More Dirt Please–Purchasing Land For a Real Estate Development
Dirt, mud, rocks, soil, and grit–it all has a ton of value to your real estate development project! Whether you are working with a single parcel or developing a massive master-planned project, land is often the very first thing you will invest in when developing any new property. After all, our buildings have to sit on something. They can’t be built on air.
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The value of land is tied to your specific site’s characteristics, yet it is also subject to external market conditions and local regulations. Unlike with buildings, land doesn’t depreciate (something you can’t use for tax purposes). And its value fluctuates like any other market.
As land is often the very first thing developers analyze when taking on new projects, how does one even begin to dig into the dirt (pun intended) to evaluate the viability of a specific parcel, site, city block, or region?
If you’re beginning at step one and want to start researching land, be sure to consider these site characteristics as you way your options:
We live in a world that’s constrained by physical limitations. Site size plays a big role in what can be built. Does your project call for 150 parking spaces? If so, you likely won’t be searching for a half-acre site. Do you anticipate two or more phases for your project? If so, extra vacant land will be needed. When starting, if you have a general idea for the project you want to develop, site size is best analyzed in buckets because of the variability from site to site (think something like: 0-2 acres, 2-6 acres, 6-15 acres, etc.).
I considered writing “zoning” in all caps because it’s such a crucial element of any project. Many projects are derailed because of zoning and entitlement issues. A site’s value is often aligned with the zoning regulations that govern its planned use. Since value is tied closely to a site’s highest and best use, one can add value instantly to a site if they are able to change/improve zoning restrictions. However, this typically doesn’t happen without public input and approval from one’s local zoning board–which are two unknowns and can often be part of a lengthy process. Zoning is an element of land valuation that requires close collaboration with local zoning officials and the public. On top of zoning specific to the site, adjacent land uses can play an important role in your land acquisition.
I sat through a workshop recently that outlined the investment strategy of land banking. The strategy hinges on identifying markets and specific parcels that will likely appreciate in value as development occurs in and around the area. While hard to predict, development trends can play a large role in the value of a site. A vacant parcel of agricultural land with nothing around for miles probably has less value than that same parcel with retail centers and subdivisions popping up everywhere (unless there’s something in that soil!). If you have the ability to take the pulse of your market before the growth or decline occurs–which is easier said than done–development trends will put you in a strong position to gauge the market strength for your specific site.
Comparable Land Sales
Comparable land sales are weighed heavily when valuing a specific parcel of land because, unlike improved properties, other approaches tied to income generation and cost of construction aren’t relevant. As with comparable building sales, land sales have discounting and appreciating adjustments to consider. No two sites are ever alike, so the comparable qualities of a land sale should be adjusted accordingly.
Similar to building sales, land sales don’t always occur at full market value. When evaluating comparable sales, if any hint of distress or non-arms length terms are present, a comparable sale might not fully articulate market value for a specific site. For a quick example: I researched a 12-acre mixed-use parcel that was sold six months ago for $1.2 million. Every aspect of the analysis indicated that this price was appropriate for the site. A year prior to that sale the same site sold for $500,000 at a bank foreclosure auction. This first sale did not provide the clearest indication of value because the transaction occurred under an element of considerable distress. Did the most recent sale occur substantially above market value? No exactly. Did the buyer in the distressed sale get a heck of a deal? More than likely.
Utilities and Infrastructure
Utilities and infrastructure are major expenses for any project at any scale. If a site has utilities, roads, and sidewalks already in place (assuming your project calls for them), the value of your land should increase because these expenses won’t be incurred during construction. If these site improvements are obsolete and have to be torn out or reworked, one has to consider the extra expense in their development pro forma. The acquisition price should adjust accordingly.
A super fund site is going to have very different environmental concerns than a vacant greenfield agricultural site. Environmental conditions are not always obvious on the surface–often an environmental study is required. Before any shovel hits the dirt, make sure you’re well aware of the expenses required to alleviate or avoid any environmental issues. Many sites look ripe for development, yet remain vacant because of environmental problems that came up during pre-development.
Have you ever driven through a densely built area and been surprised that one or two parcels are completely vacant? Why hasn’t anyone built on that site!? In some cases, the site’s location within a flood plain is the single answer to that question. Flood zones can dramatically impact the value of a site if there is high potential for a flood.
Quick tip: Check out FEMAs flood plain maps (FEMA.gov) to view detailed flood information for any site in the United States (search “FEMA flood plain maps” in your favorite search engine). When you type in the address of the parcel you’re interested in, a map can be viewed that shows where flood plains are in that area. If you see that your site is right in the middle of a major flood plain, be cautious about the “buildability” of the site.
99 times out of 100 it is more expensive to build on a sloped site than a flat site. Topography plays a large role in site preparation expenses, design, and site constraints. If your site has large topography changes, consider the added expenses needed to build retaining walls, heftier foundations, leveling, etc.
A Few Extra Things to Consider
Here are a few additional questions to be aware of when evaluating a site’s viability for your development project. Are new roads, sidewalks, sewer/water/gas/electric lines needed on your land? Will your city/municipality assist or finance this site prep or will you need to cover these expenses–all before a single building is built? Can you cover carrying costs related to taxes, utilities, insurance, and financing while you hold the land?
While there are many factors that contribute to valuing, acquiring, and building on vacant land, it’s an exciting part of the development process. It’s also a piece of the development puzzle where one can add considerable value and creativity. Yet, given the elements that can quickly derail a project, land acquisition should be analyzed holistically and thoroughly.