As the first quarter of the year draws to a close, we see emerging trends in land development and building
by Greg Vogel
The land and finished lot market is continuing to evolve back into a full recovery mode. All of the distressed land and lots, and many of the most opportunistic purchases, have made their way through the system. The land market has now moved into a full swing development cycle by necessity, bringing with it several new trends for the year 2018. Below is a list of the major trends in the land and lot economy to be aware of:
1. Extreme Housing And Lot Shortage
The housing shortage is continuing to worsen and growing to reach crisis levels in many regions. This shortage has many implications for the land market. In most markets, the housing shortage is due to a decade of under-building, compounded now by an extreme lot shortage. The re-sale housing inventory is at new lows, but this is having a positive impact on new home sales rates per subdivision. This acceleration in sales further reduces the lot supplies. Most markets are not providing the go-forward supply of lots to satisfy near term and future demand. This creates the opportunity to increase spec counts, acquire any remaining “C” lots, and build single-family homes for rent.
2. Land Developers
The housing and lot shortage is also compounded by an extreme scarcity of land and lot developers across the U.S. The mantra from local land developers is, “There is no room for a fair return.” This is due to direct competition from homebuilders for the small to mid-size projects that remove the “middleman,” patient (greedy) land sellers, rising horizontal development costs, lack of labor, and rising government regulation and impact fees. This provides the natural opportunity for private builders to source land that is larger than they need and provide inventory and development expertise to public builders.
3. Public vs Private Behavior
Public builders continue to dominate most major and even secondary markets. The publics’ lower cost of capital and thin margins discourages the formation and expansion of private homebuilders. This trend is accelerating due to recent and to be announced mergers and acquisitions, public builders’ new land platform strategies, and foreign money acquiring and funding builders with a lower cost of longer-term capital. Private builders have barriers to reasonably priced capital and are less willing to take on recourse debt, or over leverage projects with thin margins, this cycle. This offers the opportunity to find private builders through debt, equity, and joint ventures while private builders target secondary and tertiary markets.
4. Infill vs. Suburban
The financial crisis provided a gateway to well-priced land in “infill” locations. The desire and attraction to infill was all the buzz from 2011 to 2015, which attracted private builders. The buzz is now off infill, due to two major issues: The performance of a majority of these projects faced slow absorption, not hitting the projected returns for the builder or their capital; and, even with moderate prior success, the replacement parcels became non-existent or out of reach from a financial performance perspective. On the other hand, the next several rings of development patterns surrounding the urban area are experiencing increasing demand in the search for affordability, volume, and a future lot supply. Thankfully, innovative designs can increase infill-detached densities.
Banks moving higher up the capital stack and into more products for acquisition, development, and construction is a positive sign. There is greater demand for builder’s bond offerings where there is perceived safety and yield. Larger Public Builders are awash in cash, credit, and a new tax holiday to add to their returns and liquidity. Multiple platforms are offering lot banking at 12 to 14 percent. New private equity driven funds are being formed to kick start larger land development projects. Banks are still conservative or non-existent for large scale land development projects. We are seeing an increase in the use and feasibility of district financing. Many municipalities are seeing these districts as a necessary component to fulfill the large infrastructure requirements they are unwilling or unable to take on.
6. Periphery Land
The one asset class in real estate to not show a commensurate recovery is land outside of the five to 10 year path of growth. At this point in the cycle, land on the outside rings would rise with the tide of inner ring land values. Properly selected, the path of growth plays will prove to be a hidden opportunity for high multiples and a source of long-term supply at a low current and especially future basis.
The above trends illustrate the many concerns and constraints for a clear path on supplying both public and private builders with their most important resource: land. Thankfully, wherever heavy constraints exist, opportunities are discovered.