Builders/developers: how much do you pay for lots?

Question

Builders: Is there a particular percentage of the ARV or other rule of thumb that you rely on to calculate what you can pay for a developed (or

undeveloped) lot?

Roger Lin · Answer

The number various based on regional housing market.  Just like any real estate purchase, you need to go backward:  Resale value- costs of construction-profit margin=value of finished lots

If you are talking about undeveloped lots, you also need to talk out all the engineering costs, entitlement costs, attorney fees, proffers, any risk premium, etc.  Some developers will sell the lots after they are entitled, so, there's a profit margin here too.

Bryan Hancock · Answer

Our litmus test is $60k/door net, net profits for a buildable lot per door.  So if the lot supports a condo regime with 2 doors we need to make $120k.  As others have mentioned there is a fixed cost with development as well in terms of city brain damage and other overhead.  Thus the bar can go down for the net profit needed provided your investor base is willing to accept the absolute dollar versus ROE tradeoff.  Larger deals will make more dollars, but they generally take longer and often present bigger financing challenges as well.  This is especially true if you are developing infrastructure and are trying to do so with debt.

Risk can be hedged by doing things in stages, but this also increases the project duration.  The capital has to work at a certain clip or the deal is infeasible.  One also has to size the deal to their borrowing capacity or experience for it to be viable for a lender to take a portion of the capital stack to decrease the cost of capital sufficiently so the equity can work at the rate it needs to work.

The formula for smaller deals is pretty simple really.  You just need to be able to accurately forecast what building and development will cost and establish a net profit number.  From there you can price your dirt and filter projects pretty easily.  The hard part if you're new will be forecasting the building and development costs accurately with sufficient margin in reserve to take the risk of capital calls out.

Tom Meade · Answer

Full disclosure, I've never actually executed on a raw land development, but have crunched the numbers on a bunch of them and taken negotiations deep on a couple.  A while back we worked with a guy who specialized in entitlement deals - he'd buy raw land, then sell the permitted lots.  He always said developers could buy permitted lots on the 1/3rd rule.  1/3rd land cost, 1/3 construction cost, 1/3 profit.  This is definitely one of those "rules of thumb" that can be debated ad nauseam (see posts on the 50% rule and 1% or 2% rule), but if you're asking for generalities, there's one!

Bill Gulley · Answer

Adam, look to lending guidelines (again, it's about financing). General rule of thumb is 20%, a 100K home will be on a 20K lot. As prices increase the ratios will increase to 25% say at a 200+K home becomes allowable. What can't be built and financed is seldom built. At a 400K home you're looking at an 80 to 120K lot. Variances are allowed in pricing as common for the area.

Then look to appraisal guidelines as to the treatment for excess land, the value diminishes as excess land increases for lending collateral value and as to market in residential uses. Most lots won't fall into this situation. :)

Karen Margrave · Answer

Account Closed

Bill Gulley · Answer

Adam, buy it! Higher end subdivisions will fill, developers are all ready on it.

Check on the HOA, covenants, I know you know that, these higher end subdivisions often have build requirements to start, like within a year.

I almost bought a lot across the street from Kenny Rogers, yes, The Know When To Hold'em Kenny Rogers. The requirement was to start building with 12 months, no spec deal there even at a great price.

Water is a big plus!  :)

Tom Meade · Answer

To me the wildcard in your deal is the larger looming foreclosure.  Is the neighborhood set up such that you could build your house or two and sell them before the rest of the lots are developed?  Realize that the bank foreclosure/new developer process could take a while...  If I were considering an investment in a deal like this, I'd want to see at least a 25-30% return based on very conservative numbers.  First I'd have to be comfortable that I could sell the house(s) without the rest of the lots being developed (assume the worst case, foreclosure takes forever)...this is a threshold issue.  If I'm ok there, then I'd get very conservative with my construction and carry cost assumptions, as well as my end value.  If I can get thing to pencil out a 25% return, and I believe I have a good chance of doing better than that, I'd take a good hard look at it.

J Scott · Answer

Exactly.  If I were to build a single $400K house, I'd want a profit of at least $80K, due to the long process and inherent risk of building one off.  But, give me 20 adjacent lots where I could build twenty $400K houses, and I'd probably be happy with a profit of $40K per lot.  The development wouldn't take much longer than a single lot, risks aren't increased dramatically and I'd have economies of scale both on the financial side and the time commitment side.

Karen Margrave · Answer

Account Closed  Each state is different in requirements for HOA's. When the original developer subdivided the land, they more than likely submitted the fee schedule, etc. and had it approved in the process. You should be able to get the bank or the title company to give you a copy of the HOA agreement, that will spell out what it covers, costs, etc. If not, before you purchase any lots, I'd try to get the bank to give you some kind of agreement on the maximum fees your lots would pay, that any future developer would need to abide by.

Bill Gulley · Answer

That's a horse of a different color! Still not enough info, streets, curbs, gutters in, utilities (underground?) poles up, power to sites, I suppose is all there if sewer is in.

Were the lots ever listed? The bank is probably into it at 50% LTV as to the land and 50/60% to improvements. They may take 50 cents on the dollar, at 80 cents on the dollar I'd say it goes out the door!

All lots won't be the same, if they were listed to lot numbers you'll be ahead in seeing the difference perceived in the market as to location. First few lots toward an entrance may be sold at cost, sometimes less to generate activity in the subdivision.

The HOA, gosh I'd destroy that if possible, I dislike HOAs, but in some areas it is a plus. I'd give no dollar amount to it, as you know it's soft costs of legal and filing fees.

I've seen subs with end lots, second phase at 100K with the entry lots sold first at 20K. The size and potential of the subdivision needs to be looked at long term, could take 20 years to fill 200 lots, I've seen 50 sell in 6 months, location, location, location. Best of luck. :)

Builders/developers: how much do you pay for lots?

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