Subdivision Development Method: Risk, Profit & Developer Surveys
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features Subdivision Development: Risk, Profit, and Developer abstract Surveys by Tony Sevelka, MAI This research paper addresses some of the critical aspects of subdivi- sion development that have not been fully here are some communities across North America in which it is rela- explored by the appraisal T tively easy to achieve draft or preliminary subdivision plan approval, but which profession. Subdivision is a carry onerous and costly conditions for final subdivision approval. Land carried dynamic and complex to the subdivision draft-approval stage will often remain dormant for years until process, and carries many the developer is reasonably sure that the proposed subdivision (concept plan) will be financially successful. But with the passage of time, the concept plan risks, both anticipated and may have to be revised to reflect changes in demand for new housing. unanticipated. The risks In the subdivision development approvals process, draft plan approval (“of- associated with subdivision ficial unofficial approval”) signifies no more than municipal or regional development, which have acknowledgement that a developer’s concept plan of subdivision is in compli- an impact on the expecta- ance with established planning criteria. Final subdivision approval remains con- tion of developer’s profit, ditional on meeting a number of imposed preconditions. are often understated or In some jurisdictions, draft plan approval allows builders to commence a house-marketing campaign. Draft plan approval, however, does not speak to a not fully accounted for developer’s ability to physically or financially achieve the preconditions of final within the valuation subdivision approval. Obstacles or hurdles to final subdivision approval that are process. Developers often outside of the control or jurisdiction of the approving authority, but critical to employ land contracts as bringing a proposed subdivision to fruition and financially successful comple- an effective means of tion, might not be readily overcome by the developer. reducing subdivision risk A prudent developer will fulfill the conditions of draft plan approval and enter into a subdivision agreement with the approving authority only when (1) and enhancing the sufficient demand for new housing at appropriate price levels exists; (2) condi- potential for profit. tional lot presales have been negotiated;1 (3) all easement and landowners’ cost share agreements have been finalized; (4) development costs have been final- ized; and (5) a letter of credit (performance bond) and construction financing have been secured. Premature registration of a plan of subdivision could lead to significant capital expenditures and holding costs, including financing charges and increased realty taxes, and may undermine the financial feasibility of the proposed subdivision. Sub- 1. If the developer also is a house builder, this requirement would not apply. 242 The Appraisal Journal, Summer 2004 division agreements typically require the developer to enters into one of a number of legal arrangements to commence construction within a specific time frame, get the ball rolling. The most commonly used legal with the expected costs of construction backed by a agreements include: letter of credit or other means of collateral. Lot levies • straightforward purchase contracts with time lines or development charges must be paid to the munici- for approvals backed by escape clauses underpin- pality and region by the developer either when the plan ning the when and how a parcel eventually will be of subdivision is registered or upon issuance of a build- sold to the builder. ing permit for the individual finished lots.2 • a simple right of first refusal that may be the pre- Sometimes it may not be possible to delay devel- cursor to a purchase contract with all timing is- opment of a subdivision for reasons unrelated to the sues spelled out. risk of financial feasibility or marketability. For ex- • an option agreement might give the builder all the ample, where reserve sewage capacity is only allocated confidence he or she needs to invest time into the 3 upon execution of a subdivision agreement on a first- property to seek entitlements. come, first-served basis, any delay in securing final Timing is an important consideration and is subject subdivision approval carries the risk that available ca- to local peculiarities. pacity would be allocated to other proposed subdivi- sions. Also, failure to complete the conditions of fi- Local entitlement realities dictate much of the timing nal subdivision approval within prescribed statutory spelled out in any agreement that will result in land ac- time limits may lead to a complete disentitlement of quisition for development. Getting a parcel rezoned and pending development rights and imposition of more putting an approved map in place, with densities speci- stringent development restrictions. fied, generally requires a year to 18 months in most places. But this time line can run much longer in states such as Subdivision Risk California and New Jersey where development bureau- cracies tend to draw out approvals over many years. A In subdivision analysis, understanding risk is cru- point stressed continually by builders who successfully cial. The amount of risk varies at different stages in control land without owning it is the importance of en- the subdivision process. Land in a raw state, unzoned tering only agreements that allow enough time for en- to permit urbanization, carries the highest level of titlements to be won before land must be taken down.4 overall development risk and would be of little in- terest to a bona fide developer. Subdivision devel- During 1972, Goldberg5 used a detailed question- opment can only proceed with planning approvals naire to survey 63 residential developers in the in place accompanied by an executed subdivision Vancouver region of British Columbia. At that time, agreement; this is a critical factor considered by pro- the region had a population of roughly 1.1 million spective developer-purchasers of raw land. people and 350,000 housing units. Overcoming the Land contracts play an important role in mini- hurdles associated with unzoned land was cited as the mizing risk and benefit both the landowner (vender) most critical component in the development process. and the developer/builder (purchaser). Developer/ Proper zoning appears as the most important element, builders may apply the following strategies for tying giving substance to recent claims by many developers up land that has subdivision potential: that time and effort involved in getting land rezoned is not worth the expense...[N]early two-thirds (65.1%) The landowner must see clearly that the price he or of the respondents used options for land purchases she ultimately receives for the parcel will be based not with approximately half of the options (42.9%) run- on current market values but on a future yield the ning for less than 6 months, and nearly three-fourths builder can deliver...A part of this step involves let- (74.6%) of the developers included some or all of the ting the landowner know that to realize the highest cost of the option in a higher than market option potential price for the property, he or she must wait purchase price... Developers in the region neither hold until the builder receives some certainty that the sizable inventories nor acquire land very much in ad- project will be approved. In return, the landowner vance of actual development.6 2. Subdivision requirements vary from jurisdiction to jurisdiction, and are highly dependent upon the ordinances, policies, and procedures of the jurisdiction in which the property is located. 3. “How to Control Land Without Owning It,” Professional Builder 68, no.8 (August 1, 2003): 50–57, 54. 4. Ibid, 56. 5. Michael A. Goldberg, “Residential Developer Behavior: Some Empirical Findings,” Appraisal Institute Magazine (Winter 1975): 11–14. 6. Ibid., 12. subdivision development: risk, profit, and developer surveys 243 At the time of Goldberg’s 1972 survey of resi- tained, and there are no nongovernmental impedi- dential developers, the subdivision approvals pro- ments to development, the contributory value of the cess was less onerous and time consuming than to- permits and approvals, as well as the permitting risk day. There was not the heightened awareness of en- reward, accrue to the raw land. The permitting risk vironmental issues, such as pollution and soil con- may be minimal where the necessary rezoning, sub- tamination, that came to the forefront as major de- division approvals, and permitting is relatively simple velopment risks during the 1980s. These concerns and where there exists little chance of denial or sig- have brought about the necessity for environmental nificant modification to the plan from governmental audits as a regulatory requirement. In addition, agencies. The permitting risk may be great, however, smart-growth concepts that began being adopted by in areas where the likelihood of obtaining the neces- communities throughout North America during the sary approvals and permits cannot be easily known, 1990s have enhanced the regulatory framework of or where significant modifications to the plan by gov- the development process. ernmental agencies are likely. Subdivision standards The types of subdivision risk that can be en- and requirements are typically significantly higher in countered are too broad and diverse to enumerate major urban centers than in rural or semirural mu- here individually.7