REI Virgin Territory: Investing in TDR Density Bonus Credits
“And now, for something completely different.”
~ Monty Python
As near as I can tell, a discussion on investing in real estate-based Transferable Development Rights credits has never before appeared on Bigger Pockets nor, for that matter, anywhere else on the InterWebs. As an investment strategy, this truly is virgin territory. So, this very long new thread seems to be the historic first-ever introduction and group discussion on this unique and potentially profitable real estate investment “medium” and I’m anxious to see what the crowd wisdom of BP can do with it for investment strategizing etc. I’ve identified a bunch of different profit centers and strategies over the past few years as I’ve been waiting for my local TDR market to mature and finally catch up with my plans, but can’t imagine that I’ve spotted them all.
(This post may also set a new BP record for length! it’s not easy to quickly convey and discuss in any sort of in-depth new information regarding a subject about which most people have never even heard.)
I should start out by stating that there will surely someday be new TDR-based REI possibilities coming to scattered pockets all over the US over the next 10 to 20 years. However, at the moment, playing this opportunity for the kinds of expected returns that I'm projecting - "infinite ROI" always makes my head swim - is only possible within Snohomish county, WA, just 20 minutes north of Seattle, Kirkland and Bellevue. I'm based with my land near Everett, right in the middle of things, and currently sitting on 304 Receiving credits. But, for now, at least, you can't play this REI game in Hoquiam, WA or Lima, OH or even in Denver (although there might be something old worth checking out in both Pitkin and Boulder counties). That's for now, at least.
Fortunately, while the geographic range for the active TDR program under which I’m operating is limited to just Snohomish County, WA, it is not mandatory to actually be on the ground here in order to play the TDR profits game here. At least, with some good local partners. Mostly, this method of investing is played by moving around pieces of paper, some with pictures of presidents on them. There’s no scrubbing, no heavy lifting and no toilet-clogging tenants to deal with.
Since this is my first extensive post on BP, although I've been a lurking member since last June, a quick bit about me: I just turned 66. I attended my first paid real estate investment seminar (Seattle's George Hawkins & Associates), and quick-flipped my first SFR (at a very nice profit, without an agent), in the mid-1970's. Since then, I've spent four-plus decades in entrepreneurship over a broad range of industries, including more REI flipping. I haven't had a boss, other than a wife or two, since 1983. I'm very big into self-education over a broad range of topics as a way to outgrow life's challenges. So, I'm not exactly a newbie to free market wheeling and dealing: It's how I've fed my family for most of my adult life. While I may have fallen off the turnip truck, but it wasn't yesterday.
But, until about 30 years ago, I had never before encountered anything exactly like a “development right” as a real estate investment “medium,” when a business partner parlayed $60,000 into a government check for $240,000 six months later for the land’s development rights and he got to keep his land, leasing it for 10 more years and ultimately selling it to the tenant for another $200,000. This was all done with paper-pushing and that certainly got my attention. (More details on his deal and the circumstances surrounding it will be found much further below.)
What I've been into locally for the last six years or so is a variation on this called a "Transferable Development Rights Credit" or TDR credit, for short. These unique newly-born real estate-based instruments recently added $8 million or so to the equity of my $150,000 farmland acreage (purchased zero-down in 2010 in anticipation of this specific windfall), without having to sell the land. The main difference between then and now is that the land owner now needs to find their own buyers, instead of the government. My immediate challenge is figuring how to pull out some of this equity a bit early in order to move forward with more REI, while the getting's especially good.
I've spent a LOT of time over the past handful of years researching these new concepts/things and using what I've learned to craft the best REI strategies for them. So far, I've identified at least four different profit centers, in addition to the option of using them oneself through complete vertical integration: Can you say "arbitrage?"
Horse-Choking Time
Including all of the linked documents below, this introduction and ongoing real life case study of my property is initially going to run more than 50 pages to read. If you’re into creative deal making, i.e. “The Art of the Deal,” you’re going to love the new possibilities that these open. It’s a little like playing Monopoly, except that you can now clip off the rights to build houses and hotels from Mediterranean Avenue and transfer them over to Park Place, with one Med. Ave. house turning into eight on Park Place. But, this is for real money.
There are certainly a lot of traditional real estate investment strategies and considerations that will play well here, but there are also some fascinating twists that call for brand new creative ideas. One of the most fascinating ideas is the possibility to essentially corner, and control, most of the credits for the Snohomish county market, which I believe is going to be worth at least $50 million in profits. If you slog through all of this education, you're going to know something worthwhile that 99% of your competition doesn't, at least yet. Even if you're still just starting out your REI career, you'll still learn a lot worthwhile that will be good to know in your future - certain aspects of buying and selling don't change, just the "flavor."
A Quick Hit of History
Starting on the east coast, the TDR concept for resource land preservation has been around for about 40 years, with around 200 similar (only in name) programs all over the US. These other programs varied wildly in terms of practicality and success. In terms of saving resource land, most programs so far have been abject failures, because the local program developers didn’t line up their program parameters with the hard economic realities. Sort of like hiring nuns to design a sex education program: They sincerely believe that they know what they’re doing, but not really, so they ignore critical elements.
The general philosophical theme for most program framers has been that they wanted something for nothing, or at least for a lot less than it was really worth. i.e. I’m not going to permanently lock away a good building site from development for just five years of free property tax shelter. One jurisdiction actually tried that, and save no acreage at all.
None of the TDR program rules, including SnoCo’s were designed to be intermediary real estate investment opportunities, although the vaguely-understood concept of “market forces” or “conservation incentives” is always a component in the planning. That’s fine, though: That’s how the new loopholes for smart entrepreneurs to exploit get created.
The new (2013) Snohomish county TDR "Conservation Incentive" program is the best of the bunch, to date. It was built upon a good understanding of the best and worst features of the other region's past efforts, with the benefit of knowing the final results over decades of experience. Ours is one of the newest in the country and is arguably the first 2.0 version of this resource land preservation concept. For a government program, the SnoCo framers actually did a pretty good job of it, even if it did take them 35 years and they left in some interesting loopholes and omissions of special interest to us REI folks.
For the Millenials in the crowd: Transfer of Development Rights, from the beginning result of permanently preserving vital resource land to the conclusion of the process that results in the creation of large new walkable, transit-oriented and affordable urban communities, is an incredibly Green thing to do. TDR, when done right and invested in at the right time, is one of the best examples of “Doing Good, while doing well” and/or “making money while making a difference” that I’ve ever seen. Good TDR programs create that vital balance between the needs of people and the needs of the Earth that we must achieve if we are to ever hope for Sustainability. But, there’s certainly nothing wrong with making some cold hard cash in the process. :-) The more that you have, the more that you have to give.
More than Local
What makes this a general subject for Bigger Pockets is that, even if you live in another part of the country, there may already be a TDR program in your area with some low-hanging fruit. The odds seem slim, though. Further down, you’ll find a link to a document that has a list of 20 other regions across the US (including two in Colorado) that have had some sort of TDR program, though they’re nothing as “generous” as the Snohomish county program, which has been described as the most generous in the US.
Or, there may be a new program coming near you that is getting close to opening up the new market - the above list is 6 years out of date. There’s no “central registry” for TDR programs however and each program is unique, so you’ll have to do some digging on your own. As I wrote in the beginning, this BP post seems to be the very first-ever on the subject of investing in TDR credits, so there’s lots more to explore in local markets.
If you do find a local program and it’s based upon similar values to SnoCo’s, with some known positive results, there might be some investment juice to squeeze and you’ll be able to spot the best deals long before any of your competitors, while source land prices are cheap. But, only if you have added a thorough understanding of TDR’s to your personal bag of tricks; that’s why we’re here.
If you do find a TDR program outside of SnoCo and need some help to evaluate it, go ahead and post it in a new forum thread with the keyword: TDR. Those of us who are catching onto this new deal, and remembered to add “TDR” to their keyword alerts, will chime in.
Full Disclosure: The reason why this is being posted in the BP Marketplace, instead of a blog or general forum, is that I’m also offering for sale equity in my real estate holdings and investment company. Since last June, when I joined, I’ve become a born-again convert to “The BiggerPockets Way.” I’ve also started the process of “retiring,” while I’m still healthy enough to enjoy the other things that life has to offer. So, I’m done operating as an investment loner.
Now, I am specifically seeking new smart and mostly-active partners in my local REI business. My goal is to build a dynamic investment team that can take this ball and run with it for many years to come, while I start paying some seriously overdue attention to a long bucket list. So, for the right group, I'm putting up to 50% of my debt-free holdings on the table for sale at 30 cents on the dollar. This includes formal equity in the debt-free physical land holdings, now worth closer to $600,000, and 304 certifiable TDR Receiving credits, plus active participation in all my future TDR-related deals. More on this subject will follow at the end of this post.
The Ground Floor
For now, we need to start with a quick general examination of the idea of TDR credits, why they have economic value and some of the ways to play them as high-ROI investments. I'm using my current holdings as an example because it's not practice. This is the real deal, in which I have five challenging years and some serious money invested as skin in the game, and the real world in which this is happening. At the end of the day, the money is real, too.
The first question is surely: “What the heck is a TDR credit?”
The short answer comes from the Snohomish county official flyer on the subject:
“(Transfer of Development Rights) is the process by which the (residential) development potential is removed from one property and transferred to another. The county’s TDR program seeks to use market forces to discourage residential development of important natural resource lands, considered ‘sending’ sites, and redirect this development to more suitable lands, typically within urban growth areas, considered ‘receiving’ sites, that are appropriate for more intense residential use.”
That’s TDR in a nutshell: The basic investment strategy for “IPO-level” investing is to buy these important natural resource lands, “clip off” the credits and then sell them. There are a number of ways to deal with the “residual” Sending land which, if it’s the right situation, will still be worth at least as much as originally, even without its TDR credits.
Where it starts getting economically real interesting for REI hustlers is that, during the process between the "clipping off" of the "development potential" and the "cashing in," the "potential" doubles three times: In other words, what started out as one farmland "development potential" credit, that has a documented median market value of $53,000, becomes eight of them in an urban growth area that are arguably and conservatively worth a total of at least $200,000. Technically, the straight-across value totals $363,300 for the multiplied rural credit, but we need to leave something on the table for the intermediate investors and the end-use buyer.
Where it gets even more interesting for us REI folks is my expectation that there is quickly going to develop a shortage of TDR credits available for sale, just as demand starts heating up, which is going to drive near-term market prices even higher. There is a huge variation in Sending property price/credit valuations and most of them have too few credits and aren't economically worth the bother. So, one key strategy is to lock up the best deals before someone else does - the same basic strategy as gold mining.
You’ll find the full document on the SnoCo TDR program here: http://snohomishcountywa.gov/DocumentCenter/Home/View/8118
This will give a full basic explanation on the purpose, the program and the hard numbers when it comes to the credit’s creation and end use “face” values. You really should read this before continuing below - it’s only two short pages of text and four of graphics. But, what follows will then make a lot more sense.
Also interesting is that this file is also just about the only promotion that the county is doing regarding the TDR program. This will tend to limit the number of initial REI competitors while the best acquisition deals are still waiting to be scooped up, before the sellers learn that their property is worth a lot more than normal market values would indicate.
In my case, my present owned holdings of 38 certifiable Sending credits are from farmland and the Receiving area is an Urban Center with 12 or more new units per acre. This fission’s into 304 Receiving area credits in my current inventory. This Sending part of the TDR program is a done deal, with the final county council passage in late 2013. So, the Supply side of the rules is completed.
The Final Puzzle Piece: The Receiving Areas
With the rules for TDR Supply now in place, the final piece of the puzzle that will ignite the market is the Demand side. For every seller, of course, there needs to be a buyer who will benefit from the purchase. At the end of the day, the end-use buyer is a multi-family/mixed-use developer. Their benefit, per credit, is the right to build “one more” dwelling unit above base permitting on their site. It’s a lot like bribing the local Planning Commission, but above board, legal and guaranteed.
For this program to work, there needs to be a place for the end-users, the commercial multi-family developers, to cash in their Receiving credits in exchange for reasonable profits that make the effort worthwhile. In my analysis, this completion of the Demand side is imminent, as in probably months and, unlikely more than a year from now. Then the bell rings and we're off to the TDR-REI races, in which (in all humility) I have a long head start.
The opening of the first large new rezoned Receiving area is imminent, as will be examined in a long document (26 pp) that I’ve written and just posted to the BP FilePlace. My conclusions and a full examination of the basis for my expectations for the SnoCo TDR program are there and most of that won’t be repeated here. I’m especially anxious to know if other BP folks agree with my conclusions and assumptions. You’ll find this new document at http://www.biggerpockets.com/files/user/ChrisNewman/file/investing-in-snohomish-county-wa-tdr-credits
Other Ways to View a TDR Credit
To be an effective seller of anything, we must be able to view things from the perspective of the buyer. In this case, the ultimate buyer is a commercial developer who needs these credits to boost their development’s density up to 260% beyond the base zoning.
Another way to view a TDR credit, from the perspective of the end-user, is that it is what I have termed a “Multi-family Pocket Lot.” Under the county program, just like physical land of appropriate size, a credit, too, conveys the right to build one multi-family dwelling unit, except that it’s above and beyond the base zoning.
The biggest difference between a TDR credit paper asset and a physical land asset is that this “virtual land” does not yet have a fixed “location.” That’s as in the “Location, location, location,” fame that determines real estate values. So, you could also call it “portable land,” in that it can be finally “pasted onto” any qualifying location, of any grade, anywhere along a stretch of urban growth area that will be starting at 3.5 miles long and eventually expanding to 10 miles that will have far more “slots” to plug credits into than there will be total credits to plug in. Some of these locations are more valuable than others, so it’s nice to be able to literally choose the final destination location of the “mobile building lot.” This, too, is covered in depth in the attached file at http://www.biggerpockets.com/files/user/ChrisNewman/file/investing-in-snohomish-county-wa-tdr-credits
Another big difference is that you can store your certified lot-equivalent credit in your shirt pocket, hence the name “Pocket Lot.” While its economic worth tracks the market value of physical land, there are no property taxes, rehabbing, management, cleanup, tenant issues and/or toilets to unclog. It just quietly sits in your pocket (or safe deposit box) piggybacking on the market values for physical land. If market values for land go up, so do the values of the land’s equivalent - that county-registered piece of paper that says “TDR Credit” on it.
Another way to look at these credits is as “virtual land.” They convey the same benefit of physical land - the right to build “one more” dwelling unit, except that this right is stored on a county-registered paper certificate. It’s not unlike owning a stock certificate, except that, instead of a share in a company, it’s a guaranteed density bonus building permit.
For one last analogy, the way that I think of TDR credits is that, from the point of view of the end-user, they’re Magic Stickers. If you’re a developer with a big piece of land that cost you $1 million/acre, you’re going to make a lot more money, for a variety of reasons, if you can build at 58 units per acre, instead of the original 22 (that was the price basis when you acquired it), and a 75’ height limit, instead of the original 45’. To do that, you need to apply one Sticker to your building permit application at the rate of one TDR Receiving credit per desired extra bonus unit, up to 260% of the base permitting. Just one 10 acre site would consume 360 credits for a full build-out.
So, whatever you call them, you could hold hundreds of these credits as essentially buy-and-hold building lots that you store in your safety deposit box, where they will never expire and, in an appreciating land market, should automatically track upward in value at least as much as the physical land.
More likely, I expect their market value appreciation to outpace the general land market because there is quickly going to be a real shortage of credits, shortening supply just as the demand starts to explode. That’s my speculation, at least, and why I’m mostly on an acquisition track right now. This is another one of the specific subjects upon which I’m counting on the BP wisdom to confirm or refute.
Establishing A Legal Monopoly?
Another subject that is worth exploring here is the idea of literally cornering the market in SnoCo TDR credits as the dominant buyer/seller/broker. Right now is the ground floor, where the easy pickings of big batches of cheap, or even no-cost, credits is very limited. When you have the market cornered, you can then control prices (to a point) by controlling Supply in balance with Demand. It’s basic Yield Management that’s only possible if one controls most of the supply.
The idea of establishing a legal virtual monopoly in a brand new investment niche that’s based within a new government social engineering program, with millions of dollars awaiting harvest, is a once in a lifetime chance. At least for us Unlimited Life types, becoming the king pin, or at least a part of the group that is in control of a market of serious value, is certainly an intriguing prospect to ponder.
How would you go about creating this dominating TDR market power position in the Snohomish county circumstances? Any better ideas than to just “buy all the Sending credits that you can while the getting is best?”
$$$$$$$$
The student’s second question is surely, “What are these things worth?”
The short answer is: “Nobody knows, yet. There has never been a sale to establish a value precedent.”
That's what makes this a virgin REI opportunity, where the best profits go to the visionaries. The first sale is going to happen, without question, and soon, but it hasn't happened yet. It's certainly possible to wait for a market to develop before jumping in, but that will also mean coming in after the fattest profits have already been harvested. The race goes to the bold.
A Pretty Good Guess
However, there are some ways to reasonably project what a fair market target value should be. I’ve put a lot of thoughts into this subject, of course, and I’m curious to see if my fellow BP investors come to the same conclusions, based on local market conditions and values. Again, you’ll find an exhaustive overview of my market value prediction analysis at http://www.biggerpockets.com/files/user/ChrisNewma... Am I missing anything in my calculations?
In short, however, the easiest way to visualize a Receiving credit’s likely value is that it is a consequence of its economic value to the end user, typically a large (200-500 unit) multi-family developer. Developers are the ones who are ultimately going to be paying the “Retail” price, and trying very hard to get them for a lot cheaper. The credit is worth to them what it does for them, which is to replace the need to buy more physical land for their development in order to build a higher number of dwelling units.
Original Credit Acquisition Costs
As investors, we want to acquire these credits before the end user does, and for much less than the final Retail price. The cheaper the better. The spread between cost and selling price is our profit margin, the fatter the better. One of the most interesting factors right now is that the cost of credit acquisitions for holding and/or resale, has little or nothing to do with the ultimate Retail value.
A credit’s acquisition cost is mostly a factor of the present circumstances of the source land and/or its current owner, both of which vary wildly. How to quickly tell the difference between the “minnows” and the “whales” in terms of credit cost and total volume is one of the details that I will NOT be discussing in a public forum. The reader is welcome to do the same deep research and original creative planning that’s built upon a foundation of decades of successful investing experience, or else buy a place at the table in my game and come along for the ride.
I will say, however, that there are only two credit-source land whales that I’ve found anywhere in the county. These have a massive number of “bonus” certifiable credits on them, compared to the normal “rules,” and I already own one of them (@ 37X), with a strong line on the other, even bigger, one. But, there are also at least a couple of hundred “salmon” in between that are still well worth the catching, with credit acquisition costs that will be near zero.
However, I’ll give you a teaser clue: These (high density) whales and (medium-density” salmon properties (from a TDR credit standpoint) exist at all because of a revision in county land use codes that date back to 2007 and that have absolutely no direct connection to the TDR program.
Getting Down to the Numbers
Again, the general answer in pinning down a TDR credit's value is that, like all other real estate or REI instruments, its free market value is a function of Supply and Demand. The Demand is a function of the benefit that the credit conveys to the end user, which in this case is a practical (and mandated) alternative to the need to purchase additional physical land, when you're developing a high density multi-family/mixed use project.
If Supply is limited, either organically or deliberately (through control and withholding of inventory), and Demand is strong enough (while still leaving enough additional profit margin on the table for the developer to make it worth their while to bother with), the credit’s market value should rise. That’s the way that free markets work.
The one thing that we can be sure of is that Demand will continue strong, as the local population explodes and needs 2,000 new places to live every year, for at least the next 20 years in a massive gentrification ultimately stretching for 10 miles,
The future in the greater Seattle area is high-density urban and this new receiving area is where it’s going to happen, with a mandate to use TDR credits to boost densities up to 260% of the current base.
(If you don’t mind some tangent, in order to gain an even stronger understanding of the essential TDR concept, it starts with this: The unavoidable fact is that it costs serious money to permanently remove from rural resource land its potential for residential development. You can still do everything else on the land that was already permitted, except to build a house. In the local case, the documented median value (in 2011, with a market now up 15% from then) of the right to build a house is $53,000 - I have a copy of this 75 page unpublished professional report. In short, this means that the median reduction in the land’s market value, after a development right is clipped off, goes down by about $53k.
(Without some sort of economic incentive, the landowner will only suffer if they don’t eventually build, or sell to a developer. Lots of folks will buy a big piece of inexpensive rural land for their retirement plan and live on it for decades, paying it off, until civilization catches up with them - aka urban sprawl - and they can then sell it for big money, which then funds their retirement years. Since urban sprawl is coming to an end, in favor of high density urban in existing cities, if this is your retirement plan near any major city, I’d think twice about it; this is the national trend over the next generation or two.
(But, the overriding goal of the planners is to preserve resource lands as-is. There are many reasons for this, that we won’t go into right now, but their passion to control what other people do with their own land is strong. So, they’ll try most anything that they can think of to get what they want, even if it screws over someone else. Progressives tend to do that a lot.
(Back in the mid-1980’s, King county to the south did the right thing and simply purchased development rights directly from the owners for a fair market value. A business partner of mine at the time saw this PDS (Purchase of Development Rights) program coming in the near future and bought 12 acres just north of Kirkland for $60,000 cash. Six months later, the county cut him a check for $240,000, and he still got to keep the land. He then leased the land to a farm co-op for 10 years of pure monthly profits, then sold it to them for another $200,000. Woof! That’s how I got into this whole developments rights deal in the first place.
(The problem with this approach, that it is to the benefit of society in general to preserve disappearing resource lands and so the general public should pay for it, is that the taxpayers screamed their heads off. The conservatives hated the extra tax burden and the liberals wanted the money for their favorite social welfare programs. So, after the first round of PDS, King County gave up on this approach.
(Their next attempt was to unilaterally, by government fiat, rezone large rural tracts that were already slated for future development out of the game. All of a sudden, the lifetime of personal planning that the owners had worked so hard for was wiped out with the stroke of a bureaucratic pen. These owners were simply screwed, without compensation. That didn’t last long, though. The landowners sued the county and won, getting their original zoning restored.
(Then, they turned to the TDR approach, which started on the east coast. King county’s program is only worth 1/4 the cash-in value of SnoCo, but even then it has worked: The land gets preserved and the original owners don’t get screwed. However, as we all should know, “There Ain’t No Such Thing As A Free Lunch.” The money to compensate the property owners for the loss of their development rights has to come from somewhere. And, it still does, but now the cost is hidden from the person from whose pocket it comes.
(The reality is that the regional population growth is going to be channeled into high density urban neighborhoods, no matter what. Other than unacceptable sprawl, there there’s simply no other place to house all the new citizens. Increasing density is mostly a matter of going up - consuming more airspace. Locally, this means seven story buildings, instead of four story. This airspace costs the county nothing to grant.
(But, somebody had the bright idea, “Hey, let’s force developers to buy and trade-in TDR credits in order to get the higher density that makes them more profits. We’ll do this by mandating their use and calling it voluntary.”
(By mandating the use of purchased credits in exchange for airspace, it doesn’t necessarily raise the price of each dwelling unit’s “building pad” cost beyond the current market value. Indeed, if the retail cost of the density bonus credit is below the cost of the related physical land, the pad cost of the bonus unit is somewhat cheaper.
(However, if the needed density bonuses were simply bestowed upon the land at 260% of current limits, again by government fiat, the cost per unit pad would be just 38% of the current base value. Essentially, that would be a pad cost of $17,290 each, instead of $45,500. That’s a difference of $28,210 that the developer could lower the selling price of the units and still make the same profits. The buyer of the unit has no idea that they could have paid $28k less for the unit, if they were not subsidizing, by a complicated method, the preservation of resource land that they’ll never see.
(In other words, TDR programs are a giant trick-f*** that is foisted off onto the citizens to secretly force them to pay for resource land preservation without even knowing it. ISo, if you're wondering specifically where the fat investment profits that derive from the REI of buying credit Sending land, clipping off TDR credits and then selling the credits to developers, this is it.)
As I’ve written, I’ve been thinking about this whole subject of liquid development rights a lot, for most of my adult life. The time for this to happen in Snohomish county has finally arrived.
Getting back to the discussion of current local market values...
In other words, the value of a TDR credit to the end user/developer, is the value of the additional land that the developer does not need to buy in order to build additional units. Using a TDR credit, if you can get it, obviates the need to buy additional physical land. If the cost of the credit for the end user is far enough below the cost of the physical land, it's a good deal for them. The fact that the seller may have literally paid a zero net cost (infinite ROI) for the credit has nothing to do with its end value.
To get specific, in SnoCo, the average market price of a physical land multi-family building lot is about $45,500. That’s based upon a typical $1 million/acre local market price for undeveloped commercial land, which comes with a baseline development permitting limit of 22 units on that acre.
Without TDR credits, if the developer wants to build more units for the total project (which boosts their profits through a higher amortization of the fixed project costs etc.), they would have to buy more physical land. If you’re building a 4 story building, it’s just a lot cheaper to build another three floors on top of it, than another whole building. (A much more profitable use for the extra land, if it even can be acquired, would be to upzone it with TDR credits, too.)
But, with credits in hand, the developers don’t have to buy more physical land. If they can buy guaranteed density bonus credits, instead of land, for enough less than the cost of the comparable land, it’s a good deal for them.
Bottom Line?
Somewhat arbitrarily, if I was a developer who was paying $45k per unit for the land, I'd be pretty happy to pay $25,000 for a functional replacement of physical land that would also let me build higher to 7 stories, instead of 4, with 260% of the base number permitted units. That's what I value my holdings at, for now, as "top Retail dollar." If a TDR investor pays $53k for a Sending credit and resells it as a package 8 Receiving credits, for $25k each ($200k, total), that's a pretty nice near-term 400% ROI, for mostly moving a piece of paper from one place to another. If the credit sold for only 50% of the $25k, you'd still quickly double your money, which can hardly be said for almost every other real estate investment medium.
But, if the credits can be originally sourced at a zero net cost, because the land can be resold for at least the purchase cost, the ROI is considerably higher, but I can't count that high because it's literally infinity.
The Extra Value of Having “Portable Land”
While there are a number of minor factors that will effect the final value of the credit to the developer, chief among them is the market value of the physical land upon which the Magic Sticker will be applied. If the Receiving land is worth more than an average market value, so is its functional equivalent, even while it’s still sitting there in the seller’s pocket. This is where some hard negotiation comes in.
Remember, the “face” value of each TDR credit is fixed @ “One more unit.” So, if credits are pasted onto an A-quality multi-family property, perhaps with a view, that costs $100,000 per building site, the value of the TDR credit is a lot higher to the developer, too. A $25,000 credit here guarantees a $75,000 extra profit margin on the unit, for using a TDR credit instead of buying more expensive land. Make sense?
So, if you’re a developer, the smart thing to do is to first lock down your credits even before locking in your site. Locking in your credits, in a market scarcity situation, also locks out your developer competition for the land, who didn’t get the memo and think that there’s a “TDR credit” store where they can just drive through to pick up a basketful of credits at a steep bargain: There isn’t.
The Blue Ribbon Deal
Wrapping up the topic of the extra value of “portable land” (the TDR credit) that can be “located” wherever you choose, the best profit for the source-land TDR credit investor is this: The Blue Ribbon Deal. This was one of the coolest ideas that I learned from George Hawkins so many years ago.
To do this strategy, after you’ve secured your credits, instead of selling them at a big discount ($25k each) to someone else, you then buy the best super-premium development site that you can find in the new rezoned Receiving area. This will probably be something special with a view or other distinguishing elements that make it an A-grade property. If you have to pay top-dollar retail for it (based upon its base development permitting), that’s OK: The higher the value of each base building permit, the higher the value of the related TDR credits that will effectively increase the “size” of the property by 260%.
Once credits and land are in-hand, the TDR investor takes the next step and gets the site pre-permitted with the local Planning board, using as many TDR credits as it takes to max it out. Once through this stage, the whole pre-permitted high-density development is “tied up with a Blue Ribbon,” for sale as a simple and easy to sell package.
Then, you sell the convenient premium package to an Asian investor. There are hundreds of millions of dollars of Chinese investment funds currently being converted with cash into land holdings in the Puget Sound region and they’re always interested in premium sites that are ready to build without a lot of fuss. Compared to the Seattle/Bellevue urban core prices, this would still be dirt cheap. Compared to the Asian urban prices, even Seattle/Bellevue sites are cheap, with the extra advantage that they’re not located in China, with its iffy laws that county on payoffs as much as anything else. There is a team of two local real estate agents who have made 90% of recent sales to Asian investors and I have their names.
Bottom line, if this new premium development has building pad values of $100,000, instead of $45,500, the new credits that are pasted onto it are also technically valued at $100,000 each. To offer some land buyer incentive for a quick sale, let’s call the selling price per Receiving credit $75,000. Since the permitting is already accomplished and the site is conveniently ready for groundbreaking, the developer’s discount should be smaller.
Running the numbers, if an A-grade site has building pads worth $100,000 each, it’s going to cost $2,2 million per acre, or $22 million for a 10 acre site. Using credits, that 10 acre site can be upzoned from 220 units by another 360, to 580.
So, the selling price of the land would break down as follows: $22 million for the land with base zoning of 22 permits, plus another 360 bonus permits @ $75,000 each (another $27 million). That works out to $49 million, or an average cost per permit of $84,500, that was formerly $100,000. That works out to an extra $9 million project profit to the investor/developer, which can be either pocketed or used to discount the premium units for a fast turnover.
For the Blue Ribbon TDR-REI. selling 360 credits for $75,000 each, instead of $25,000 each, raises the selling price from $9 million to $27 million, for the exact same pieces of paper, but taken to the next stage in the development process to create a simple clean pre-permitted package. An extra $18 million in one deal certainly seems worth chasing, to say the least.
Of course, that means that there needs to be some way to lock down a $22 million site, Even if the downside risk is essentially zero, that’s still a big chunk of cash. But, we BP’ers have more tricks up our sleeves than laying out suitcases full of hard cash. Another option would be a variation on wholesaling, where we somehow tie up control of the site for a small amount down, perhaps an escrow fee or small non-refundable purchase option for full price.
Or, work some kind of a deal with the site’s seller to work together to put together a Blue Ribbon package. Perhaps offer them $25 million for their $22 million site, once all the dust settles. That would reduce our bonus TDR sale profits, on top of the base $9 million, to a mere $15 million, instead of $18 million. But, I think that I could somehow find the courage to carry on. :-)
Can you think of any other ways to more directly play these credits in order to realize more than the “base” value $25,000?
Terms
Another interesting REI facet in either a straight sale, or collaboration, scenario is working with the developers with some sort of payment terms, other than full price in all-cash upfront. I'm not going to get into all of these options for terms here, but will throw it open to the crowd: "If you owned a bunch of TDR credits that cost you nothing, net, what sort of terms would you offer to a developer/end-user?" Please feel free to share your ideas below.
If you want more discussion and more depth regarding selling on terms, again, you’ll need to download Part One of the new and exhaustive white paper that I’ve just finished and posted to the BP FilePlace. You’ll find it, again, at http://www.biggerpockets.com/files/user/ChrisNewman/file/investing-in-snohomish-county-wa-tdr-credits
Part One covers in substantial depth what these credits are, how they work and when the strong market demand is set to ignite. If there’s a more exhaustive examination of the subject anywhere else, I’d love to see it.
This part also covers in-depth two of the ways to play TDR credits: One is the best strategy for developers. Another option, for the non-developers, is passively investing in discounted Receiving credits in quantities of eight or more, for a passive buy-and-hold position in anticipation of a rising market demand, with some extra margin built in for being first to the party.
Also within this white paper, you’ll find links to other official source documents, including the development rules on the imminent new major TDR Receiving area rezoning and a tracking of the progress of this part of the program to its current location: In the county council’s office, being formatted into a formal resolution for the council to pass.
There is a Part Two, even longer, that details the exact strategies that I've developed for picking up and playing original credit source lands at an infinite ROI, but those original trade secret strategies are reserved for my new partners. For instance, no one can possibly tell the difference between a Whale and a Minnow Sending site by driving down the street in front. There is a way to identify the best buys, but you need to know what to look for and where to look, neither of which is especially obvious. Again, while there are some really decent profits to be made playing Snohomish county TDR credits, there's a strictly limited supply of the super deals: Certainly not enough to go around for more than a small group of investors.
Even More to Read
I was recently lucky to recently discover what may be the only academic historical comparison ever performed of most of the major US TDR programs. It comes from the Winter 2009 Journal of the American Planning Association, “What Makes Transfer of Development Rights Work?”
Not only does this 11 page in-depth article analyze the top 20 TDR programs across the US, it also has identified the top 10 success factors that are required to make TDR programs work at all, including scoring each of the top 20 programs. If you want to play or promote or wholesale or consult on these things outside of Snohomish county, with a chance to corner your own market, you really need to read and understand what’s contained in this article. Check out the list of the Top 20 programs and see if there are any near you that are worth researching. It’s very handy that the Top 20 scoring has already been done for you.
If you’re a true glutton for understanding, at the end you’ll find references to another 40 or so related articles and studies. I haven’t read them all. It’s a lot more important to understand what does work, instead of worrying about what doesn’t, other than recognizing the dealbreaker red flags.
You’ll find this valuable article for free download at http://www.ecy.wa.gov/climatechange/2010TAGdocs/japatdr_winter2009.pdf
(I was surprised to see King county, Seattle’s home and neighbor to the south of Snohomish county, rated as the #1 TDR program in the country, at least in 2009. By comparison, a Sending credit from the 2013 SnoCo program is economically worth four times as much as a KingCo credit. Then again, these programs are ranked by the number of resource land acres that are preserved, not whether or not they offer any sort of profit to the program’s participants.)
Questions?
Once you’ve come up to speed on this whole new TDR thing, which is going to require you to do your required reading, what do you think?
Is my price projection to the end user developer of $25,000, which is 55% of the market value of the comparable physical land, reasonable?
Do small blocks of Receiving credits, purchased at a discount, and held for an expected appreciation of the physical land that they mirror, sound like decent fully-passive investments?
What would be some interesting terms to offer developers that would somehow induce them to pay top dollar?
This whole thing, on the verge of being born, is so profitable by ordinary standards that it makes my head swirl. Am I hallucinating?
Selling Equity in My Investment Business
If you’re as big a Richard Branson fan as I am, you’ll recognize that I’m violating one of Branson’s Laws here: “Never try to sell something that you have to explain.” One can’t get much more contrarian than this.
As I mentioned above, I have some basic personal goals, that sometimes transcend the value of profits that I have not yet realized. There’s more to life than just dollars and cents, at least if you have enough of them:
1. To transition over from an REI solo act to a tight investment team organization. There are a fair number of small fortunes to be made with TDRs, but not really enough to go around for everyone. They're sure not going to make any more of these SnoCo credits. So, it's best to hit the ground running hard before the best supplies run out. I know where to find them and have several great next deals located, but I sure can't do all this in time alone. Even 50% of what could be is worth a lot more of 100% of what I have now.
2. Over the next few years, I want to start transitioning out of active business life to the point where I can mostly just phone in what I do best - putting together deals - and to keep contributing while my younger partners carry more of the load. My best takeaway from my guru George Hawkins 40 years ago, right after “Make a ridiculous offer once a week,” was “The reason why we want to make money is that it gives us the time in life for the precious things that money can’t buy.” I’m starting to run low on the time thing, which money can’t buy more of, either. Just liquidating my current position, with half of it going for 30 cents on the dollar, will get me where I need to be. But I’m game to fatten up my financial cushion some more.
3. Most immediately, I need to get my land’s mortgage paid off ASAP, so that I can then get the TDR credits certified and into active play, just as the demand for them starts to heat up. So, the first $200,000 that’s raised from new active investment partners will go toward getting the land completely debt-free and credits certified. We’ll do this in escrow, if need be.
4. I need to find a house to possibly retire in and get it ready for my inevitable future. At least, a safety net if nothing better, like 80 acres with a huge house and private 15 acre lake @ $3.5 mm, becomes reachable. I currently have my eye on an interesting 2/1 light fixer on 3/4 acre in the woods with a 40' in-ground pool and a ton of room to build a garden to putter in, for less than half of its ARV. For top security, I want to pay cash for it. That will take another $150,000, plus more for some future major remodeling, like enclosing the pool with a greenhouse.
5. Some extra cash would be nice to buy a tractor, a newer truck and to keep the lights on for at least a couple of years, until the TDR cashflow comes in.
6. Anything raised above $500,000 or so would be earmarked for further TDR investments, along with the rest of the group. I might even consider loaning some to the group for more source land acquisitions, with repayment after it liquidates.
This is what I'm looking for, at least. How it is reached is open to discussion.
In order to achieve all of this, I’m willing to sell up to half the interest (in the form of equity) in both my current holdings and my future TDR deals, to the right new partners, for 30 cents on the dollar. This means that I’m leaving about $3 million of profits (as I calculate things) on the table for the potential partners, which is why I’ll be picky: Just being able to write the check won’t necessarily be enough, though that will go a long way. :-) I’ll more than recoup the big discount on just my remaining share of the next deal, with more deals to come, and I’ll have a solid dream team to play with. So, this “investment” in solid new team partners will be well-worth it. I’m not thinking in terms of a fixed size equity share, though there will have to be some sort of minimum investment and there will probably need to be some sort of limit to the number of partners.
Specifically, I’m seeking at least a couple of local partners, plus the possibility of investment from other geographic areas, with the expectation of a lot of brainstorming to decide what’s next. Eventually, probably within a few years, the best sources of TDR credits are going to run out and it will be necessary to transition the investment portfolio over to more-traditional real estate investments, possibly anywhere in the country. Fortunately, there should be eight-figures worth of profits to play with, if that’s the way the group wants to play it.
The initial skill levels can range from motivated beginner who is anxious to learn to, especially a top shelf CEO and/or CFO, while I transition to a quieter lifestyle as others are able take over local operations. At a minimum, new partners need to be registered BP members. I’ve ID’d at least a couple of local BP members with whom it would seem fun to work - we’ll see if they check in.
Well, there it is. Believe it or not, this WAS the short version of "Investing in TDR credits." If you have any questions or comments about TDRs, and you’ve read all the other source material, I’ll do my best to answer them. I’d better be able to. If you think I’m hallucinating, tell me why.
If you’re interested in jumping onto this particular Snohomish county TDR investment strategy with me and the rest, either active or passive, please PM me and we’ll take it from there. Almost everything is negotiable. And, yes, I expect a full due diligence before anyone buys in. If I was running a con, it would be involve something a lot simpler and more familiar than TDR credits. :-)
Thanks for reading. If you got this far, you are truly dedicated to real estate investing.
And, finally, if you like what I’ve shared, please be sure to give me a “Vote,” just below the photo of myself and my opinionated friend.