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While "location, location, location" is certainly important, capital is king in the development game.
Everyone in pursuit of capital in today's real estate development environment is striving for access to equity investors - especially when it comes to residential land development projects and master planned communities. Today's reality, however, is that traditional methods of capitalization from the big Wall Street investment banking houses are becoming significantly more challenging - if not impossible - to secure.
From a financial perspective, it appears that everyone and their brother is a wannabe developer. The very fact that inexperienced individuals are entering the market and vying for the same capital that the experienced developers are seeking is seriously clouding the capital markets. This means that even the experienced players must significantly differentiate their projects from the rest of the pack.
The result is that the primary issue when seeking capital for a development project today is the lack of quality projects that actually attract investors' attention.
The Challenge
The challenge for developers is to effectively position the project to make it attractive to traditional and private capital investors. Developers must go back to the basics of getting the right people onboard first, even if it requires hiring professional help to get the job done.
Effective positioning enables equity capital investors to clearly see a well thought out development business plan.
Investors also want to know that the developer leading the project has the experience to successfully complete the development. Both are critical factors in successfully procuring capital. Increasingly, capital providers are embracing the importance of "capital engineering."
The Capital Engineering Process
What is capital engineering? It means turning over every rock and mitigating the hurdles so capital investors will naturally be attracted to the project. The first thing investors want to know is that the developer has discovered and addressed all the primary development hurdles prior to submitting the project for capital. This is why proper capital engineering is critical to the process of getting an investor to take a second and third look at a deal. They are also looking for the developer to have meaningful capital of their own in the transaction (or skin in the game) so investors know the developer is fully committed to the project's success.
The capital engineering process encompasses much more than brokering the deal or finding the capital. Capital engineering, when properly executed for a project, will make it stand out and be attractive to the capital markets.
While location will always drive real estate market fundamentals, the capital markets are interested in well-thought-out and proven deal points. They require thorough due diligence; and in some cases, full market studies. Once conducted, investors have more confidence that the development hurdles have been identified and can be satisfactorily mitigated.
Successful projects have the following characteristics that generally appeal to the capital markets:
<> Location: Good to great locations are a necessity. Marginal locations won't get a second look. >
Entitlements: Investors prefer an easily understood or proven entitlement process.
Developer Commitment: Developers must invest their own capital in the project of at least 10% of the total equity required for the deal to be funded.
Healthy Balance Sheet: A good balance sheet is required to attract the horizontal A&D (acquisition and development) capital to complete the project. Alternatively, the developer must be willing to consider joint venturing the deal with a proper sponsor that can enhance the balance sheet.
Exit Strategies: The developer must be open to multiple exit strategies since the market will dictate how a deal ultimately is executed.
Soft Cost Funding: The developer must be prepared to fund soft costs to get the project positioned and ready to submit to the capital markets including full due diligence, capital engineering, and packaging - or be willing to joint venture with someone who will fund the soft costs. Soft cost examples include: land contract deposits, land planning, site engineering, legal fees, market studies, and other related consultant or professional fees required to bring the transaction to market.
Flexibility: The developer must have the right expectations in responding to investors' suggestions and requirements prior to and after funding.
The Market
As in any business investment, investors in residential land development projects and master planned communities must believe in the market or they won't buy in to even the best packaged opportunity. This means developers who focus on projects within the logical path of growth will gain investors' interest due to the fact that market and absorption rates will be easy to understand and quantify. The contrary point is developing anything far outside of the path of growth which will become more difficult but not impossible to prove out the market. Developers must realize that it is important to understand how investors view the market, because investors will always prefer the sure thing to being a pioneer in a new market.
The one exception to this is the "build it and they will come" project. This is usually a unique project outside any major path of growth and will require a significant marketing program to secure sales, and most importantly, to attract capital. These projects are becoming more popular and the capital markets are beginning to invest significant dollars in them, but the developer will be required to have significant skin in the game and have hired the best of breed in every field.
While both of these project types can attract capital, there are far fewer sources of capital willing to play in the "build it they will come" development. The latter will put a heavier burden on the developer to prove out and package the opportunity prior to submission to investors.
The Opportunity
With the ever-increasing appetite for newly developed land and the demand for new homes, the opportunity for developers to procure, entitle, and develop land appears to be never-ending. Sustained business and profits will be achieved by attracting and developing relationships with capital partners for the long haul. The competition to acquire raw land is becoming a relentless race to see who can tie up prime development land in the path of growth. In many cases, several entities or individuals are often bidding for the same parcel of land. The typical developer in this instance falls into one of three basic groups:
1. The public homebuilder, looking for ways to control as many finished lots as they can get their hands on.
2. The private homebuilder, looking for ways to compete with the publics by buying and developing lots for their own homebuilding operation.
3. The land developers, who sell their paper or finished lots to the homebuilder market.
The greatest opportunity lies in the hands of those who can execute on the acquisition, entitlement, and development of the right parcels of land in their respective market. The ability to successfully underwrite the project and have it engineered for the capital markets in the most efficient manner will provide greater access to better opportunities and increased profits over the long term. The capital markets are searching for developers who get it - those who will take the right approach to the development and have the right expectation of how a deal can be structured and financially engineered.
The bottom line is this: there is more money available than will ever be placed, simply because it can't find its way to the right developer or their project. Therein lies the opportunity for the developer who can crack the capital markets code.
The Solution
Capital engineering is a hybrid between three different business disciplines, blending the experiences of all to create a better solution. It consists of the expertise of a real estate advisory firm, a developer, and an investment banker. While each has its own ideology and specific role, when executed together, they bring a remarkable business model that is gaining respect and traction in the marketplace.
The fundamental truth is this: even the largest homebuilders and land developers in the country will spend a significant amount of time and money prior to funding a project, making sure they get the most out of a land development opportunity. They have some of the brightest people in the industry testing and proving out assumptions, trying not to make a mistake.
The capital markets take a similar approach, in that they want to hedge their investment by ensuring complete and thorough due diligence - and by focusing only on the best opportunities that are presented to them. Investors are adamant about not wasting time with someone who doesn't have skin in the game or who doesn't have their project positioned and engineered to be successful.
The effort and process of capital engineering a project to give it the greatest likelihood of attracting capital may require hiring professional advisors who can objectively present a case study to investors as to why they should invest in a given transaction. SLDT
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Sustainable Land Development Today 
