By Charles C. Shinn, Jr.
1. Paying Too Much for the Land Purchase
Paying too much for the land purchase is always an issue for homebuilders particularly during such times as these when there is a feeding frenzy and land appears to be scarce. Builders begin to hoard land and bid land prices up. The land purchased may not fit the current product line the builder is offering or the price might move his home sales price out of the competitive price band forcing him to develop new product or reducing the sales velocity of the community. Builders should keep the emotions out of the land purchasing process and use the economic model that was presented last month.
2. Lack of Adequate Market Research
Prior to going hard for the land the builder should have a market research study done to determine the appropriate product for the land, the current and potential competition, the depth of the market, the appropriate sales price for the homes and the anticipated absorption rate. It surprises me at how often the builders buy land without a market research study to determine the feasibility of the project.
3. Going Hard for the Land Too Early
In today’s hot land market, many builders are making the mistake of going hard on the land prior to completing their due diligence. Builders should negotiate an adequate option period to allow enough time to conduct several basic studies to ensure the projects feasibility and profitability. The builder will start spending money, but the
money will be well spent at this point instead of making a land acquisition mistake. The preliminary research should include: market research to determine product, sales price, and absorption; feasibility study to determine the basic financial model and profitability; environmental study to determine the presence of endangered species or wetlands; political study to determine the political atmosphere of the community in general and the given parcel of land in particular; utility study to make sure that all necessary utilities are
or will be available and adequate for the community; and a preliminary land plan to determine and verify the lot yield.. If any of these studies generate a problem not anticipated the builder can renegotiate the price or walk from the agreement.
4. Aggressive Takedown Schedules
Today, landowners and developers are requesting aggressive take-down schedules. If the builders cannot sell homes at the same rate as the lot take-down, they will have to inventory land to stay in the community. Wile builders are naturally optimistic, they should negotiate a conservative land take-down schedule that matches or
is a little short of the community’s projected sales volume. Builders need to protect their cash flow. If the take-down schedule proves too aggressive, the builder needs to go back to the landowner and renegotiate.
5. Holding Too Much Land
Builders tend to be gluttons for land. Consequently, today we are seeing builders amass huge land inventories. Builders should have a clear land strategy such as outlined in the article in the May issue. The land strategy should match production capacity and sales velocity. Large land holding with its drain on cash flow has been the cause of numerous homebuilder failures. Builders holding land ready for development or developed that cannot be absorbed within the target period of time, should flip the land to another builder, capture the profits, improve company liquidity, and/or reinvest the funds in land that better fits future needs.
6. Lack of Adequate Financing for the Project
The land development process can have many very expensive surprises. The amount of time need for both entitlement and development can be substantial expended.
During the entitlement process the builder will hire a number of professionals to assist
with the land planning and municipal submissions. Generally their will be delays and
numerous resubmissions during the entitlement process and the professionals clocks are
running during the whole process. During the actual development process there can be
substantial cost overruns for unanticipated events. If the project gets delayed and the
roads are not installed before the asphalt plants close for the winter the project opening
may be delayed for six months. Also don’t forget the municipality will typically require
a bond for the public improvements which may not be released until the end of the
warranty period.
7. Not Developing the Team Approach
During the land planning process the builder will rely on a number of professional: civil engineer, environmental engineer, land planner, market researcher, architect, marketers, merchandisers, advertising agencies, etc. Frequently the builder works with each of the professionals one on one. The professionals should work as a
team to allow for cross fertilization. The builder is the team leader giving the team direction.
8. Phases Are Too Large
Generally there are efficiencies in developing large phases due to the mobilization costs, and the ability to spread the up front costs of the amenities, fencing, monuments, utilities, spine roads, etc. over more lots. However, there are a lot of negatives. Large phases substantially increase the required carrying costs. Construction tends to be spread throughout the phase on scattered bases reducing efficiency and the appearance of excitement and viability of the community. It also reduces the ability to increase prices
with the opening of a new phase which not only increases profitability but allows for the liquidation of the less desirable lots in the earlier phase without discounting.
9. Selling Premium Lots First
The balance of premium lots to standard lots needs to be maintained thought the development. Too often the builders sell off the premium lots first and then are left with the standard lots and the less desirable lots for the remainder of the communities build out. The balance of premium lots should constantly be monitored and the lot premiums adjusted to assure there will be premium lots available throughout the developments live. The lot premiums should not be discounted just to get sales since it will eventually have a greater impact on sales and the premiums will not be available for the discounting of the inferior lots.
10. Not Offering Multiple Product Lines
Instead of developing the site for one product line the builder should consider designing the property for multiple product lines. Since each of the product lines will be marketed to different target markets the lot absorption will be increased. This will reduce the risk and increase the builders return on investment.
11. Going It Alone
Consider putting a consortium of complementary builders together for land acquisition. The builders can afford to buy a larger development, and spread the advertising, promotional, marketing costs amongst themselves. The community will have more energy, excitement, and vitality. They can develop the land into separate
neighborhood for each of the builders and improve their return on investment.
12. Land Not Treated as a Profit Center
Builders should keep the land development operation in a separate profit center from the homebuilding operation and transfer the finished lots to the homebuilding operation at the “builder retail price” or the price at which the finished lots can be sold to independent builders, thus capturing the land profit in the land development operation. Too many builders subsidize the homebuilding operation with the land profits realized from the land’s increased value as derived from entitlement, development, and appreciation. Finished lots are recorded at cost instead of market value in the house cost of sales. The builder thinks he is making a profit on his homebuilding operation but in truth he is making money on the land and potentially losing money on the homebuilding operation. He would be better off selling the land instead of building homes.
13. Lots Not Adequate for Standard Plans
Too often builders end up with a number of lots that will not accept the standard plans. The builder should make sure that all lot building envelops will accept all standard plans with the standard options. If the builder is going to offer a three car garage option it should fit on all lots. Too often I see builders having to design specific houses for specific lots because the building envelope will not accept the standard plan. This happens very frequently on cul-de-sac lots and lots with utility easements. This is typically a result of lack of adequate review of the land plan, trying to force the number of lots, and/or the architect and land planner not working as a team.
Land acquisition and development can substantially improve builders’ profitability provided the builder establishes a land strategy, makes sure the purchase agreement is structured for the targeted housing sales price, profit objective and sales velocity, and the builder does not make too many mistakes. Land is an appreciating asset as it moves through the development process. Therefore, it should be treated as a profit
center to capture it profit instead of commingling it with homebuilding profit. |