What would you do or not do?

Question

I have a couple of acres that I subdivided from a larger property.  Once I sell the main parcel, my cost basis in these two acres will be near $0.  A builder I trust is interested in putting townhomes on it.  To make the math easy, let's say the current value of the land represents 20% of the total cost, and the builder intends to build 10 units.

If I sold the land to the builder, it would be a bird-in-the-hand and I could move on to the next deal.  But suppose the builder won't or can't do the deal if he has to buy the land upfront.  Would you rather:

--contribute the land to a partnership deal where you end up owning 2 units (20%)?

--contribute the land to a partnership deal where the builder pays back the value of the land plus 20% of his profit?

--owner-finance the land? maybe with a balloon payment due at 24 months?

--Something else?

Obviously, everybody's situation is different, but I'm interested in WHY somebody might choose (or warn against!) any of these scenarios.  Thanks in advance for any guidance or suggestions.

Account Closed · Answer

Has any developer asked for any creative seller financing? Might be looking for a problem where there is none. Market your land and post the offers that come in for suggestions. Best of luck with your investment.

Dave Foster · Answer

@Pearce G., Check your figures you're using for comparative analysis.  Your cost basis in that property is not $0.  You cost basis in it was determined when you spun it off.  That number will be huge determiner in your tax liability if you sell it as is at capital gain rates.

Jay Hinrichs · Answer

most compelling issue here will be how you want to structure your tax liabilities.

If you remain on title and partner you just went from long term cap to inventory and the highest tax treatment.... plus you lose your 1031 option which many times is the best and least risky especially if your considering keeping units for cash flow.. just go buy some other multi in the Charleston .. I will give you a pre sale look at a 8 unit I am building on Amherst.. for instance.

Seller carry back on development deals simply does not work.  ( unless builder has cash for vertical which is not common at all)

Bank will want first position.. you would have to subordinate  ( not subrigate).. which is about as risky of a thing you can do in this industry  2nd position behind a construction loan... if you choose this route you need good legal council to set up your transaction were you have the right to step in for the builder for cause... this is critical in second position lender docs.

So in my mind I bet once you run all the numbers and consider your tax planning you may come to the conclusion that a straight sale and 1031 is best.. given risk reward.. and as hot as Charleston is

selling the dirt to a builder is just a matter of putting it on the MLS at a fair price.. if your builder balks at a cash sale.

Tommy F. · Answer

@Pearce G.  You have an interested builder, so I suppose he/she knows the the 2 acre parcel zoned for planned unit development (PUD)/town homes and there is public sewer access. If you don't already have that in place, then you and the builder have some work to do. It's only two acres and builder wants to put 10 town homes - it shouldn't be a difficult project if zoning and sewer is in place.  Assuming 1,100 sf each unit @ cost of $120 psf to build that's $132k per unit without considering land.  Simple numbers, 2 acres for $300,000 divided by 10 units, $30k per unit for land, that puts you at $160 range total cost for a town home. Ask yourself, do those numbers make sense for your market? If not, back yourself into the numbers starting with the going rate for a comparable townhouse in the area.

Answering your specific questions:

(1) contribute the land to a partnership deal where you end up owning 2 units (20%)? - "Maybe" What's the expected retail value of the finished townhouse? Does that equal your selling price of raw land? What would you do with two townhouses?  If you rent, then you can cash-out refinance the two units that cost you nothing, put tax-free cash in your pocket, and create monthly rental cash flow from two units.

(2) contribute the land to a partnership deal where the builder pays back the value of the land plus 20% of his profit? - "I would not do it."  What if the builder you "trust" runs into trouble, has cost overruns that shrink his profits, or has other margin erosion.  If his profit shrinks, is $0, or a loss, and you get 20% of his profit, then you get nothing.

(3) owner-finance the land? maybe with a balloon payment due at 24 months? - "Maybe" A bank financing the construction will likely require you to take a second position behind them.  A developer could simply buy the land from you and develop the land and sell pads to the builder. It's a really small development which may be the reason other builders aren't interested. The time and effort to get 10 units versus 50 is probably similar and the profits just aren't there for 10 units.

(4) Something else?  You have not mentioned taxes. You did say your cost basis will be $0.  Capital gains on $0 cost basis equates to a lot of tax.  Did you consider a 1031 exchange?  Does your builder friend have a spec home for sale that you can exchange for the raw land?

Rob Harris · Answer

Could note carry with substantial down payment. Don't subrogate your interest/position and let the Builder come up with scenarios that keeps you clean and your interest in tract.

Could partner, but have to be concerned about liens and any other encumbrances as to whether or not you can truly have two units free and clear.

Maybe he can buy a portion for cash and you note carry on the other half.??? Builder needs to see what banks in that area will do under different scenarios for financing options.

My quick couple of cents worth!