I have listened to every one of your podcasts since Dec 2018 and because of your influence in my growth as a real estate professional I’m now working with an experienced developer and we currently have 83 acres under contract. I’ve attached the details to this email. I personally would like to develop a community designed for resilience. What are your thoughts?
John,
This is a great question and one that often perplexes new developers. The specifics of your proposed development project don’t work in the current market conditions. The land can be seen as a bargain. 83 acres for $900,000 comes to $10,800 per acre or about $0.25 per square foot. That’s not quite free, but it’s a very attractive price for raw land.
The problem with the specific proposal you sent is that comparable sales in the area range from about $135 per SF to about $180 per SF. Since new home construction in today’s market is costing about $150 per SF, and you also need to build the entire subdivision including roads, utilities, storm water management, landscaping and so on, the values in the area are not supporting new construction at this time. The infrastructure is going to cost you anywhere between $30,000 to $75,000 per buildable lot. Some items can really add to the cost. Don’t forget you need to bring fiber internet service at a cost of $7.00 per linear foot to each property. All of these costs are significant and it would cost you more to build these properties than the current local market is attracting in sales prices.
But by far the biggest cost is the site work and offsite improvements required to bring the infrastructure to the site. Many of the lots are larger lots. Even though the land is inexpensive to purchase, the cost of creating a shovel-ready lot can still be considerable.
The value of the particular property about 30 minutes outside Dallas will vary as a function of time. There has been some growth in the local area in recent years. Most major cities tend to grow outwards. Eventually those outlying areas become close enough to the city that people are willing to move there.
People move to the outlying areas for two major reasons.
- They’re in search of lower cost real estate because the city has become too expensive.
- They prefer to have more space and be outside the city. But they want to be close enough that they can drive into the city whenever they want to.
I find it useful to examine what major developers have done historically. They know that the land doesn’t support development today. So they will purchase land a few years ahead of their planned development and simply land bank it. Land banking is extremely effective, but it ties up cash. Land doesn’t generate cash flow. So the entire investment will likely be made with equity and zero debt.
The major developers plan a few decades ahead in their land acquisition. They will buy land inexpensively and sit on it until it becomes worth developing. At that moment, they look like geniuses. Land will sell for 100 times what they paid for it. But remember, they took the risk, tied up a bunch of cash and sat on it for a long time waiting for the growth of the city to create the value in the outlying area.
In retrospect when you run the math on the initial investment, the annualized rate of return looks incredibly healthy. But it’s a bit like melting ice. You might start out with a block of ice at -40 degrees. You start by adding heat. The temperature rises slowly, bit by bit. After a bunch of years, the ice is still 10 degrees below freezing. Then one day, you reach a tipping point and the ice melts. But you have to keep applying heat and have faith that the ice will melt a long distance into the future. So it goes with land banking.
