(2) There is a dis-connect between the land and housing markets. When a housing market takes off, the first to know are the builders because they are looking at the sales data. Eventually, the land market catches on and begins raising prices. However, when a market is in decline, the builders are the first to know and the land owners hold their pricing until it is too late and they realize the downturn is for real. Did you hear that banks?
(3) Types of Land Owners. The most ignorant is the farmer or long time owner. This person has a basis of practically zero because it has been in the family forever or 30 plus years. They are not sophisticated and don't really understand the full value of their land. Next up are the speculators. These guys bought land 5-20 years ago hoping growth would come there way. Their basis is higher, but they have no debt and don't have to do a deal if they don't want to. The next group of land owners is the Investor who put together an LLC with a time frame of less than 5 years to either entitle or entitle and develop to sell to either a dumber investor or a builder. These guys are highly leveraged and their loan is based on a project basis. Thus, unless the bank changes the terms of the loan, then the loan expires when the project was supposed to be mature (sold). You can make a lot of money here in a good market and in a bad market you lose everything.
(4) Land location. Most people segment land into A, B and C parcels. An A parcel is usually an infill piece in a top tier submarket. In any given MSA such as Tampa or Atlanta you may have 20-40 submarkets representing geographical areas that everyone recognizes. Your top tier submarkets are usually 90% plus built out with commercial, residential, retail, etc... These are the built out cities that have the better school districts and the higher household incomes and home prices. A B parcel is usually found in your middle tier submarkets most of which are not built out fully. So there are opportunities to do large master planned communities in addition to infill projects. However, these submarkets don't have the prestige of the A submarkets for the most part. They are still good and represent your bread and butter. Finally there are C parcels. These parcels are located in the fringe areas of your MSA. You know when you live in a fringe area when your friend says you live where!!!!! Dude, that is way out there. C parcels are mostly in rural locations with less than 20% of the area built out. The reason why it is a C parcel besides being on the fringe is that it is surrounded by a lot of open space land, thus there is plenty of supply. Why does a big builder buy C parcels? When housing demand gets really hot and affordability decreases, where do people move to get a big house? They move way on the outskirts of the general population. However, when housing is in the tank, these same people can now get great deals in better communities in A and B locations. Thus, making C parcels worthless.
(5) Land Type. Land can be categorized into un-entitled dirt, entitled dirt and finished lots. Un-entitled dirt is basically raw land that is not zoned for residential and has no P.U.D. or the proper zoning to build a residential community. The worst kind of un-entitled dirt is that which has future land use (FLU) of non-residential. It is extremely difficult to get a planning commission to change its FLU. Most intelligent builders buy un-entitled dirt that has current zoning of say agriculture and FLU of residential. If you own un-entitled dirt in a downturn you are (4 letter word). No one wants this land, especially for what you paid for it, in a downturn. I can think of several top 5 builders that have 100 million dollar un-entitled land plays in Orlando and SW Florida. Tsk tsk. The next higher grade of land is entitled land. Land magically doubles in price or more when the gavel drops and you get entitlement. This means that the land you own is now entitled to be developed for the purposes you set forth, which is to build a residential community. You can start moving dirt and developing the property. Finally, there are finished lots. Basically, this means you have streets in, sewer and water connections, etc... start building that home!!!
(6) Due Diligence Period. Before you buy a piece of land you always want time to do due diligence work. Environmental and soil studies, investigate the zoning, etc... Only a complete idiot buys land without understanding if there are obstacles to converting land to the purposes he chooses. Normally you get 90 days. However, in the go go days some sellers would only give you 30 days to close. Less time means sloppier due diligence.
(7) Land Takedowns. Another condition on how you buy land is timing and takes. The big pig builders would buy 500 entitled raw lots in one take. The problem is that you need to have some really strong sales absorptions to plow through this many lots. In the go go days there were communities in which the entire 500 lots were bought and developed all at once. Think of the ROIC if you have 500 lots at 30k a piece and you spent another 35k to develop the lots. What if your absorptions go from 12 a month to a trickle of 3 a month? Not exactly a great ROIC. Read lesson (5 of 20). You're especially in big trouble if you financed this land with a lot of debt. The smarter builders would buy this land in two takes, 250 in year one and 250 in year two. In year two you may pay 7% more per lot, but you have the option to walk away from the second take or re-negotiate the price in a down market. Haven't you seen in statements by builders where they say they are walking away from options or renegotiating. Now you understand. So why do one take instead of two. See lesson (5 of 20) again. The market was so red hot, builders were doing anything to land a deal including ill advised terms in addition to overpaying. Finally, you can buy the land on a finished lot basis, where the seller takes on the risk of development and sells you the land in finished lots. The best way to do this is on a rolling option where you take down finished lots on a monthly or quarterly basis and not all at once. Does it cost more? Yes, but you take on virtually no debt to buy land and when the market turns down you can walk away from options or renegotiate.
Now that you understand the 7 basic concepts, in the next lesson we will apply these concepts to understanding the land recession that is upon us.