All Forum Posts by: Scott Choppin

Looks good @Amit Barman

Given this set of facts, I would suggest phased closings with seller where you would only purchase a few lots at a time. This it the rolling options method I mentioned before. 

You would propose X number of phased closings in your negotiations, once agreed upon deal, then close on phase 1 purchase, and provide him with option money for the future phases, to incentivize hime to wait for the future closings. If market turns against you, you can bail out, you lose your option payments, but you aren't forced to close future phases unless you want to, and you don't close the whole thing in the beginning and hold land when market turns down. Many large homebuilders use this method to protect against market downturns.

Suggest you get those option payments to be applicable to purchase price. Put some money in his pocket to get him patient, but you pay down your purchase price while you move through the options. 

You only pull trigger once you build out X homes, then roll to the next phase, hence the term rolling options.

Have fun!

@Karen Margrave

Thanks for checking in.

Plans are complete through plan check, with permits ready to issue. The project is fully bid out to the subcontractor markets and we have a final internal approval on the schedule of values. Putting the finishing touches on the financing, now that costs are finalized. Should be ready to start here in the next 2-3 weeks.

Now that we are closes to start, you guys will get to see 

1. a post about the process of initiating and managing the bid process, assessing scopes of work, and finalizing pricing from the selected subcontractors (this process can apply to general contractors as well). I'll post the schedule of values for the projects (numbers redacted to protect the innocent). 

2. a post about the "get ready" process, disconnecting utilities, paying permit, development impact and school fees, etc.

3. a post/s with some actual demolition and construction

I don't have any renderings per se, only the black and white 2D elevations from the CD's. Let me know and I can post those.

Scott

@Amit Barman

BTW there are other land contract structures, such as extended escrows, rolling options, phased take downs, land joint ventures, builder joint ventures, and many many other types of land contract structures. 

Once you can answer the questions above in the my first reply, it will guide this conversation further on how to approach the deal.

Thanks.

@Amit Barman

First question: What does the land developer want, what's their ask? Most want to close and get out of the deal.

Most deals like this you would close the land, then build the homes and sell, or sell lots to other builders as fast as you can, and in this case you must underwrite your carry cost for the entire time you are holding the land, from land close to sale of last lot. 

Are you using financing plus equity to close? All equity? 

Each is different in how you act, i.e. all equity has you be more patient, or at least you can be more patient. You should want to execute cleanly and with velocity on any deal you put together. 

Who will finance the construction of the land infrastructure? 

Who will finance the construction of the homes? 

Will you build the homes, or will you sell the lots to 3rd party builders? What is the price of the homes? What is the price of the lots? What is the per lot finishing cost, infrastructure, soft costs, development impact fees?

Have you run a proforma? To see if the land price the developer is asking makes sense in the direct home building model and did you account for land infrastructure in the model (that is if you are finishing the lots)?

My instinct is, that if you are asking this type of question here on BP, you should very seriously consider hiring a development consultant, or partnering with a developer who has experience in this process. 

Many folks have gotten into land deals and lost significant amounts of capital when they can't or are unable to answer the questions I wrote above. 

Finally, these questions are the starter set of questions. Most real estate development projects have 200 or more individual variables that need to be assessed, and an infinite number of solutions to address problems and issues that always arise when grounding assessments of the 200+ variables. 

There are always issues that arise and exist in these types of development deals. This is why developers can make huge amount of profit, and why they (the new ones at least) can lose huge amounts of capital when entering unfamiliar domains.

@Account Closed

Put together what we call a Land Joint Venture, or Land JV.

1. Negotiate the deal terms in a letter of intent, keep it dead simple, you want to negotiate the deals terms, without lawyers, principcal to principal on all major buiness points.

2. Run a proforma based on the deal terms (you should really do this upfront, but you won't know his exact land value until you fully negotiate that part), make sure the deal works, paying particular attention and grounding assessments on rents, operating expenses, construction costs, financing costs, and values upon sale of the asset.

2. Sign that LOI assuming the proforma works for the deal.

3. Send that signed LOI to an attorney to draw up an LLC operating agreement based on the LOI terms, with the following general JV structure:

A. Land owner will transfer land into the LLC at the value based on you proforma and negotiations.

B. You will put your capital up, to the extent it's needed. I say this, because you will be able to claim equity credit with the lender for the value of the land that will be in the LLC once you close the deal and transfer the land. Your capital should only fill the equity gap, and should be available to backstop the liquidity requirements of the lender to make the loan if you do the loan guarantee. Usually, we see the cash equity partner pay for predevelopment activities, such as entitlement processing, architectural construction drawings, plan check fees, soils engineering, etc. These all require payment before the construction loan closes.

C. Who will provide the construction loan guarantees, you or him, or both of you. Most land JV's we have been involved in, the "seller" or land partner, does not want to put up financials for a loan guarantee.

D. Preferred return that will be paid for invested equity - the land equity, and your cash equity.

E. The back end or profit splits based on paid-in equity. If you provide the loan guarantees, I would not go any less than 50% of the back end. Normal market value for the loan guarantee by itself it 20-25% of the back end. You also will put the entire deal together, so that has value. 

F. Agreement on who will manage the project and the general contractor during the build process.

4. Sign the LLC, close the deal, transfer the land, complete entitlements, complete working drawings, pull permits, build, lease, season the rental stream.

5. Sell the project, pay the lender back, pay the invested equity back - the land value and your cash equity, pay the preferred return, pay the back end profits. Done, do the next one.

I thought I would add to this thread with a more detailed explanation of apartment financial underwriting. Earlier in this thread, I delineated how to underwrite and model an apartment project income and expense summary and construction cash flow. 

Investment Yield Ratios

Here we'll cover investment yield ratios that we utilize as a professional development company, to analyze the return characteristics to determine if a project is worthwhile in our initial underwriting, as well as, provide final financial return reporting on completed projects.

In the development business, these are the major financial ratios used to measure investment yields on equity investment by professional developers, institutional level and mid-size equity investors:

Internal Rate of Return

Equity Multiple

ROI or Cash on Cash

Internal Rate of Return

First, the textbook definition:

Internal rate of return (IRR) is the interest rate at which the net present value of all the cash flows (both positive and negative) from a project or investment equal zero.

Internal rate of return is used to evaluate the attractiveness of a project or investment. If the IRR of a new project exceeds a company's required rate of return, that project is desirable. If IRR falls below the required rate of return, the project should be rejected.

Now, the real world definition:

IRR is the rate of return produced by investing equity into a development project at the beginning of a project's investment cycle (this could be cash used for predevelopment costs, land close, and funds for construction) and getting repayment of original investment plus yield on the invested capital at the end of the project. The major advantage to using IRR, is that it takes into account the time/value of an investment, and allows IRR or rates of return to be compared between investments with different time cycles. You can compare an equity investment for a project that takes 1 year to invest and repay, to a project that takes 7 years to invest and repay, then choose which produces the higher IRR. This is why IRR is used by sophisticated and institutional level investors.

Understand this: the longer an investment takes timewise, the more likely the total IRR will be lower and trend downward. As well, the opposite is true, if the investment time cycle of a project is very short, the IRR could spike very high, especially when an investment period is under one year.

Once the first dollar of equity is invested then the clock to calculate the IRR starts and ends upon the final repayment of the original equity investment, any preferred return (called "pref") and the backend profit splits allocated to the equity investor. We'll explain more about the practical aspects and presentation of IRR's when we write about raising capital in the equity markets.

One item to remember: IRR is not an assessment of risk, and is an assessment of generated returns on invested equity over a given time period. Although IRR can be used to compare investment choices as stated above, you as the developer must make an assessment of risk and any associated mitigations to risk in order to effectively compare potential investments.

Equity Multiple

First, the textbook definition: A ratio dividing the total net profit plus the maximum amount of equity invested by the maximum amount of equity invested. The Equity Multiple (EM) of an investment does not take into account when the return is made and does not reflect the risk profile of the offering or any other variables potentially affecting the project’s return.

There basic formulaic structure for EM:

Equity multiple = cumulative distributed returns / paid-in equity

or

Equity multiple = paid-in equity+yield on equity / paid-in equity

The way I think of equity multiple pragmatically is this: What's the ratio of the dollars I get back based on dollars I put in? EM is a way to measure the whole dollar return of the project given the investment. Many times an institutional investor or fund wants to achieve a certain amount of dollars back from the investment, say 2 dollars for every dollar invested, or a 2.0 equity multiple. This can help them measure and account for the time, energy, and money they invested. Is it worth investing in, if it does or does not return a certain amount of whole dollars?

As an example: An equity multiple of 1.3 is less attractive to an investor versus 2.0 multiple. EM is a static measurement and does NOT account for the time value of money in the measurement. It just says plainly: How much money do I invest, and how much money do I get back, and what is that ratio?

Example: We invested $50,000 in equity in the project, and received total distributions of $100,000. So our EM is 2.0. But, if the time period for the payout was 18 month the IRR might be 40%, but if paid over 10 years the IRR might be 15%*.

* these examples are simplified for this explanation and are not real measurement of yield.

You really want to use IRR and Equity Multiple in tandem, each to measure yield on the project in different ways. IRR is a dynamic measurement of yield that accounts for the time value of money and total investment returns over time. EM is that ratio or measure of the total magnitude of generated yield in terms of whole dollars.

Cash on Cash (COC) Return or Return on Investment (ROI)

COC/ROI = Yield*/Paid-In Equity

* In this case, yield could be total profits generated from the sale of property, or it could be annualized cash flows from income producing projects.

This is a simplified method of calculating yields on equity investments. It is (or can be) a dynamic measurement of yield if applied to ongoing cash flows generated from net rental income. When applied to a one time capital event, a sale for example, it is a static measurement. Some non-institutional investors use ROI as their preferred measurement, in many cases because calculating IRR is a more complicated calculation. But like EM, it does not take into account net present values of cash flows over time, and therefore is not completely accurate and usable to compare alternative investment choices. For our company, we like to use COC to measure the potential annual net cash flows when underwriting development projects that may be long term hold candidates.

Investment Yield Ratios

In Part 1 of this series, we covered the basic organization and structure of an apartment proforma, income and expense summary, and a construction cash flow schedule.

In this 2nd part, we'll cover investment yield ratios that we utilize as a professional development company, to analyze the return characteristics to determine if a project is worthwhile in our initial underwriting, as well as, provide final financial return reporting on completed projects.

In the development business, these are the major financial ratios used to measure investment yields on equity investment by professional developers, institutional level and mid-size equity investors:

Internal Rate of Return

Equity Multiple

ROI or Cash on Cash

Internal Rate of Return

First, the textbook definition:

Internal rate of return (IRR) is the interest rate at which the net present value of all the cash flows (both positive and negative) from a project or investment equal zero.

Internal rate of return is used to evaluate the attractiveness of a project or investment. If the IRR of a new project exceeds a company's required rate of return, that project is desirable. If IRR falls below the required rate of return, the project should be rejected.

Now, the real world definition:

IRR is the rate of return produced by investing equity into a development project at the beginning of a project's investment cycle (this could be cash used for predevelopment costs, land close, and funds for construction) and getting repayment of original investment plus yield on the invested capital at the end of the project. The major advantage to using IRR, is that it takes into account the time/value of an investment, and allows IRR or rates of return to be compared between investments with different time cycles. You can compare an equity investment for a project that takes 1 year to invest and repay, to a project that takes 7 years to invest and repay, then choose which produces the higher IRR. This is why IRR is used by sophisticated and institutional level investors.

Understand this: the longer an investment takes time wise, the more likely the total IRR will be lower and trend downward. As well, the opposite is true, if the investment time cycle of a project is very short, the IRR could spike very high, especially when an investment period is under one year.

Once the first dollar of equity is invested then the clock to calculate the IRR starts and ends upon the final repayment of the original equity investment, any preferred return (called "pref") and the backend profit splits allocated to the equity investor. We'll explain more about the practical aspects and presentation of IRR's when we write about raising capital in the equity markets.

One item to remember: IRR is not an assessment of risk, and is an assessment of generated returns on invested equity over a given time period. Although IRR can be used to compare investment choices as stated above, you as the developer must make an assessment of risk and any associated mitigations to risk in order to effectively compare potential investments.

Equity Multiple

First, the textbook definition: A ratio dividing the total net profit plus the maximum amount of equity invested by the maximum amount of equity invested. The Equity Multiple (EM) of an investment does not take into account when the return is made and does not reflect the risk profile of the offering or any other variables potentially affecting the project’s return.

There basic formulaic structure for EM:

Equity multiple = cumulative distributed returns / paid-in equity

or

Equity multiple = paid-in equity+yield on equity / paid-in equity

The way I think of equity multiple pragmatically is this: What's the ratio of the dollars I get back based on dollars I put in? EM is a way to measure the whole dollar return of the project given the investment. Many times an institutional investor or fund wants to achieve a certain amount of dollars back from the investment, say 2 dollars for every dollar invested, or a 2.0 equity multiple. This can help them measure and account for the time, energy, and money they invested. Is it worth investing in, if it does or does not return a certain amount of whole dollars?

As an example: An equity multiple of 1.3 is less attractive to an investor versus 2.0 multiple. EM is a static measurement and does NOT account for the time value of money in the measurement. It just says plainly: How much money do I invest, and how much money do I get back, and what is that ratio?

Example: We invested $50,000 in equity in the project, and received total distributions of $100,000. So our EM is 2.0. But, if the time period for the payout was 18 month the IRR might be 40%, but if paid over 10 years the IRR might be 15%*.

* these examples are simplified for this explanation and are not real measurement of yield.

You really want to use IRR and Equity Multiple in tandem, each to measure yield on the project in different ways. IRR is a dynamic measurement of yield that accounts for the time value of money and total investment returns over time. EM is that ratio or measure of the total magnitude of generated yield in terms of whole dollars.

Cash on Cash (COC) Return or Return on Investment (ROI)

COC/ROI = Yield*/Paid-In Equity

* In this case, yield could be total profits generated from the sale of property, or it could be annualized cash flows from income producing projects.

This is a simplified method of calculating yields on equity investments. It is (or can be) a dynamic measurement of yield if applied to ongoing cash flows generated from net rental income. When applied to a one time capital event, a sale for example, it is a static measurement. Some non-institutional investors use ROI as their preferred measurement, in many cases because calculating IRR is a more complicated calculation. But like EM, it does not take into account net present values of cash flows over time, and therefore is not completely accurate and usable to compare alternative investment choices. For our company, we like to use COC to measure the potential annual net cash flows when underwriting development projects that may be long term hold candidates.

@Luis Escobar

The answer to your question depends on the nature of the easement itself. @Wayne Brooks could be correct if the easement really precludes building on the surface, but it might not. You indicated this is a drainage easement, which can be fuzzy, meaning is may give the right to drainage over a portion or all or the site. You won't know until you get a copy of the easement and read it. 

So do this: call your local title company or title rep, ask them to issue a Preliminary Title Report and ask them to include backup documents. They may call them by different names in your area, but the concept is the same, you want all documents that are recorded against the parcel of land, that's fundamental to all property. 

Open up the easement and read it, it may be complicated, but in most cases you may be able to understand the nature of the easement. If the legal description is too complicated (generally most are written as "metes and bounds") ask the title company to plot the easement and send it to you. If it's a general easement over the entire property, you will likely see that for yourself when you read it.

If the drainage easement is in a specific area over your site, then you'll know you most likely will need to keep your buildings out of that area. Is there already a drainage channel there? If so, it will be somewhat more clear, and the drainage needs to stay in place. If it goes through the middle of the site or a part that you want to use, you might ask the easement holder (called the dominant tenement, which means they own the easement and control or dominate that area of the easement) if you can relocate the drainage in your new project. They may or may not agree, and you will likely pay for any drainage relocation.

If the easement is general and over the entire property, you might ask the easement holder if a drainage course or structure can be built to accommodate their need for drainage, then redraft the easement to include only that area of the new drainage course thereby freeing the rest of the site from the easement and allowing you to build on it. Again, you will pay for the drainage construction and all legal costs for amending the easement. 

Note: I say you will pay, because that's what any sophisticated easement holder would ask (that's what I would ask) and they do this because they control the situation by owning the easement. You are asking their permission and approval to change things, they'll want to keep their costs low. You can always ask them if they'll share, but if you want them to agree, any incentive you can offer them to agree will help your case.

Hope that helps. 

General note: Our company offers real estate advisory services, DM me if you need more sophisticated help.

Scott

Thanks Fred (@Will F.) !!

Appreciate the positive feedback!! 

Hi Drew: 

You and I have communicated directly via DM, but I thought I might add an answer to your question above.

First, read through this thread we created on the RED process

https://www.biggerpockets.com/forums/44/topics/427...

This thread walks you through the entire front end of the RED (the rest will come as the project develops further). From you other posts, I understand you are working on your parents site, which can/may be a land development opportunity. The info on this thread about zoning research, and hiring a design team are discussed. I will caveat, that the RED process can be exceptionally complex, particularly in the Bay Area, where the growth politics are the most difficult you will ever encounter.

Second, take a look at our BP blog:

https://www.biggerpockets.com/blogs/9960-real-esta...

This has a number of articles on the basics, as well as, more complex subjects such as proforma modeling and project financial underwriting.

Third, here is a more general RED topics Q/A we created:

https://www.biggerpockets.com/forums/44/topics/491...

This has some land development Q/A in it, that may be of help in your situation. 

Feel free to reach out, as always I am an offer of help. By way of background, our company has developed over $900M dollars worth of development projects, including numerous major land development deals. Our last large land deal, we entitled land for 453 apartment units in Westminster, CO. The project was then joint ventured with Lennar's Multi-Family Communities Investment division. I have personally been in RED development since 1983 and my family in RED since 1960.

Take care.