Residential Land Development – Part 3: Zoning, Design and Financing

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To recap Residential Land Development Part 2, we discussed the importance of performing an economic feasibility study with cost estimating to determine a max price land offer and whether or not there is enough profit in your potential deal to warrant spending more time on it, or actually developing the land.

Assuming you’ve done that initial research and arrived at the conclusion your numbers look good, you’re ready to go back and do it all over again.  This time you’re going to be more exact with your numbers.  To do that, you’ll really need to hone in on the potential design of your house, and to do that you need to research what’s possible on your lot.  You do that by learning all you can about the zoning codes in your city.  These are the third and fourth steps in the residential land development process.

Zoning

Zoning is what’s known as a police power of the government.  It is the control of what and where real estate can be built in any given city.  Zoning codes are usually built into the overall municipal code of every city, which is made available through most municipal websites for free.

There are many zoning rules, even with the simple single family residential land use.  The ones most residential land developers will be interested in are the following:

Property Type

Some residential zoning only allow for single family properties to be built.  Others allow duplexes or anything 1-4 units.  Usually this will be expressed in density.  For example, the density of a lot zoned SFR-5000 might mean that only one unit is allowed on a lot 5,000 sf or smaller.  This is a stark contrast to multifamily zoning, which may allow extremely dense development.  That might be listed as L3-1/800 which means low rise with one unit per 800 sf of land area.  On a 9,600 sf lot, a developer could build 12 units of condos or multifamily apartments.  Make sure you can legally build the type of property you are planning to build on your potential lot purchase.   If you need to build and sell 3 units to make your required return, but can only build 2, your project might need some rethinking.

Height Limit

Most residential zoned lots have a height limit in the mid 20′ to 35′ range.  This will typically allow two stories. There are restrictions as to how the roof is pitched and there may be rules about blocking the view of other homeowners in the area.  Make sure you check your height limit and stay within that limit when building.  It can be very expensive to fight this rule after your property is built.  This rule has been the impetus for many lawsuits in many neighborhoods in coastal areas.

Setbacks

Setbacks create a buffer between your building and the lot lines.  This is done for a few reasons. It creates a conforming look throughout the neighborhood, and it prevents buildings from encroaching on neighboring property lines.  Setbacks are usually measured in feet, and are not necessarily uniform throughout.  For instance, a front setback may be 25 feet, while the side and rear setbacks may only be 10 feet.  What this means is that you can not build your home within 25 feet of the front property line, the side that faces the street, and within 10 feet of either the rear property line or side lines facing your neighbors.

Why is this important?  Setbacks will determine how much develop-able land you actually have, and that will determine the footprint, and ultimately the final square footage of your home.  This of course will directly affect the cost of development.

Let’s look at an example:

You have  a small 3,600 sf lot, roughly square in shape (60′ wide x 60′ deep).  Without zoning restrictions you’d be able to build right up to the property lines, which would make your building footprint 3,600sf (60′ x 60′).  If you could go up two stories, you could have  a max home size of 7,200 sf.

Now, assume a 25′ front setback and 10′ rear and side setback. To determine your develop-able area you’ll minus out that area from the square footage and mark out the area for the potential build.

setbacks

In the picture above, you’ll see the buffer setback area hashed in red, and the final develop-able area in green.  The build-able dimensions are brown at 25’x40′, yielding a max develop-able area of 1,000sf.  This is your real footprint, and if you were to go up two stories, you could build a home with a max area of 2,000 sf.  This is a huge difference (72%)  from what we calculated without the setback, and will make a big difference to the architect as well.  This is why its so important to understand your zoning.

Design

Once you have your building pad size you can turn it over to your architect for the design process. They will handle the particular orientation, final size, and room distribution.  At this point you may need to incur some costs if you want more than just their estimates. If you want the actual design drawings you will probably need to pay the architect for their work.  If you do not have the cash for this, you might consider making the architect your partner on the job.  Just remember you’ll have to split profits if you decide to do that.

The point doing this work is to estimate the amount and types of materials needed to build your home, as well as the cost to actually build it. Once you have those numbers you can plug them back into your equation and make sure your required return figures are still met.  If so, continue on.  If not, you’ll have to make changes.  Reduce your building size, use cheaper materials, negotiate contractor fees down, or offer less on the land.

Financing

In residential construction financing is a four letter word.  No other process boils the blood of the developer more, especially when financing falls apart.  There is no trick to financing.  It’s all numbers.  If the numbers don’t work you don’t get financing.  Plain and simple.

We tell people to line up the financing before they start work, so when they really get down into it there are fewer surprises.  Look around your neighborhood for local banks.  Walk in and talk to a few loan officers or bank managers and ask about their financing programs for development and construction.

In this tough market, you may find that many banks wont lend development money at all, but they will lend you money to buy the land and build the home, especially if you’re building it to live in it yourself. Overall, you can expect lenders to loan you a percentage of the overall cost.  This is called a loan to cost ratio (LTC).  IT is a ratio of the amount of money they lend to the overall cost of the development.  For instance, a 80% LTC loan means they will lend 80% of the total cost of the development.  For investment properties built on spec, you can expect most conventional lenders to max out at 80-85% LTC.  For construction, most private lenders will cap out between 50-65% LTC.  If you’re building the home to live in it,you should be able to get standard bank financing at great rates with high LTV’s, if you qualify.

Construction financing will require some additional documentation.  You’ll likely need to supply the  lenders with the following, in addition to standard loan documents:

  • Construction Estimates from licensed contractor
  • Copy of contractor’s license and bonding info
  • Architectural or construction drawings
  • Building permits and/or zoning approvals
  • Feasibility Studies
  • Additional appraisals
  • Environmental studies

Again, it helps to ask your lender what they need in your first meeting.  That way you can begin the documentation process while the architect is finishing their design drawings.  If you can’t give them an item on their list you have two options, find a new lender or get working on that document.

Once you do find financing from your lender the money will come in a series of draws.  The bank’s construction manager will likely want to meet with you and your contractors and architects to discuss staging.  They wont just give you all that money upfront, they’ll release it in stages.  Typically, they want you to order the supplies and have them delivered on site before the bank releases money.  This is standard in the industry and your suppliers know it.  They will try to get money upfront when they can, but you should be able to counter that.  If a supplier demands money at time of order you may need to cover it with cash or credit until the bank draw comes through.

In the next part, we’ll talk more about construction and finish with marketing.

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About Author

Mr. Grella is co-founder of Cornerstone Funding, a business consulting firm helping clients finance their business and real estate ventures. He has held positions with several national banks and lending institutions, and has consulted for small businesses, non-profits, government municipalities, and Fortune 500 firms alike.

4 Comments

  1. I’m with the other commenters. This has been a fantastic set of posts. Can you tell us ow many there will be in the series?

  2. Thank you for the article. The financing is very important to have lined up first, especially in this market. Only a few banks are providing construction lending right now.

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