Since there is low inventory, doesn't development make sense?

7 Replies

If there isn't a lot of inventory than Why don't investors, especially in the Los Angeles area run towards developments?

Sorry if this is a dumb question.

And im too young to remember, but from what i read, doesn't this look like the times before the big crash?! House prices are skyrocketing, and banks are slowly making it easier to borrow?  Why would we repeat the same mistake? or is it somehow different this time around?

Thanks 

Hi @Gary Erdoglyan

Good question. Let's geek out a little and look at new development from the point of view of an economist.

First of all, real estate is cyclical and typically, there is a period of expansion in inventory (period of new construction) after the recovery of a crash before you enter the "oversupply" phase and back into another recession. 

Take a look at this chart showing the four phases of real estate:

OK, that said - we've got declining vacancy (3.3% apartment vacancy rate - lower than NYC) and a housing shortage so we should be well into Phase II - right?

Well, we are. Kind of. Check out these 23 New Developments in Downtown L.A.

But, even with the development popping up over the city, L.A. is building at a much slower pace and a much lower density relative to population growth/demand. This contrast greatly with New York, where they simply blow our numbers away in terms of new units built each year.

Because we're so much slower at adding supply and we're not building dense enough, we're simply not able to keep up with the demand and that is keeping prices high, effectively stalling Phase III - Hypersupply of the real estate cycle.

Just to meet the demand and prevent home prices from growing at the 200%+ rate it's been heading, we need to be building hundreds of thousands of new units more than we're already building every year.



So why aren't developers rushing to develop in Los Angeles?
The answer to this question essentially boils down to time, cost and risk.

For a variety of different reasons, it is expensive and cumbersome to develop in L.A. and this can be largely blamed on the fact that starting in the 1960's, much of the control over the building and planning process was delegated to individual communities.

So, why isn't the state building like we used to? One familiar reason is NIMBYs ...while it is important that local residents have input on new housing, their resistance to new development is "heightened" especially in coastal California, and it's slowing down the ability of developers to build more housing to alleviate the stress on the limited housing supply. - source

And while the average project approval time for new construction is about four months nationally, it takes eight months on average in L.A.

To recap, here are some of the challenges inhibiting development in LA:

  • Getting entitlements for new development is expensive and timely
  • NIMBYism and the control of local communities over the planning process adds tremendous risk as a project could be stopped due to law suits, lack of approvals, or requirements which make deals unprofitable
  • The high cost of land and entitlements coupled with a lack of incentives restricts the pool of developers who can afford to develop
  • Because it is so challenging to develop and because we have such a shortage of housing, developers can only make their deals profitable if they target high-end buyers, further contributing to macro-gentriction wherein only the affluent can own homes

That said, it isn't impossible for a developer to develop. Folks like @Karen Margrave and others have found ways to make it work.

But until we tackle the density and entitlement issues, we can continue to look for rising values and declining affordability.

A bit of a long answer, but hopefully helpful to you and others who may across this thread.

@Joshua McGinnis  is correct. It is very difficult in many areas of California to get projects to market at anything close to the pace other states can do it. We have far more environmental regulations that we have to contend with, along with a lack of available supply of land.  

Here in Orange County, there are THOUSANDS of units being built by the Irvine Company and other big developers. These guys develop "communities" not subdivisions or multi unit complexes. From what I see, you can be small (like us) or you have to be huge like the Irvine Company in order to be in this market. The mid sized developer just doesn't have a place. I'm sure L.A. is much the same. 

@Karen Margrave  from my talks at conventions and such with the bigger companies... and or the presentations they make... Most are on 10 year cycles.  IE what they buy today they plan on building on in 10 years..

In Oregon it used to be we could buy a 20 acre site.. get it approved for 120 lots in 90 days build it out and have sticks in the air in 9 to 10 months.

the gresham project that I have posted about ( with your help )  its taken right at 20 months to go from contract to sticks in the air.. we broke ground last week on the first 6 homes.  

Each market of course is very different.  I am doing a 24 lot one in Charleston right now.. but I think because we are taking a mini ghetto MHP that the city wants gone in the worse way we will get some fast track there but still going to be well over a year just to get it approved

One of the problems that I see if that realtors (and I am a realtor) don't invest in education on how to price or value land on the mls. I see lots of land overpriced relative to the costs and risks of development. I don't quite understand who wins with the over-priced land that sits forever on the mls.

@Ryland Taniguchi  That's a huge problem here too. Most agents have no clue how to value property. In this market, vacant land is very rare. Sometimes I think agents go online and look at what other agents are "listing" for, then price theirs similarly, not based on sales. It ends up the few parcels that make it to market are far over priced. They don't account for much of the land that is on sloped lots and will require hundreds of thousands of dollars to excavate, and get the point of being buildable.

In order to dump dirt, you need a soils report to prove what the composition of the soil is. Different sites accept different types of soil, etc. If you have to haul the soil any distance, those hourly fees for the trucks add up quickly, especially if there's traffic. 

Add to that the agents that list old houses where the value is in the lot, and they price high, never considering the cost of demo and hauling off the structure! 

In reality, there should be a specific educational or experience requirement for those agents that list land, it's just a crap shoot! 

LOL, exactly right, I got some invitation for a 1 acre land, looked at it and told them what I would pay for it, then the agent said, oh no, the owner wants 3 times that, I told him to get his phone out and I told him what it will cost to build a 2500 sf 3/2, I wasn't even done with soft costs and it hit lowest figure of the comps. He was like, uhh, how sure are you that the figures for soft costs are accurate, simple answer? I asked...

I do not think special education for RE agents on this is a requirement, but it is simply a niche for real estate agents didn't explore, they ask themselves where the money is? This is the answer.

They might need to spend time working for a development company, or devote some time to talk to some, or something, but to me, a regular government educational requirement only points you to the direction where you won't get sued, they won't actually require to get the agent "educated" on actual and factual basis. I agree with the experience requirement though, perhaps a number of hours working as such and such for a company that operates such and such.

@Ryland Taniguchi

So true. I think the agent wins out a lot of the time. I've seen so many newbie investors end up buying land that is unbuildable only to have sell it later at a steep discount once they realize they can't even afford to keep up with the taxes needed to keep the land.

For future readers, one common way to evaluate and price land is through the Land Residual Method, which is pretty much a simply formula:

Land Value = Developed Value (highest and best use after development) - Cost of Development

It requires a little work on the agent's part to dig into what the costs and potential developed value will be, but I wouldn't consider it rocket science.

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