Recently, it has been a common point from all developers and investors with whom we have conversations that "land is too expensive". Of course, it must be understood and shared that the landowner wants to make the most of it, as it is their only opportunity to receive incomes, however, the investor wants to pay as little as possible to maximise their potential returns, regardless of the risk they face and to avoid leverage in the early stage of the project.
Given this situation, any development must be approached analytically:
What does the land represent in the total cost of the development?
How much is the land worth if we start from the assumptions of selling price and development cost?
What are the ways to achieve the seller's target price?
How does any variation in land payment/cost affect project returns?
All these questions can be answered by a thorough analysis of the project, taking into account all the variables of the project: acquisition cost (land), construction cost (hard costs), development costs (soft costs) and financing costs.
Without going into an exhaustive detail of each of the costs that could be included in the abovementioned categories, we will focus this article on the details of the land transaction.
From the land owner's point of view
The seller's objectives are usually clear:
Maximise revenue from the sale of the land
To receive the money as soon as possible (or at least to ensure that they receive the money).
Not to lose the value of their land in the event of a partial sale of the land.
From the investor/developer's point of view:
Main objectives:
Pay as little as possible for the land
Not to be leveraged initially (especially if alternative financing is available due to the high interest of this financing way).
Explore other routes where liquidity and leverage risk are reduced.
Intermediate agreements
Having described the premises, there are alternative ways in which both the investor/developer and the seller of the land can benefit from a deal, among others we have recently discussed:
Payment in installments (structured and linked to time or project milestones).
Swapping the land for the final product
If several phases can be carried out, initial payment with purchase option (by means of advance payment) of one of the phases and payment of the following phases in milestones.
Payment with discount and swap
Any mix of those described above
Always keep in mind that a detailed cash flow analysis helps to understand the main economic variables of the project.
Project return (IRR of the project)
Investor's return (usually different depending on the financing channels, whether it is alternative, bank, etc.).
Multiplier on the capital of each of the project's financial agents.
The sensitivity of the price of land depending on the size of the development, the type of product to be put on sale, as well as the time at which the disbursement is made, usually has a significant influence on the decision to invest or not in this project.
Role of the administration
Given that the land to be developed is finite, we are currently facing a problem that is difficult to solve, as the owner of the land is aware that his land represents a unique opportunity for the expansion of the municipality and the investor/developer needs to reach an agreement with them in order to continue with his business.
A solution that is being proposed recently in some communities is the fact that land that has been declared developable, has the "obligation" to be developed for a future period of time, being penalised if in that time it is demonstrated that there has been a possibility of development and it has not been covered.
Another solution proposed by other agents in the real estate sector is to declare all land as developable, based on clearly established measures, and for the market itself to regulate urban development. This measure would obviously require greater attention from the administration to ensure the sustainable development of the city.
These measures obviously have their advantages and disadvantages, as real estate development is not an exact science, but depends on macro and microeconomic factors, coupled with a factor of "subjective sentiment" in investment, as well as "vigilance" on the part of the administration to ensure that urban development is in line with the needs of the city.
Conclusions
Given the current regulatory conditions, we are in a scenario where the investor/developer and the land owner have to reach an agreement in order to continue with the urban development, these agreements vary depending on multiple factors and per project, as there is no single solution.
The landowner wants to get the most for his land, and the investor/developer wants to get the maximum profit. The solution is based on a detailed analysis of all the factors that influence a project and on a series of values that depend on the project, price, cost and type of product to be developed.
As in any agreement, the solution is usually a middle ground between the claims of the owner and those of the investor/developer, so negotiations are usually time sensitive and defended by both parties with market data.
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