It is pretty tough out there. Between the housing crisis, the energy crisis, steadily increasing unemployment,  and overall global economic inflation, we are running out of things to be worried about. In our land development microcosm, things are downright miserable. With debt tougher to come by, equity riding the bench, and buyers home sick, is there anyone left to play? Should we expect worse?

Follow the leaders
If you have been in this industry a couple cycles you know all too well that owning land is expensive. This market highlights the fact that land values are the pejorative “hot potato” as it pertains to risk. With property taxes, liability insurance, and maintenance expenses, (and did I mention lack of current cash flow?) why would you want to own unentitled land in this economic climate? Besides, unless you are akin to royalty, land financing options are few.    

Misery in the markets
From a debt standpoint, it’s awfully tough to get a loan right now on entitled and pre-development land. And if you have unentitled dirt, you might as well put up your internal organs as collateral. It used to be that 40-50 percent of loan to value (LTV) from your local/regional bank would do the trick. Now you are likely to get laughed at by your bank as they struggle to dispose of their existing land loans to a dried up secondary market.

Sure, existing commercial product is readily financeable, but the writing is on the wall. Lower LTVs, higher debt coverage ratios, and exit capitalization well above 100 basis points in some sub-markets spells trouble for low CAP rates we have become accustomed to (which, if you haven’t noticed also adversely affects the underwriting of the product we wish to create in the future). This adds to the anxiety of traditional development lenders.

So maybe debt isn’t the answer to financing your development project today. How about equity? If you can find it, there is plenty of money out there.

But investors are stingy. The pension fund spigot from which we drank with pride and revel is switched off. And private equity funds wear with pride the badge of “vulture” in search of decaying deals left in a flourishing market once kept alive by brokers, investors and hype-sters from coast to coast. If a deal can be found at twenty to thirty cents on the peak-market dollar, then equity money can be had (at an expensive price). Unfortunately, as more deals are found at these prices, equity maintains the luxury of selectivity. Real Capital Analytics just completed a nationwide survey of land values suggesting that the price per buildable SF of land earmarked for retail development averaged $44 this year, compared with $80 in 2007. The average price for attached residential is $87 this year versus $151/SF in that same time period. Tough times if you are in the selling mode or looking to refinance without having deep equity pockets.

Option, my friend, option
When times are good, markets are hot and demand for land is high. Sellers tend to want high prices and quick closes. Can’t blame ‘em for that. Not the case today. No, while Mortimer and Randolph Duke are busy selling, we need NOT buy. We must option! And for good reason. The cost and risk of ownership for developers is too high while project financing options are too few. If money is to be spent, it shouldn’t be on holding costs or taxes; rather on development applications and design for projects of the future.

Options can be as simple or as complicated as the transaction requires. For example, one popular option on raw land would be to acquire “subject to” approvals of the city council or county municipality. Another scenario is to option subject to construction financing. Whatever the case, you can control the land for a period of time at a fraction of the purchase price. Don’t get me wrong, pitfalls do exist; like a market downturn or a denial of approvals. But what’s worse: a denial of approvals after acquisition or denial of approvals when you can kick out of an option? Your financial exposure is substantially limited in the later scenario. The upside is even better. Consider your cost of capital. You can increase the paper value of your dirt through approvals with little cash down, thus positioning yourself better for acquisition financing. The window for options is now open with greater inventories, deteriorating land values and sellers eager to demonstrate to their creditors that a buyer is in place for their land.

With options, we can control the land, process our developments through starving municipalities and be in position when the misery subsides. New market mantra for land: ‘option low, sell high.’ SLDT