The Evolution of Land Development

Builders need land, and land needs to be developed

by Manuel Lazerov

There have been dramatic changes in the land development business, especially since the financial crisis of 2008. The recent focus on land development is due to a shortage of finished lots, which is impairing a normal recovery in the housing market.

At one time, the business was dominated by entrepreneurs who would buy land, take it through the review and subdivision process, and sell the lots to builders who had neither the patience or temperament for that kind of activity. Typically, builders prefer to purchase land and apply for a building permit soon thereafter, holding the land for a short period of time in order to finish the construction of a house, which normally takes about one hundred and twenty days.

The land development process, however, is lengthier. It often requires zoning, community meetings, securing the approvals of local, state and even federal engineering agencies, and creating multiple drawings and plans before even being able to sink a spade into the ground. Consequently, builders were delighted to pay land developers to do that kind of work. In the past, a land developer could take a lot through the process in about a year or two. However, that time became longer as environmental laws became more complex.

At one time, the relationship between land developers and builders was pretty well-defined. Very few companies did both. As the economy grew, the scale of the business grew as well, and building shifted from small operators to regional and national companies. At the same time, there was a commensurate need for the development of larger parcels of finished land, which is land that had gone through the review process and had utilities and streets already established. Larger builders needed lots by the hundreds so that they could be assured of being able to build over a period of years in one spot.

This necessitated that land developers be able to commit large amounts of capital over a period of several years, most of which they borrowed, so that builders could take down finished lots over time. This was facilitated by land developers getting a contract from a builder to buy lots at a predetermined pace which generally reflected an estimate of how fast houses could be sold. It was a negotiation, but builders didn’t want to get stuck with land for which there would be no homebuyer. The general compromise reached was that builders would settle on a couple of lots, build a couple of models, and have an option to settle on the rest over time.

The housing business is highly cyclical, and there were times when months could go by without a sale. In recognition of that, builders and land developers had a tacit agreement that, in order to move the project along, both would cut their prices to “work out of a slow deal.” Builders needed sales, and land developers needed to retire loans they had taken for land development, which is how they worked together when housing slowed down.

During the financial crisis, the entire model was upended. Builders became deeply concerned that they may not be able to survive. Some builders had also decided to get into land development when sales were robust, so as to get more profit out of each house. When housing collapsed during the crisis, they had huge amounts of unapproved, undeveloped land on their books with no customers, as well as obligations to buy land from developers, some of whom they had partnered with.

Banks were under enormous pressure to get those non-performing loans off of their books, which included land held by builders and land developers for which there was no market. This time, however, builders did not attempt to “work out deals”. What they did was unceremoniously default on their commitments to buy land, leaving many land developers stranded, or even bankrupt. All of those barbeques and dinners, all of those relationships were dumped in order to survive.

Fast forward to today. Builders need land, and housing is not as robust as it could be because of a lack of finished lots. Land developers will no longer make the type of deals that caused so much financial hardship after the financial crisis. Today, a builder will have to put so much down on a piece of land being developed for them that, should they ever default, it would have a real financial impact and, at the same time, insulate the land developer from financial exposure.

The financial crisis also transformed the business from one where a couple of partners combined their resources to develop land to one which now requires institutional resources. Review times are considerably longer, with approvals taking as much a decade. Public resistance to development, far more complex environmental regulations, stricter controls over bank lending, the difficulties of zoning, stringent credit qualifications, the lack of adequate utilities, insufficient public schools, and fees charged by state and local government have contributed to dramatically rising lot prices, which in turn has driven house prices to high levels. It has also greatly diminished the possibility of delivering affordable housing.

Manuel H. Lazerov is President of Infrastructure Financial.org. He may be reached at Lazerov@InfrastructureFinancial.org

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