Last week, a few new investing partners and I took a drive around our neighborhood looking at potential short sale…
Author Craig Grella
To recap Residential Land Development Part 3 we discussed researching zoning, designing your home, and financing the property. In this…
To recap Residential Land Development Part 2, we discussed the importance of performing an economic feasibility study with cost estimating to determine a max price land offer and whether or not there is enough profit in your potential deal to warrant spending more time on it, or actually developing the land.
Assuming you’ve done that initial research and arrived at the conclusion your numbers look good, you’re ready to go back and do it all over again. This time you’re going to be more exact with your numbers. To do that, you’ll really need to hone in on the potential design of your house, and to do that you need to research what’s possible on your lot. You do that by learning all you can about the zoning codes in your city. These are the third and fourth steps in the residential land development process.
This is Part 2 in the Residential Land Development series showing you how to find, price, and develop land for residential single family property.
If you’ve followed Residential Land Development Part 1 you’ve put together your development team, done a little research into the type of property you want to build and the market you will farm for potential land purchases. You’ve determined the highest and best use, researched zoning and other legal matters, and now need to determine the economic feasibility of the project. We do this by estimating the overall costs of the project. The results of your down and dirty, quick economic feasibility analysis will determine whether you move forward with your project, or whether you dump it and move on to the next piece of land. Here’s what you’ll do:
Last week I wrote an article describing how to price and develop offers on land purchases. While that information is an important part of the overall development process, it is only a small fraction of the work that needs to go into developing land for residential use. As such, I’d like to explore the residential land development process in a more thorough manner, which will include this article, and several to follow.
With that said, this article will focus on the process of land development, risks and rewards, and a few things you’ll need to get started in the business of Residential Land Development.
Land development is the process of preparing raw land for the construction of improvements.
It can include:
- Demolition of existing improvements
- Clearing and Grading
- Rezoning if required
- Installing utilities, sewers, streets, and sidewalks
- Constructing Improvements like driveways, foundations, and building pads
Although developed land creates no more income than raw land, it is nevertheless brings land one step closer to its ultimate use; a home, apartments, office buildings, hotels, etc.
Pricing land for development can be a daunting task for the untrained investor. As a niche subset of both residential and commercial real estate, using comparables for land can be as dangerous to a developer as it is mysterious, sometimes causing the failure of what was certain to be a fantastic development.
However, for the savvy investor, there is one universally accepted land valuation method used by development professionals, corporations, and appraisers alike; the Land Residual Method. By using this method you will be able to determine the current and future value of any piece of land, whether its use be residential or commercial. You will also be able to price land, such that any development you propose will have built in profit. With some practice, you will be able to employ the land residual method in just a few moments, summing up the value of almost any property just on sight.
The land residual method has a fancy sounding name, but to use it all you need is an understanding of some simple math. The land residual method is a calculation that takes the highest and best use of a particular piece of property and subtracts out the total cost of development to arrive at the residual value: the land value. Once you have the numbers it’s that easy. “How do you get the numbers?” You ask. It takes some research, but even a novice investor can figure it out relatively quickly.
For the sake of this article I’ll be speaking to residential single family development or single family lot land. Rest assured, commercial development uses the same principles, though the calculations are a little more in depth.
It’s no secret that the real estate market is at its worst since the great depression. It doesn’t help that most of the media seems to set their sights on publishing only articles that highlight the latest crash or the biggest loan scandal. Defaults are rising, foreclosures are at an all time high and Realtors are leaving their jobs to pursue careers in acting.
It’s not really as bad as it seems though. At least, not in the long run. Boom and bust cycles are nothing new, and thankfully there has always been a boom that followed a bust. In part due to the investors who sweep with the time tested strategy of “buy low…sell high.” The time has come to prepare for the next boom cycle, and those who can invest now will find great wealth in the near future.
You may be saying, “Thanks for the tip, Craig. Tell us something we don’t know. Problem is, we don’t have any money to invest. How do we do it.” Great question. Let’s start by discussing how not to do it.
How Not to Get Money to Invest
A simple search on BiggerPockets for the term “bulk reo” yields over 400 forum posts and articles about buying or flipping bulk reo portfolios. Go out further by searching “bulk reo” on Google and you’ll find just under a half million results. Take a moment and read a few of them and you’ll notice many newbie investors stating their plan is to go out and search for the mother lode of REO portfolios, buy them at four cents on the dollar and then wholesale them at twenty five cents on the dollar. They all plead for other people to invest with them stating if they could just pool some money they could go out and take over Citibank’s entire portfolio. Mostly, those posts go unanswered or just get ignored, the would-be investor tucks his tail and moves onto the next brilliant money making scheme. That’s a great example of how not to do it.
I don’t mean to pick entirely on newbie investors because there are many seasoned investors out there using the same strategy. We all understand the math of “buy low and sell high” but it begs the question:
How is it that Sam Zell, even during bankruptcy, can raise $600 million to buy property in this market when you can’t raise a dime? The answer: he’s got a plan and you don’t.
That is… until now!