This is the first in a series of posts that describe the stages and activities in the real estate development process. We are writing this series through the lens of doing ground-up development on a raw piece of land, or developing land with an existing structure on it that is not currently income-producing.
Stage 1: Pursuit/Site Control, Part 1
The first stage of the real estate development process is pursuit, or site control. Here is what is involved in getting a development site, in rough chronological order:
Visioning. Before anything else happens, you as the developer need to generate a vision of what change you will make to the status quo. This can be as simple as walking down the street, seeing an empty lot or dilapidated building, and saying, “I’m going to put up a new building right there on that piece of land.”
Land Valuation. The number one question related to land acquisition is “what should I pay for the site?” The two ways to answer this are through residual land valuation, either back of the envelope (a “static”, or single point in time) analysis or a more thorough discounted cash flow (DCF) analysis, and by getting land sale comparables (“comps”) to the extent that any recent, relevant comps are available.
Residual land valuation is basically the process of back-solving for the “worth” of the land given:
- Assumed valuation of the developed asset at stabilization
- less Assumed costs, exclusive of the land price, to develop the asset and stabilize it
- less Required profit dollar amount
The net of these items is the “residual”, or remaining value, of the land, i.e., the maximum you would be willing to pay for the land given the assumptions above.
Comparable sales are exactly what they sound like — recent trades of development sites for the same development type, preferably between an equally sophisticated buyer/seller pair as the one you and your seller will make. Comps always need to be verified in the land records to the extent possible (don’t just take the brokers’ word for it), and need to be understood for exactly what they are — don’t just assume that the land bought is an apples-to-apples comparison with the land you are contemplating acquiring.
Also, you need to understand the nature of the buyer and their cost of capital relative to your cost of capital. If their money only costs them 2% to 3% (if they are a public REIT, for example), they can pay much more for land than you can if you are a private buyer with a higher cost of funds.
For more on the residual land valuation process, see our free webinar here.