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The Land Development Two-step: Why Investors Profit By Selling To Homebuilders, Not Homebuyers
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Investors are drawn to land for residential development. But they might do better completing only part of the process, selling rezoned property to homebuilders.
This is an exceptional time to develop raw land for residential and commercial use in the UK. With a growing population, a housing shortage reaching crisis proportions and recession-devalued land, all the key factors favour the investor-builder.
But if it were so easy, why do not deep-pocket investors, builders or landowners simply cash in on such a fortuitous confluence of circumstances?
The facts include that not all land is appropriately situated for residential development. Not all towns are amenable to change of use authorizations and economic growth. In many areas existing transport and other broad infrastructure cannot support new inhabitants. Not all homebuilders have the capital or stomach for carrying land through the process of acquisition, rezoning, construction and marketing. And not all investors wish to be involved in the same process.
But there are land specialists who can look at the full land-to-homes development process, even if their financial interests encompass only a portion of that. This is a relatively new approach and one that is gaining popularity among investors who look to land as an alternative investment to traditional and volatile market-traded securities. Real estate, after all, has built some of history’s greatest fortunes, in the UK as well as in countries around the globe.
The equation boils down to two factors:
Return on investment timeframe – In the traditional model, a homebuilder (and its financiers or investors) assumed all risk over the lifecycle of development. From site selection to acquisition to rezoning to construction could take as long as five years – sometimes even longer – when situations such as a deep recession make it unlikely the homes would sell. But breaking the task into two pieces – where an investor group coordinated by land experts identify optimal strategic land and achieve use changes, then sell to homebuilders to construct the properties – each player reduces the time over which their capital investment is tied up. Land investors can cut that time down to as little as 18 months.
Skill sets – It is one thing to know the market of homebuyers (what they want in kitchens, gardens and bedroom sizes) and quite something else to know how to achieve land use designation changes with local planning authorities. When an investor group can focus on the latter, and do a very good job of crunching the numbers to determine an optimal return on investment, the business of actual construction and marketing of the built properties can still be the province of homebuilders. Each of the two players can focus on what they do best.
Make no mistake, there are additional transactional costs involved in this two-part development scheme. But experienced land specialists who initiate the entire enterprise typically work with a handful of national homebuilders, establishing means of transactions that are efficient and do not necessarily involve third-party brokers.
In the best of worlds, there are no unseen variables, the spreadsheet for each project could be etched into stone and the precise profit margin could be predicted. But through the process of development, much can happen. The point is that experienced investor groups and the homebuilders will be able to minimize the risks, identify variables and have the talent to circumvent such problems as they arise. Meanwhile, each will stay on top of developments within their respective professions and industries to identify new efficiencies. It’s a formula for continuous improvement – and comes at a time when buying low and selling high is a likely scenario for all parties in the development chain.
Individual investors are now participating in land development to a degree never before seen (typically, they would have a minimum of £10,000 or more to invest). But such individuals should always consult with an independent financial advisor who can assess whether land investments are a good mix with the investor’s broader portfolio.
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