Risk Management In Land Development
Land development as a very risky proposition in my opinion. There are a hundred reasons why, but I would narrow it down a bit by pointing out that the costs are pretty much all front-loaded and there is no guarantee of a return. I also need to factor in time as to when any possible return on the investment will be realized, while estimating future market value of the end-product. I also have to remember that any profit will be realized only toward the end of the sales cycle, since up until then I will just be recapturing cost basis. However, there are positive ways to work with these stark Land Development Realities.
Here’s one example
Recapturing acquisition costs to reduce risk - A guy I worked for assembled several pieces of raw land in the Forestry Tax Classification from different owners. He closed on all of them and wound up with an aggregate total of over one thousand contiguous acres. I was brought in for the development part afterward, but in looking over the financials upon arrival I saw something very interesting that can apply to properties of many sizes, not just bigger ones like this.
He paid a little over one million in total for this rural assemblage from cash, no financing. Before he even finished closing he had hired a Certified Forester to timber cruise the properties. It was a mixed stand of timber and the merchantable part was mostly cedar, fir, hemlock, alder, and a few other mixed species. The forester was a top-notch professional and knew what was marketable and what could not be harvested, considering that some of the bigger trees were in wetland buffer areas or on steep slopes that would be No Cut Zones in the permit. He also knew current market values and could reliably project future stumpage prices in the short term.
The Forester applied for a Class IV Conversion Option Forestry Permit. That way a conversion from forest land to another development use was already contemplated in the permit application. Anyway, it was approved in a few weeks at minimal cost. I wasn’t around for the actual harvest, but the P&L told me later that the owner brought in 1.2 million in timber harvest sales in less than a year after acquisition. So, this very smart guy shelled out 1 million to acquire, then quickly brought in 1.2 million in timber revenue in in less than a year and more than recaptured his initial cost basis. That can really take some pressure off……
(A cautionary note on the above example. Notice there was no harvesting of timber until my client actually closed on and owned the described property outright. I would never, ever, ever, let a third-party harvest timber on property that I own. Some guys out there, and I won’t say who, will contract the land and cut the timber, then run leaving the land owner to “hold the bag” by never closing and leaving him responsible for any harvesting violations. More on “Cut and Run” in an upcoming post on forest practices).
Basic ways I manage risk prior to acquisition
Like all things real estate, risk management is property specific because each piece brings unique risks, but I do use some general guiding principals:
· Is there a way to recapture acquisition costs on the front end?
· Do I have a realistic Pro Forma cost projection?
· Do I have a contingency line in the projection for unanticipated costs?
· What is my Plan “B”? What will I do with the land if Plan “A” doesn’t work?
· Have I developed my plan with the appropriate professionals, such as a civil engineer, environmental consultants and land use attorney?
· Have I contracted for enough inspection time prior to closing?
· Did I make provisions in the contract for extensions based on my feasibility inspections?
If I start thinking that I’ll figure stuff out later, after closing, I need to think again. A nightmare for me is owning a property and then the plan goes sideways resulting in a long delay because of something I should have known before closing. Remember the old saying: “Dirt is a lot easier to buy than to get rid of”.
Basic ways to manage risk after closing
· I keep great financials.
· I create a Critical Path – a step-by-step timeline with benchmarks for key progress points.
· Is my team in sync with each other? Engineer, Environmental, Legal etc.
· I track costs daily. That way I can see if I start to drift.
· Review every cost for efficiency.
· Stay current on proposed permitting changes that might affect the project.
· Know who is opposing the project and might testify at the Public Hearings. Then reach out.
· Keep adjoining landowners informed on key activities, especially construction.
· Keep an eye on other development projects
· Closely monitor market value changes.
Time – Tick Tock
I have to admit that my biggest single failure in project management is time itself. I have consistently gone beyond expected time-to-completion estimates. I have tried many ways to mitigate this but in the end there are things I can’t control or project. One example was during a boom time where county staff was taking months to review applications because of the glut of plat applications stemming from an unexpected change in the development permitting code, combined with a great market. Everybody was filing.
Areas of Risk
A sober and realistic view of financial risk is a big issue. As stated, this is a front-loaded investment that just keeps taking and taking, sometimes more than I think. Entitlement and permitting can, and frequently does, take more time than expected. Entitlement delays can create liquidity risk, so I always remember my contingency costs in factoring my estimates for the unknown. After acquisition and before submitting a vested application, development laws can change, as described above. This is when a solid Plan “B” is essential. If money is borrowed interest rate changes can come into play.
All the same, land development can be extremely rewarding both financially and for the satisfaction of a job well done. I just make sure my eyes are wide open as much as possible. This gets me to thinking about not only my style, but also the risk characteristics of other folks that I know who have been consistently successful in land development. Here is what I have observed over the years:
10 Traits of consistently successful land developers
· thinks before they act
· does their homework
· has a high risk profile
· follows applicable laws
· hires professionals when needed
· realizes when professionals are needed
· is visionary and creative
· keeps good financial records
· wants to make money and is willing to invest it with no guarantee of return
· realizes that there is usually heavy up-front spending before a profit can be realized
10 Traits unsuccessful land developers
· already in trouble with a property and is looking for help
· won’t hire an attorney or other professional when needed
· has a low risk profile
· “Cowboys” – defined as: “moves dirt first, then gets permits if caught”
· signs written contracts they do not fully understand
· participates in verbal agreements for real estate matters
· underestimates costs
· tends to “figure things out later”
· Is looking for fast and easy ways to make money in real estate
· Does not understand that development is about following rigid rules
So, LDR tries its hardest to be in the first group. If I do, my chance of success are as good as they are going to get. I have failed many times along the way but if I understand risk and mange it proactively, I stand the best chance to get the satisfaction of a job well done. It is a high risk / high reward proposition and a key measure of getting the reward is knowledge and active, thoughtful management. I don’t hold all of the answers, so I make sure I have a solid team of experts. No one person knows it all in my world, but collectively we have the capability to be effective across the spectrum of challenges.