The Land Development Process – Four Stages of Land DevelopmentJanuary 18, 2019 / Land Investment / 0 Comments
The primary investment strategy of Arizona Land Partners is to purchase well-located and well-priced land, and then to add substantial value by entitling it during a holding period. We typically sell that land at a substantially inflated price to an eager developer or builder. That strategy has served us well for decades, and I suspect will continue to produce radical returns in the decade ahead.
To gain a better understanding of why it works and what we do exactly, you need to distinguish between the different land development stages, how each affects its value, and the processes which prepare land in one stage for another.
Land Entitlement Process
Entitlement is the process by which a landowner provides the necessary engineering and development research to various municipalities in order to get final approval for a development plan. The owner works with civil engineers to develop flood control proposals, power and utility arrangements, drawings for roads, traffic signals, street lights, or any other such requirement made by whichever municipality has authority over the parcel, typically a county or city.
The engineers, knowledgeable of these requirements, help develop a plan to maximize the land’s development potential and value. These plans are then presented to the appropriate government agencies for review. Owners expect to have back-and-forth interactions with cities, counties, and engineers, as the drawings are modified, submitted, red-lined, adjusted, and resubmitted.
The final output is fully entitled land. The controlling municipality stamps a set of plans as approved, rendering it “shovel ready.” Parcels with approved plans are much more attractive to developers, and therefore have a higher value in the market.
Values Rise with Land Entitlement and Development
Here are the four stages in which land can exist. As land moves from lower stages to higher, its value increases substantially.
Stage I: Raw land has had no entitlement work done and is the least developed stage. Sometimes, raw land is part of a master development plan, so the controlling municipality might have a preference for how it is developed and its current zoning will reflect that preference. Zoning will broadly designate the land as either residential, industrial, agricultural, commercial or other possible designations.
Raw land outside city development often has no such designation, holding only a “General” zoning. In these cases, the likely future use hasn’t yet been determined.
Stage II: Platted land has been entitled, even though no actual construction of roads, curbing, utilities and the like has necessarily begun. With platted land, we are typically speaking of designated lots. In a platted development, each lot has been assigned a unique parcel number and the county assessor will begin to estimate the value of that lot for tax purposes. Roadways, utility easements, flood control will all have been designed and approved. Platted land may look identical to raw land to passersby, but there’s a huge difference between the two in the resale market. The entitlement process adds a lot of value.
Stage III: Improved land has had actual construction activity to lay at least some portion of the asphalt, curbing, water retention or utilities required by the development plan. These improvements are costly and can be complicated to implement. Obviously, land that has been improved is worth much more than unimproved (but platted) land (Stage II).
However, the added value is not substantially bigger than the cost of these improvements. In a normal market, a developer might only save 10% of the cost of improved lots by buying platted land and doing the improvements himself.
Stage IV: Developed land is land upon which buildings or other structures have been erected for an end-use. Built-out housing subdivisions, commerce parks, medical centers, or solar farms are, by virtue of the buildings, all located on developed land. Remaining pieces are typically quite valuable. Once the land in an area is largely developed, the dynamics of its real estate market change significantly.
A Great Land Investment Strategy
Moving land from a lower to a higher stage adds value, but also adds cost, work, and risk. However, the value added is not the same for each transition, nor is the associated cost, work, and risk. Examining these potential stage transitions yields a clear land investment strategy, one that has been employed by successful investors for decades:
The Risk/Reward Sweet Spot
It’s worth pointing out that there’s money to be made in each of the three transitions. Nonetheless, the one with the best combination of high return potential plus lower risk is Transition A: Moving from raw land to platted lots.
- No development risks.
This is a big one. By selling the platted (Stage II) land to a builder or developer, the investor passes on the associated development risks. Lowering risk is a critical part of any sound investment strategy.
- Significant value-add beyond the cost of the engineering.
When we entitle raw land (Stage I) in a growth corridor, we expect a three-fold increase in values over our purchase price and engineering costs. It’s not unusual to experience four and five-fold increases in these values.
- Lower costs.
When compared to the development cost of doing land improvements (paving, curbing, drainage, utilities, etc.), engineering is a value-add bargain. Because these development costs are as high as they are, transitions B and C don’t add enough value beyond their costs to satisfy most investors. Land improvements (Stage III) can easily equal the cost of acquiring entitled land (Stage II).
Further, a typical building (Stage IV) is 4-5 times the cost of the improved lot it sits on (Stage III). On the contrary, the costs of engineering and entitling to move the land from Stage I to Stage II are a small fraction of the value of what will eventually be built on a parcel and are even only a fraction of the initial cost to acquire the raw land.
- No debt necessary.
Most developers use debt. Most land entitlers don’t. The reason is that debt is typically necessary for developers to make a reasonable return on their investment, but is typically not necessary for those doing the entitlement. Debt increases an investment return but concurrently increases investment risk. In strategic entitlement investments, the prospects for great returns are strong without the use of debt.
I know plenty of people who make good money building, and some who are happy to do the land improvements before beginning their construction. However, I’m confident that the sweet spot for the investor is purchasing raw land, doing the entitlement work, then selling to those builders or developers. That’s what we’re going to keep doing.