sellers contact me years after I met them with new and better terms.
June 19, 2005
Don't even think about making offers on properties in your local area until you have an intimate knowledge of your zoning laws and map. The easiest way to make money in real estate is know which properties are improperly zoned due to obsolete thinking towards them. Zoning literally is a block-by-block process and the more detailed and precise your knowledge, the easier it is to make money fast with land or any other type of improved real estate. Get a zoning map at your local municipal land use office and LEARN IT. Attend zoning board meetings and get to know the players and how they think and why they decide the way they do. All this takes time but it is not complicated or hard work. Proper zoning knowledge can make you money faster than any physical rehab ever could.
June 20, 2005
One of the most common mistakes real estate investors make is underestimating their holding costs of their investment. Generally this is true because investors will hold assets longer than expected. In other words, many will have a handle on how much holding their property costs them each month but they will not have a clear plan for disposing of their investment within the initially projected time frame. This is especially true when doing rehabs when unforeseen damage is discovered but also true of selling land. The cost of holding an investment is more than the negative cash flow of expenses and debt service, it is the opportunity cost of not having that cash available for other investments, including the mere earning of interest in a money-market account. So investing $100,000 in a project with a negative cash flow of $1,000 per month (also called a "burn rate") also means an additional opportunity cost loss of $166.66 per month at 2%. The lesson is have a specific timetable to sell any investment where the holding costs are greater than zero and a detailed plan to stick to that timetable no matter what happens. If you have a positive cash flow on your investment after calculating opportunity cost losses, then your holding costs are zero and your holding period can literally be infinite.
June 21, 2005
It is very common for local communities to ask developers to pay for infrastructure improvements around new development projects, such things as road widening, sidewalks, lighting and traffic lights, water and sewer upgrades, even the "donation" of parkland or public use structures like schools or community centers. To be blunt, many municipalities are broke and rely on cash-rich developers to do the jobs taxpayers refuse to support through bond offerings on the ballot or general property tax increases. These "requests" from communities, commonly called "proffers" in many areas, usually occur after the first official review of your development proposal. Not only expect them but budget for them. It is very rare for a community to get everything it asks for in its initial request. A sort of bargaining process begins very much like something you would find in a Mideastern bazaar. You ask for $150 because you really want $90 and know the other party will likely settle on $100. These proffer requests are now an inherent part of the development process and developers should not take great offense at them or threaten litigation. New development does place burdens on existing infrastructure so it is not unreasonable to pay for some of the improvements required to make a project work. But do not let local municipalities bully you or request excessive items. Negotiate in good faith over proffers and know you will have to pick up some of the tab but don't let yourself be steamrolled in the process either.
June 22, 2005
Be very friendly with the members of your local zoning board and other land use officials in your community. If you are a real estate developer with continual business in an area, take the time to get to know each member on a personal level, their likes and dislikes, and especially their long-term view for their community and land use there. You aren't necessarily trying to make friends, the kind you invite over for Sunday dinner and a game of cards. But you want to be viewed as an individual and not just a paper proposal when you have business before the group. The more people understand what you are trying to do as a real estate developer, the more likely they will approve your plans. The one important exception to this rule is do not have any personal contract with board members after you have submitted a proposal and before a decision is publicly announced. These ex parte communications can taint the formal process and give critics of your plan legal grounds to set aside a successful ruling in your favor. So get to know zoning board and other land use officials in your community BEFORE you need their help or approval. Once you submit a proposal, let it and your lawyers speak for you.
June 23, 2005
Land values in development are determined almost exclusively by the density of the permitted use. Put another way, the more rental or sale income per square foot you can build on a given site, the higher the price of the land will be. It is the potential income flow from any raw land parcel that gives the land its development value. This technique to land appraisal is commonly called "The Back Door Approach" because it essentially starts with the building of a theoretical structure on a given site and works backwards using a developer's required yield on an investment as the discounted value for the cash flow or end sales value of the structure. It is an intrinsic value approach to valuation as opposed to other models that rely upon market price analysis, such as using price comparables or "comps." So if a developer was going to build a fifty-unit apartment building with a net income of $600,000 per year and a cap rate of 12 this assumes a project value of $5 million. If their construction costs were $4 million this would mean the land would have a value of $1 million. Put another way, if this developer spends $5 million to build this apartment complex, paying $4 million in construction costs and $1 million for the land, they will earn 12% per year on the net income of the finished project. Realize if they paid $2 million for the land, their yield would be only 10% (or $600,000/$6 million). If they paid $500,000, their yield jumps to 13% ($600,000/$4.5 million). So using the Back Door Approach they can pay any amount for the land up to $1 million and still earn their required yield.
June 24, 2005
Always overestimate the times required to complete your land development production schedule. For example, many reference sources say land can be cleared of trees and other natural barriers at the rate of from a half-acre to two acres per day or it should be possible to lay 300-feet of thirty-inch drainage pipe per day. These rules of thumb are helpful but not very accurate. Local site conditions and the number of workers actually doing the job affect the numbers greatly. Many developments get behind schedule in the early days when the grunt work of land clearing and pipe laying gets behind what is projected, forcing a chain reaction of other delays as subs cannot complete their work due to excessive waits. It is better to overestimate the time required for matters like laying curbs, paving parking lots, handling water and sewer lines, and the like than underestimate them. Better be done early and surprised than late and upset. This may sound like a trivial point but I can't stress how important this is. When you get behind on your project in the early days, and that is what land clearing and pipe laying really is, it is extremely hard to get caught up both in time and lost negative cash flows.
June 25, 2005
Do not think of "land" as purely raw land or a lot filled with trees, bushes, and rocks. Think of land as ALL land, including land with buildings currently on it. Sometimes land is used for one purpose when another permitted use in the same location has greater and more profitable value. This is especially true in cities where it is not likely you will find many vacant lots waiting to be developed but you will always find the most valuable land around.
June 26, 2005
Don't fight City Hall when it comes to land use. Instead, capitalize on the offerings the government gives you. A classic example here is infrastructure improvements in a geographic area. When a county or city is expanding highways or putting in new water and sewer capacity for future land uses, they are channeling growth into an area for a reason. Buy into that formula by owning land there. This is where future real estate projects are going to be built and land will be required for all of them. You will also find getting approval on projects in growth targeted areas much easier than in places where new development is unwelcome or even shunned. Government actions are like the ocean tide. Don't fight them and instead learn to tap into them.
June 27, 2005
Maximize whatever advantageous site features you have on the land you are subdividing and developing. Examples would include thickly treed lots that provide privacy, elevations that afford distant views, or water courses like ponds, lakes, or streams that offer "waterfront" potential and value premiums. Your subdivision plan should be built around your land's site features and take full advantage of them for marketing purposes. Virtually any natural site feature can become a development focus, including an outcropping of rock or even cliff face. Avoid conventional lot placement or "lotting" where subdivisions look like grid patterns on graph paper. Buyers of land lots want uniqueness since most plan to design their own homes on these lots and welcome the chance to own something "different." The less you have to shape your land to meet conventional lot guidelines, the lower your excavation costs and the more your land lots will have unique appeal.
June 28, 2005
The most difficult task when preparing a pro forma cash flow analysis for a lender or equity investors is estimating the project absorption rate, or how quickly the new rental units or retail space of the project will be sold or leased. This is the first thing I look at as an investor when reading someone else's pro forma. An optimistic assumption above and out of line with an area's average market rates may be accurate but certainly is suspicious. Some developers take the opposite approach, equally as flawed, and underestimate the rate so they can "surprise" investors and lenders with the "success" of their property, especially if their project is being built in stages and will require extra financing. Anyone preparing a pro forma will need to explain how their absorption rate statistics were calculated with clear answers to two important questions. Using average market rates how soon can the project expect to break even financially and using the worst case scenario a developer can imagine how low can the rates go and still guarantee the survival of the project?
June 29, 2005
The riskiest part of real estate development is land acquisition. If you buy the wrong land, your project is doomed. A bad location can condemn even the best and most beautiful designed building to oblivion, not just because customers or tenants might one day object but because land use officials may not like where and what you want to build. Land acquisition also means carrying real hard costs for the first time during a project rather than all the soft costs leading up to the first turning of soil. The use of land options can minimize the holding costs of development but at some point land has to be bought. The goal is to buy land that fits your project rather than attempt to squeeze what you want to build on any given parcel of land. The key issue is not just geographic location but whether a piece of land and what you want to build on it are a match economically, practically, and legally.
June 30, 2005
The profit margins of any real estate development company are affected by two factors, the cost of land and the value that can be added to it. Adding value to land has three components of which two of them are out of the developer's control. They are the tolerance of local land use officials and their limitations on site development and local absorption rates. The other factor is managing the hard and soft costs of development. All this analysis suggest two points. First, since a good percentage of any development company's profits come from areas that the developer cannot control, they need to exercise EXTREME control on those factors they can influence, namely the cost of the land they buy and the expenses incurred building upon it. And second, any business where a good percentage of your profit margin is beyond your control is inherently risky and tight financial safeguards and tough financial discipline is necessary to avoid losses.
July 1, 2005
The vast majority of land for sale is junk unsuitable for profitable development. Either the land is geologically flawed making building prohibitively expensive or there is no reasonable way to develop certain parcels due to poor locations, restrictive zoning, or other unique features to the site that make them badly suited for any economic purpose. Junk land is cheap for a reason and that makes such land a bargain when it can be put to good use outside of a development plan. The classic example here is junk land that can be purchased to preserve a scenic view. Here the land itself has no development use except protecting the unobstructed view of another land site.
July 2, 2005
Listen to your local government and their messages on where they want to channel growth. It's where they build new highways, expand older ones, install new infrastructure, and plan for new schools and fire stations. Your local government controls growth in your area. All cities and counties have plans on where they want to channel growth. Buy land in those areas, not near them.
July 3, 2005
Put all your investing documents and especially your business plan and financial statements in three ring binders for distribution. This format allows you to substitute new information or make changes without having to reprint the entire document. Loan officers and equity investors are impressed with the format since many, like myself, use three ring binders for just about everything. The advantages of this simple binding device are numerous, starting with the fact that pages lay flat for while reading. Other binding formats like coil, spiral, glued, even stitched do not have the advantages of three hole punched. Binders with clear vinyl covers also allow for color inserts which can be changed with the project, financial requirements, or the date. This point may sound trivial but it's not. You are judged by first impressions in the real estate business and many people will see your investment prospectus or loan application long before they meet you.
July 4, 2005
Avoid investing in or near so-called Local Improvement Districts ("LIDs"). A LID is an area where public planners often finance infrastructure improvements by assessing the residents in the area the cost of those improvements. Common examples include replacing septic tank systems with public sewers or eliminating individual wells with public water works. These LIDs are unfair to large landowners in the area since most base assessments on the size of holdings. So if you own 100 acres in a 150-acre LID, you have to pay 2/3 of the cost of the LID improvements. While LIDs often offer affected property owners low cost financing, many still cannot truly afford the improvements and attempt to sell. This is why you will see a higher number of FOR SALE signs in LID than in surrounding non-LID lands. Here lies the temptation to buy from truly motivated sellers and unless you want to pay the LID charges, don't.
July 5, 2005
One extremely important consideration when designing commercial properties is considering service core requirements for small tenants, generally defined as those with offices under 3,000 square feet. The service core is the area of a building that contains the elevator shafts, the interior (and usually emergency) stairways and other mechanical spaces of the building. Larger tenants lease space away from the core and smaller tenants generally closer to it. In other words, larger tenants often enjoy exterior or "window" space that smaller tenants cannot afford. The closer to the service core any potential leased space is, the less it can be retrofitted for small tenant use and therefore a challenge to lease in tight markets. A rule of thumb in the industry that works is that all corridors leading to and from the service core should be at least thirty feet from an exterior wall, allowing some space for inventive leasing options for smaller tenants.
July 6, 2005
Why is real estate development so profitable? Aside from all the profits that can be earned buying land by the acre and selling it by the square foot, here is just a partial list of fees any developer can earn if they just structure their deals right:
- Syndication fees for putting together deals with others
- Mortgage servicing fees on purchase money mortgages
- Brokerage commissions on sales, usually split with others
- Leasing commissions, often split as well with others
- Partnership management fees for preparing project paperwork
- Property management fees
- Condominium association fees
- Loan refinancing fees for securing syndication financing
- Triple net lease income on retail tenant sales
- Property takeback fees if a new tenant has existing space to re-lease
- Pre-leasing fees from prospective tenants
- Tax benefit sales to partnerships and MANY more
Every developer should be looking to maximize fee and income streams from properties both pre-and-post construction and not simply think of development profits as just those derived from building things.
July 7, 2005
Consider arranging your take-out loans or at least getting a forward commitment on a loan before applying for construction financing on your project. You'll find getting the construction financing much easier since your lender will know they will be taken out and you won't have all those money worries to waste time on during your project, a time when other issues will likely distract you plenty.
July 8, 2005
Know your competition thoroughly when attempting to develop a project. Not only find out what properties they are developing and what product mix they will be offering and when, but know where they get their financing, who does their construction, and how they are marketing their new units. This information will help you in at least three important ways. First, it may prevent you from developing in an overbuilt area. Second, you will know what types of product will be hitting the market and when, important facts when designing promotional literature and planning a sales campaign. And third, you can often get financing and other help from the same lenders and companies that service your competition. Once an area is "hot" for development the same players and lenders often control it.
July 9, 2005
One of the great reasons to be a real estate developer is having so many options when you complete a new building. Aside from all the usual disposal methods such as arranging a cash sale, installment sale, or even a tax-free exchange for some other valuable property, one of my favorites is the so-called "pre-sale with earn-out" which simply means selling a property prior to filling the new building with tenants but maintaining the right to earn more money after the sale by still filling the building with even more tenants. This sale option is great for developers who want or need to cash out now but realize a fully rented building would earn them more money from a turnkey buyer. So they can do both using this method, get cash now and keep earning cash after the sale. In many cases the pre-sale with earn-out profit can be equal to or even greater than the straight cash sale method since all holding costs of the project end with the pre-sale but earnings from the property continue post-sale.
July 10, 2005
If you are looking for construction or development loans, you need to realize that writing such paper requires a different level of experience and competency than issuing normal mortgage loans. So the pool of lenders available is smaller but more knowledgeable as to what you are trying to do. The best bets for small developers are local commercial banks but occasionally good loans can be had at community development and public housing agencies in your area if you are building projects these government agencies support. The Small Business Administration guarantees such loans on occasion too, making the interest rates lower than expected and the underwriting process easier too. Larger developers can easily get funding these days from insurance companies, REITs, and even pension funds since these sources are awash in cheap money desperately looking for a home.
July 11, 2005
When deciding what type of residential housing to build, keep in mind the established categories buyers use when looking at properties. Entry level housing is the cheapest class, bread-and-butter units with basic amenities for first-time homebuyers, newlyweds, and others who want to own a home but can't afford much else. Move-up housing is for those who usually have some previously acquired home equity to trade and offers additional amenities, better quality construction though more exotic (and expensive) materials, and often larger lot and building footprint sizes. Luxury housing is just that, high end amenities from solid wood kitchen cabinets to master bedroom suites all on large lots with big house footprints. Move-down housing is generally for older people who have grown accustomed to large luxury homes and continue to want high-end amenties but no longer need all the space due to events in their lives planned and spontaneous, such as when kids move away or after the death of a spouse. If you know which category of buyer needs housing in your area, your project specs can be carefully tailored to target this market.
July 12, 2005
Know the local politics of where you plan to build. Some cities and counties are notoriously anti-growth no matter how much new housing or commercial space is needed there. Many rural counties are still controlled by wealthy families or "The Good Ole' Boy Network" and if you are on the outside, you will stay outside. Other areas are thirsty for development and make the building process easy and permit-friendly. The bottom line is DO NOT FIGHT THE TREND BUT RIDE IT. You can easily find out the politics in your area by attending local zoning board and land use policy meetings, by reading your local newspaper, and by speaking to developers in your area who will either bitch-and-moan about their long-suffering projects or brag how easy and profitable everything is going for them.
July 13, 2005
Compensate your equity investors up front when profits arrive. You'll need them again if you are active in this business and they will appreciate being put at the head of the line instead of at the rear with the subs, vendors, and banks. Equity investors assume the greatest risk of any project and while they are compensated (hopefully!) for assuming this risk, a project promoter showing them some courtesy will reap huge good will with the well-heeled class that makes real estate development work. Always start with the notion that equity investors get paid back first. Many will require it so don't argue.
July 14, 2005
Be careful when buying land with utility easements, especially those that seem abandoned by such companies. These easements can throw a monkey-wrench into a project and destroy the value of land. Do not expect utility companies to give these easements up easily either, even if all available facts suggest they do not need them now or forever. I've seen defunct railroad company utility easements derail, so to speak, more than one potential development. Utility easements are crucial for these companies to operate and they plan for not just current needs but future ones as well. It pays to verify the status of a utility easement since utility companies come and go, are bought up by larger ones, or service area change. But land that comes with a utility easement needs to be carefully examined since often local development obligations may conflict with a previously granted easement and the easement almost always wins.
July 15, 2005
Many investor packages or development pro formas routinely use a 5% rental vacancy rate when calculating net cash flow on a property. This is a good rule-of-thumb but a better practice is to use 150% of the current vacancy rate in your area on the type of property under review. This builds in a 50% margin of safety and is more accurate than the tired and old 5% rule which may or may not be accurate at the time used. Also, make sure you are using the correct vacancy rate for the type of property under review. Lodging or transient housing has a much higher vacancy rate than traditional residential housing, often approaching 40% or more, and many new construction projects are mixed-use, for example, hotel and condo development or apartment rentals and condos at the same time.
This is the last monthly tip of this series.
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