So, you want to be a developer?
C. Edward Boyle April 30th, 2008
During the course of their careers many real estate agents and professionals come to the understanding that real estate brokerage is really the facilitating of the transfer of wealth (real estate equity) from one party to another. On the other hand, the development of real estate (putting raw land to use, or putting land to a higher or better use) is in fact the creation of wealth. It is easy to jump to the conclusion that there is more profit in creating wealth than in transferring it. As a result, many agents decide to become developers. Sometimes, property owners and many others make a similar decision – to become a developer.
The draw is obvious. Take a property and add some capital and work – earn a profit. The difficulties are less obvious. But any venture will be fraught with difficulties. Most of the time, these can be completely or partially overcome. But not always.
During the course of several articles, we will examine an overview of the elements involved to be a developer. You will note that the previous sentence did not say successful developer. No series of articles can assure that. Diligence on the part of the entrepreneur, good judgment and financial capability on his/her part, and some element of luck will determine the outcome.
The first thing that must be recognized is that pre-planning and proper assessment of the market is required before success can even be contemplated. This does not mean that a full-fledged feasibility study will be required, but sometimes it will.
Preplanning and feasibility include (but is not limited to) such elements as follows:
Into what can the subject property be developed?
Does the market have a need for such a product?
Will the need still be in evidence when the project is completed?
Does such a plan conform to the land use in the neighborhood?
Will the neighborhood embrace the project, ignore it, or fight it?
Are there critical areas or elements that will add uncertainty?
Does the comprehensive plan allow for such use?
Does the zoning allow for such use?
Is the off site infrastructure in place to support such a use?
How much will the land cost?
Approximately how much will the development or redevelopment cost?
What will the property be worth when the development is complete?
Is there an adequate profit available for having gone through the trouble?
We will examine, briefly, each of these elements, in turn.
The start of any project is having a vision as to what the end product will be, how it will look, and how it will help the marketplace by providing a product that is needed. It helps if you don’t try to swim upstream. If, for example, the land is designated in the comprehensive plan as “5 acre residential” and is zoned as “5 acre residential”, and is surrounded by other undeveloped land or land already developed into 5 acre lots – don’t even dream of 5 lots to the acre or 1 acre lots. It ain’t agonna happen!
On the other hand, don’t be discouraged from trying to get a higher zoning. Sometimes it makes sense to you and will make sense to everyone else, as well, if you can sell your vision to them. It may be possible, for example, to “up-zone” single family residential land to apartment land if that land is contiguous to commercial use. Putting apartments between commercial and single family residential – as a buffer zone – is a commonly accepted practice and main gain favor.
In the movie Field of Dreams, the hero was admonished “Build it and they will come”. This advice might be nice for the movies, don’t bet your bankroll on it in real life. There are platted lots all over the country that have never had houses built on them. Some of them even have paved streets, sewer and water, and the entire infrastructure required to “just start building”. The problem is that there was a product completed, but no market need. Failure to properly assess the market led to a complete project failure – and a bankrupt developer. Maybe even disgruntled partners and angry bankers. It is also important to try to look into your crystal ball to see if there will likely be a future need for the product. You must keep in mind that years may lapse between the concept and market ready end product. Markets and market influences change.
An example: In the late 1960s a study was done that indicated a need in the Burien area for a number (just a couple hundred, as I recall) of additional apartment rental units. Everyone read about it in the newspaper, including a number of builder/developers and some bankers. As a result, a number of different builders moved to enter that market. Each of several banks financed the construction of all or most of the identified number of units. As the construction was occurring, Boeing entered a severe downturn. The end result was that an oversupply was created while the quantity of available tenants declined. Vacancy rates soared.
The pre-existing apartment buildings were affected with increasing vacancies, the new buildings only partially filled, and many investors found that they could not meet mortgage payments. The condition of the multi-family housing stock declined due to inadequate maintenance budgets, and ultimately many buildings were lost to foreclosure. When the properties went to auction, often no one outbid the banks (which bid their mortgage amounts), so a number of properties became REO (Real Estate Owned) in various bank portfolios. Not looking into the future on the part of a few resulted in financial difficulties for many. It took nearly a decade for the Burien apartment market to recover. During that time, no new buildings were erected.
Comprehensive Plans are fairly new, but zoning has been with us since 1932. A Supreme Court decision in the “City of Euclid” case held that governmental entities had the right to dictate that certain uses were incompatible with other uses, and could thereby control, by ordinance, uses to which land could be utilized. This governmental regulation of land use started with every good intention and a justifiable need.
The original intent was to create a device that would prevent such things as a rendering plant being built in an existing residential neighborhood. Such an event would render (pardon the pun, but have you ever smelled a rendering plant) real damage to the pre-existing properties and their market values – not to mention possible health issues, etc. As is usually the case, government and bureaucrats continued to extend their control and influence on land use to arrive at where we are today. Then, of course, there has entered the environmental considerations. Slopes, wetlands, proximity to rivers or lakes or streams, former land uses and possible resultant contamination – all of these are considerations which will impact the possible uses of any given piece of land. As a potential developer, you need to address these issues. Look before you leap.
Even if a use is permitted, it may not be clear sailing. Every full time developer can tell you from their own experience anecdotes about being delayed because of neighboring property owners, area community councils, NIMBYs, and other “interested” parties. Often the objections are without substance or merit, but the delays they cause are very real – and time lost is money lost. Personally, I have experienced such delays. Once, at an informal meeting with neighborhood residents, I was told “We may not be able to stop you, but we can sure slow you down.” This was for a completely compatible subdivision development It cost me more than $50,000 and a year’s time to overcome their objections. Their real objection was that they treated my 8 acres of land as their children’s forested park and their yard waste dumping area. They didn’t want to lose that.
Lastly, you need to develop a Pro Forma income and expense schedule. The usual motive for private parties in developing property is profit. If a realistic budget cannot be developed showing enough profit to make the exercise worth while, run –don’t walk- away from project. Don’t count on price escalations either, because that’s something on which you can’t depend. If a projection developed on today’s end product prices doesn’t work, the project doesn’t work. Just consider that the time and money expended to arrive at this decision was an insurance premium, and “move on”.
When doing your pro forma, don’t forget that there are two sets of costs. The first is what we call Hard Costs. This includes the costs for clearing and grading, putting pipe and wires in the ground, paving streets, pouring curbs, gutters and sidewalks, installing street lights, street signs, etc. Hard costs are generally easy to estimate fairly accurately – but not always. Sometimes an alligator will reach up and bite you in ways that you cannot foresee. I have had occasion, as but a single example, to see street costs soar over budget because of difficulty in getting required compaction. This was true despite the fact that professional geophysical testers were hired during the feasibility study and paid for reports which proved to be inaccurate or inadequate when construction began.
The second element of costs is Soft Costs. This includes (but unfortunately is not limited to) the following list of elements: Engineering and/or architectural expenses; the cost of borrowed money, both interest and “points” for the acquisition and development loan; surveying costs; costs for studies such as geotechnical studies, wildlife studies, wetland studies, hazardous material studies; traffic studies; construction impact studies, and if all goes badly, full environmental impact studies. Then there are fees to be paid – project application fees; plan review fees; utility design fees; final product review fees; construction inspection fees; utility hook-up fees, and others as the different governmental bodies may discover or invent. Every project should have a contingency fund for unexpected cost over-runs (they will occur). Then, of course, there are mitigation fees; for traffic, for sewer, for water, for parks, for schools, —-. Some of these may be passed on to future users such as the builder if you are developing residential lots for sales to builders.
If all of the above looks good – go ahead and start getting rich - maybe.