“You name the price, but I’ll name the terms.”
It wasn’t long ago that developers would snap up land on short escrows, with a 60-90 day due diligence, and close before they had approvals in hand. From 2020 through 2022, hot markets like Missoula, Bozeman, and Kalispell, Montana had manic levels of demand for developable land.
Liquidity has evaporated out of the market and banks are more conservative on lending. Land development deals have become more difficult to get done. Many sellers are still hanging on to price and timing expectations from 2021. Meanwhile, buyers are choosing to walk away from deals rather than take the risk of being overextended in an uncertain economy. This has resulted in more land listings becoming available with sellers hoping to cash in before the tide goes out.
Despite this, some deals are still getting done. Here are four ideas for buyers and sellers to keep land development deals on track:
1. Be Patient
Sellers will need to adjust back to the pre-pandemic norms for land sale closing time frames. Buyers may need to wait 6-12 months or more for building permits before closing on the land. Buyers use this time to vet the deal, get entitlements for the land, and complete architectural and engineering plans.
In some cases, developers may be willing to pay non-refundable earnest money for the extra time. Sellers can also require that the work products from the buyer’s due diligence be provided to the seller if they don’t end up closing on the deal. This provides some consideration to the seller allowing more time.
2. Consider Seller Carry
With banks lending less, developers may need to come up with more cash to close on land. Often, they aren’t able or willing to put in the larger amount of cash upfront to close on a property.
One option is for sellers to carry the land contract at a higher loan-to-value (LTV) ratio than what traditional banks are offering. Sellers may realize a higher value on the land. This keeps the seller’s position secure, may result in periodic cash flow to the seller/note holder, and captures a higher land value than the market might otherwise support.
Another option is for sellers to carry a second position note behind a traditional bank. This is riskier for the landowner but means that they get more cash upfront from the primary bank’s funds and the developer’s down payment.
3. Consider a Seller Contribution
Another way to get deals done is by having the sellers contribute some or all of the land value to development partnerships. Like the seller carry option mentioned above, “you name the price, I name the terms” also applies here.
There are many ways to structure these partnerships. One common method is for the seller to come in as a limited partner (LP) in the development project partnership. LPs typically only have their equity at risk, and do not usually end up signing as guarantors on construction debt.
These arrangements can offer tax advantages to the seller. The land value contribution can sometimes be structured so that it does not trigger a taxable event. It can eventually turn a non-cash-producing asset (land) into a cash-flowing one (such as an apartment or retail rental project).
4. Consider a Land Lease with Buy-Back Option
Land deals are also still getting done by arranging for a subordinated land lease. In a subordinated land lease, the seller (landlord) leases the land to the buyer/developer (tenant) for a long time, typically 50-99 years. The tenant then builds or improves the property on the land and subleases it to third-party tenants. The landlord’s interest in the land is subordinated to the tenant’s mortgage. This means that the lender has first claim to the property in the event of default.
In return for subordinating their interest, the landlord may receive higher rent from the tenant than would be typical for a non-subordinated land lease. The landlord may also negotiate other benefits. These may include a percentage of the profits from the subleases or the right to buy the improvements on the land at the end of the lease term.
For development projects, developers will often negotiate for a buy-back option for the land in the future after stabilization. Attractive financing is often easier to get once the development project is completed and stabilized. A developer (tenant) can then come back to the seller/landlord and buy the property as a part of the larger land and building package.
This can sometimes work to the seller/landlord’s advantage. The developer will often be able to pay more for the land after the deal is done than if he did so upfront.
In any case, make sure you use a real estate advisor that understands development.
Your advisor needs to understand market dynamics and how development happens. If your advisor doesn’t understand the inputs and outputs required from a development project to make it pencil, you will give away value. Development projects are complex. They require an understanding of financial modeling and extensive knowledge of land due diligence. Project management of timelines, budgets, and designs is needed. Find an advisor with a proven track record of getting land development deals done to work with.