If you understand how residential developers and builders make their buying decisions, you will be likelier to achieve success in buying or selling land. Some builders search for property strictly by geographic area. Others search for parcels that would enable them to reach particular buyer submarkets, such as housing type, price range, lifestyle and age group. Either way, they begin by casting the net into their areas or markets of choice and sifting through potential acquisition candidates. They often have to pick through dozens of properties before they find one they think they can develop profitably and frequently spend varying amounts of time, effort and money collecting information before they even know if the parcel will work. Their due diligence focuses on obtaining answers to five fundamental but critical questions:
What can I build?
How many can I build?
What can I sell them for?
How long will it take to sell them?
What are the costs?
These questions collectively define economic feasibility and influence every decision developers and builders make – from their initial contact with the property, during negotiation of the contract with the seller, through subdivision approval, to the day of closing and beyond.
How do you estimate the value of land for residential development? For starters, you should never price it by the acre or even think of it in terms of X$/acre. Raw land value is not derived from the number of acres but rather from what the property could yield, how it can be used, and the projected sale value of the total package end product (the new home on its lot). Its value is also related to the hard costs (i.e., costs for installing “horizontal improvements” to the site, such as streets, curbing, sidewalks, utility lines, and house construction costs or “vertical improvements”) and soft costs (expenses that will be incurred during the approval process). Accordingly, residential builders and developers do their income and expense projections for properties on a per-lot and not a per-acre basis. For all practical purposes, the parcel's overall size is a meaningless number in the developer's determination of property value.
Here's an illustration:
Suppose there are two vacant 50 acre parcels you're thinking about buying in the same municipality. Zoning for Parcel A requires a minimum lot size of 40,000 SF and width of 200 feet; Parcel B zoning requires 30,000 SF lots and 150 ft. widths. On average, the new homes would sell for $300,000 on Parcel A and $350,000 on Parcel B. Each parcel is fairly level with no remarkable physical constraints. Suppose per-lot improvement costs are ball parked at $56,000 for A and $43,500 for B.
In this scenario, Parcel A would probably be worth around $760,000 (or $19,000 per lot raw) to a builder who was buying fully-contingent. Parcel B, however, would command a price of over $2.3 mil ($44,000/lot). The reason that there's a big difference in the bottom-line value of these parcels is that there are differences in the lot yield, end product value and horizontal improvement costs. In this example, if Parcel A were for sale at $19,000/acre, it would be for sale for a long time because it was significantly overpriced. On the other hand, if Parcel B were for sale at $44,000/acre, it would sell in a heartbeat because it was greatly underpriced.