Buyers of development and residential real estate pay the sellers some or all of the purchase price in exchange for a deed to the property. The similarities between these two types of transactions pretty much end there. The methodology for selecting, evaluating and pricing development property, the way the deal is structured, and the time frames for closing are radically different.
What You See & What You Get
When you’re buying a home, usually everything you need to know about the property is obvious. The exterior, interior, major systems and appliances are, for the most part, visible. If you’re buying land, you can’t discover the relevant facts by eyeballing the property. Most of what you need to know in order to decide if you should buy it is not obvious. This is why due diligence plays such an important role in land development deals. Buyers must investigate a myriad of issues, including zoning, sub-surface conditions, wetlands, soils, topography, environmental hazards, utility line locations and floodplain areas. The need for this research continues well beyond acceptance of the buyer’s offer and involves the efforts of a diverse team of players.
Settlement Time Frames
Residential resale properties change hands in 30-90 days. Transfers in new construction can require 180 days, and true custom homes might take up to a year. Time frames in land development deals tend to be much longer. Although the time elapsing between offer acceptance and closing depends on the contingencies and nature of the deal, usually settlement doesn’t occur for at least 12-18 months. After a purchase contract is signed by both parties, buyers and their development teams spend months collecting all of the relevant data. During this “feasibility period,” buyers determine if they want to proceed with the deal based on the information uncovered. If all systems are a “go,” they would then apply for the municipal approvals (e.g., zoning, use, subdivision, land development) necessary to implement their intended development scenario.
Home buyers condition their offers on getting a mortgage or being satisfied with certain types of property inspections. These contingencies are usually satisfied within weeks of the offer acceptance. Several prior articles (including “Price + Terms = Land Development Contract”) discuss the types of development contingencies in land deals. Land buyers don’t want to have to purchase the parcel unless they are permitted to do what they want with it, so they make their purchases conditioned on zoning changes, use permissions, plan approvals and permits.
Pre-printed forms used in home sale transactions are not designed to address the special needs of land deals. These contracts have to be customized to address issues unique to the potential development, subdivision and use of the parcel. Buyers and their attorneys create their own “base” contracts, ranging anywhere from 5 to 30 pages, and modify them as circumstances warrant.
Determining Market Value
Real estate agents or brokers give prospective sellers a CMA (Comparative Market Analysis) that estimates value based on recent sales of comparable properties in the area. Appraisers arrive at an opinion of value through a much more detailed analysis of the residential property and the comparable sales. Buyers estimate the value of development property by applying rules of thumb and pro forma analysis. Value is based on factors including the projected sale price (or rental income), site yield, and expenses.
Although every parcel is unique, differences among residential properties are generally reduced to finite, visual conditions such as house and lot size, location, the amenities of the house and its condition. The evaluation of development real estate is more complex because it takes into account a broad range of variables that impact the suitability and development feasibility of the site. Physical features (e.g., topography, size and shape, vegetation, soils, structures), zoning classification and utility access give each parcel its own unique “fingerprint.” Each property must be evaluated in the context of issues that are specific to it and that define its potential for development.
Buyers and sellers of residential properties often turn to attorneys, real estate agents, home inspectors and financial advisers for help in the transaction. Land deals require assistance of individuals with expertise in a variety of disciplines, including civil and traffic engineers, land planners, wetlands specialists and environmental consultants. The type of property and proposed development generally dictate the size of the team and the expertise needed.
One of the most striking differences between residential and development property transactions is the extent to which emotions influence buyers’ decisions. When Mr. and Mrs. Buyer fall in love with a home, that emotional attachment can cause them to not realize that the property is fatally flawed as an investment. Not so with purchasers of development property. They cannot afford the luxury of becoming emotionally attached. Their buying decisions are based on cold, hard facts and they evaluate everything about the parcel, from its location to its natural beauty, in the context of income, expense and profit.
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