Developers and Builders

[David Benton]

I'm in the acquisition process of a few tracts of land varying from 300 to 500 acres each to complete entitlement and sell to local builders. The area I'm focusing on is selling between $6000 to $10,000 per acre and split between 2 counties. New home median sales there are $205,000 in one and $235,000 in the other. 

This is in an area of high growth. Once the entitlement is complete what should I expect to be able to sell each development for per acre? Also in raising the capital and presenting this to some investors should I be focused on presenting the ROI only or are there other metrics I should use as well? I used ROI, ARR and IRR in some other projects but this one seems to be a bit different.

[Scott Choppin]

Hi @David Benton

Our company, Urban Pacific, is both a developer of land projects sold with entitlements/mapping, as well as, a builder/developer of projects. I spent 4 years early in my career working for Kaufman and Broad (now KB Home), and have been directly involved in land acquisition my entire career (now going on 34 years). From the other responses, I see that folks have opinions about your project type and/or market. I am after conveying fundamental principals that can help you underwrite this type of deal (and other similar types) in any market anywhere at anytime. 

A few definitions to know in this domain of land development:

Raw or unfinished lot cost = raw land prices divided by number of lots derived from land planning actions 

Finish lot cost = the cost of the land, development impact fees related to land, and common infrastructure (i.e. streets, sidewalks, parks, schools, etc)

Residual land value (RLV) = analysis of home prices less all cost to complete and what remains is what a builder can pay for land. This is the residual or remainder of the revenue stream available to pay for land.

In many markets, most homebuilders will focus on the finished lot cost. Almost all builders, and certainly the nationals (KB, Lennar, Beazer, Toll, etc.) will always want to buy lots based on finished lots costs. Others will use RLV, but in this post, you have the formula, so whatever method they use, you (or your broker) can do the math for yourself

So, the general formula would be

Sales price of home - (minus)

Build cost of home, including hard costs and permit fees -

Profit (can range anywhere from 3% to 15% depending on what builder, larger/nationals will usually have lower profit margins that they make up with volume) - 

Finishing costs of lot (per costs above) =

Residual land value (RLV) or raw land/raw lot costs

Now a few questions/comments/rules of thumb to use:

1. Some builders will do the lot finishing (install streets, etc) some will not, local regional preference. 

Find this out by calling land acquisition person at local/regional builders OR talk with land brokers who sell to builders. If they want to buy finished lots only, you would need to finance/build the infrastructure. 

My opinion: do the least amount of physical work possible (leave that to others with that expertise), hire good land planner/architect/civil engineer team and you do the design/land planning (find out what lot size is best from builder/brokers), get the subdivision map approved (that's the document approved by local city/municipality that approves the single lot be divided into many smaller lots), sell the land+map to builder. Our company has generated more profits doing this land development process/land entitlement process than almost any other type of development.

2. Only use engineers/architects/brokers etc. who have actual experience with single family lot development, you don't want to waste time/energy/money where others learn how to do it on your dime, you want them to tell you how it's done. More costly, but infinitely faster/more competent. 

Speed of execution = more profits in the development business.

3. Rule of thumb (in CA this works) residual land cost should be 20-25% of sales of home cost (on a per unit basis). This varies somewhat depending on scope and cost of finishing the lot.

4. Lean heavily on your land broker, they will have the best knowledge of the markets, they know the builders, they know what the builders will pay per lot, and what their appetite is for new lots. Again, work only with brokers that have demonstrated success in selling land to builders, and do so regularly. Otherwise, you are wasting your time. While it does have higher cost, you don't want to try and go direct to the builder because they will do all they can to manipulate you as the land seller, where the broker can call BS on moves the builder land acq. guys make, and guide you on all the details. A good broker knows these lot pricing/lot finishing and residual land values cold, if they don't: move on.

There are many structures available for phased take downs (for you or the builder), and/or long term escrows/option agreements that are outside the scope of this answer. 

Feel free to reach out David, I am an offer of help in this domain.

Thanks.