Getting Financing & Developing Land Book

Contents

The Importance of Land Investment, 6

Prepare for Your Company's Growth, 10

The Financing You Need, 15

2 The Markets, 17

The Political Market, 17

The Land Market, 23

Your Market, 34

3 Development Alternatives, 47

Land Speculation, 47

Residential Development, 52

Nonresidential Development, 57

4 Find the Right Land, 67

A Checklist for Site Selection, 69

Land Use Consultants, 74

5 Alternatives to Borrowing, 75

Work Directly With the Seller, 76

Use Options, 81

The 1031 Exchange, 84

6 Write Your Business Plan, 87

Definition, 88

Purpose, 88

Preparation, 89

Content, 96

Presentation, 106

7 Investors, 109

Equity Capital Pros and Cons, 111

How Do I Find Investors?, 115

Compensating Investors, 117

The Partnership Agreement, 118

Incorporation, 120

Joint Ventures, 122

The Debt-Equity Combination, 125

"Divorcing" an Equity Partner, 126

8 Borrowing Guidelines, 129

Money Basics, 126

Advantages and Disadvantages of Borrowing, 131

Interest Basics, 133

Types of Loans, 135

Rules for Borrowing, 138

A Checklist for Borrowing, 138

Who Are the Lenders?, 139

Mortgage Brokers, 140

9 Convince your Lender, 143

Risk, 147

Expertise, 151

Feasibility, 151

Your Approach, 153

What the Lender Wants, 154

Waiting for the Answer, 155

What lf You're Turned Down?, 156

10 Get On With the Project, 159

Stay Focused, 159

Check Your Assumptions and Goals, 161

Forecast and Budget, 162

Cash Flow Projection, 165

Appendix A
Sample Business Plan, 169

Appendix B
Forms & Checklists, 201

How to Use the Disk, 223

Index, 226

Chapter 1

Getting Started

Anyone who embarks on a big undertaking without proper preparation is inviting disaster. This advice applies equally to generals at war, to students in school, and to business owners about to finance raw land development for the first time.

You may find books of advice about how to get money for your business, with all kinds of takes on how to go about it. Unfortunately, most of them are pretty theoretical. When it comes time for you to sit across a desk from a loan officer or venture capital investor, you need to be armed with hard information- facts and statistics. You don't want so many that they overwhelm the other person, but enough to demonstrate that you know what you're talking about. This book is designed to help you prepare for the big step, by showing you how to:

• Take an idea and express it in terms of specific goals.

• Identify the steps you need to get there.

• Present these ideas in the dollars and cents that bank people like to see.

Just as you need a blueprint and tools to build a house, you also need plans and tools to get the money you need to develop a project. It isn't enough to explain how interested you are in doing that project; you need to show the lender or investor how their risks are going to be managed carefully and methodically. In this book, you'll find those useful tools, including checklists, sample forms, and examples you can use to prove that your ideas make financial sense. That's the entire purpose and focus of this book.

The best and most obvious advice when you start any project is always this: "Begin at the beginning." When you're looking for financing for land development, the beginning means defining exactly what you want. That means answering these three questions:

1. How much do you need?
2. How will you use it?
3. How can you get it?

This book shows you how to answer those questions so you can get the money you need. Along the way, you'll learn how to:

• Study your operation and look for routines and procedures you 'II have to change so you can manage the new demands that more complicated projects will bring.

• Examine the local land market, economic situation, and political climate to discover the "rules" of the development game in your community.

• Make informed decisions about the best and most profitable type of development for your locality and talents.

• Assemble and present a convincing appeal to your lender for the cash you need.

You're going to ask an institution or person for money you need because they have that money to loan. But they didn't get the money, or control of it, by being foolish. They're going to ask tough questions designed to find out if they're going to get their money back, and how much profit they're going to get. They're not going to take chances just out of respect for your eagerness.

So before you go looking for the money, you need to answer for yourself the questions a lender or investor will ask. There's little sense in starting up a venture before you've thoroughly explored its pitfalls and possibilities. Consider these points:

• Can you find suitable land?

• How is the land zoned?

• Can you get the zoning changed if you have to?

• Is there a demand for your project?

• Will your plan make money?

• Will the cash flow work out?

• What's the political climate?

• Are you experienced and qualified for this project?

Your answers to these questions will determine whether land development is right for you.

The Importance of Land Investment

Land - its purchase and development - is an essential element of progress. Those who own or control the land determine how and where growth occurs. Naturally, other factors, including local politics, the current state of the economy in your region, and the willingness of lenders to work with potential developers, have an effect. But the essential truth remains: Ownership and use of land is the engine of growth. As a buyer and developer of land, that makes you the engineer.

Here are some statistics that make the case for successful land development in today's economy:

• Census reports estimate that population growth between 1995 and 2010 will be 36.2 percent. That's about 100 million more people and 30 to 50 million more households. And all those people will need homes and jobs. The largest increase will be in the age group between 40 and 64, as today's population ages.
  
  

• The aging of the population is good news for housing, commercial and industrial construction, as well as for high-end industrial properties. People in the 40-64 age group earn the most money and are the most stable in both their personal and career lives. Most families in this bracket want to own homes, can afford relatively expensive ones, and may even want a second or third home as well.
  
  

• New home sales for the 1990s were over 6 million, near the record set in the 1970s. During the first decade of the new millennium, the second-generation baby-boomers will get into the market, and records will probably continue to be broken.
  
  

• More than eight out of every 10 homes built in the United States are built by "small" builders (those having fewer than 25 employees).

Statistics also show that today's market is favorable for contractors who want to borrow money. When we talk about markets, we usually mean how many buyers there are for what we sell. But here I'm talking about the capital market - whether there's enough money available for you and others who want to borrow to invest in and develop land. Many sources predict that this decade will see a boom in new development. A primary cause of that boom will be the simple fact that money is available.

Planning for Land Investment

Since you 're reading this book, you 're already thinking about how to make money by buying and developing land. You may want to buy land and apply for a rezone, then lease, sell or develop it. Maybe you prefer a specific type of commercial or industrial development.

Sometimes a client will come to you with an empty lot and ask for a custom home. But that isn't how developers work - that's custom contracting. Developers tend to be land investors first, and builders second. Contractor-developers make more profit on the land than on the improvements.

Many contractors start out small. They buy a single lot and build a spec house. If all goes well, they sell it and use the profit to finance a larger, more expensive home. Perhaps you're ready to take on two or more projects at once, or move up to tract development or part of a planned community.

For all these scenarios, you'll have to create a project plan for a project that you can build to make a profit. Owning land isn't the end result. But it is a necessary part of the plan. And in the best of circumstances, the land will appreciate while you own it. There are a number of features that contribute to increases in land value, including improvements, more valuable use of the land, potential value created by land use changes, and the emerging path of progress which brings development pressure.

That path of progress (the direction in which growth occurs) depends on a variety of conditions:

• Increased employment and economic growth produce more demand for buildings of all kinds.
  
  

• Local governments may create progressive land use policies because they want to attract an industrial employment base.
  
  

• Development of transportation corridors bring tourist and travel related activity.
  
  

• Other local attractions lead to changes in population, employment, and land use.

Owning the land yourself increases your profit potential. But to own land, you probably need to borrow money - and that means paying back the loan. You'll have to make those periodic loan payments on schedule without fail. That means your cash flow must be healthy enough so you can make regular monthly payments while you continue to pay your other bills. When you buy land for development, it won't pay for itself until it's improved. It's impossible to find a use for raw land that will cover its investment cost - other than development.

You must prepare a realistic business plan and budget to offset that problem. Can you survive several months of negative cash flow while you build your project? If your project requires rezoning, you can expect a significant delay before construction starts. That will increase the time lag before profits begin to roll in.

And there's another possibility to consider. You could end up owning that land even longer than the time it takes to develop it. Many novice developers (and even some experienced ones) end up renting out a finished project when a falling market makes it impossible to sell the development at the predicted profit.

That's why you have to do your homework and lay a firm foundation by preparing yourself and your business for the changes that growth and expansion will bring. Only then can you successfully build a project that will fulfill your goals and expectations, and that will make money.

Speculation vs. Investment

What's the difference between the two? The dictionary defines speculation like this: assumption of unusual business risk in hopes of obtaining commensurate gain. In other words, speculation is an unusually risky investment. As a contractor looking for financing to buy raw land, you could be either an investor or a speculator, or combine the characteristics of both. It all depends on the level of risk.

When you listen to the political rhetoric about land use, it can sound like all land purchasers are either angels or devils. Angels are investors who buy land to improve it for the good of the community. Investors treat their land as a personal asset to make sure that values remain high over the long term. And devils, of course, are short-term speculators who just want to make a quick buck. Speculators buy and sell land only to drive up prices and take advantage of the local folks.

Neither of these definitions is necessarily true - nothing's that black and white. But when you invest in land, sooner or later you'll run into the politics of development, where labels are used to divide the good guys from the bad guys.

You want to be one of the good guys. So when you search for financing to develop land, you need to present yourself as a responsible developer whose project will benefit rather than harm the community. No lender will be anxious to advance you money unless you can convince them of three things:

1. There's proper zoning in place (or you have a reasonable promise of getting it).
2. Your project has passed environmental review.
3. There's no strong opposition from neighborhood groups.

Before you can get the money you'll need, you have to convince the investor that local groups and politicians favor your project because they believe the community benefits outweigh any real or perceived negative consequences. They must also believe that you'll invest much of your time and a lot of your own money in the development project.

Remember that even if today's demand for your project is strong, it may weaken before you get the project finished. If your project will take two years to complete, you need to start exactly two years before the market hits peak demand for your type of project. Good luck in predicting that! The "sure thing" in real estate is rare. But you also expose yourself to risk in a number of other ways:

• Can you develop the management skills necessary to handle the transition from contractor to land developer?

• Can you find land that's priced so you can make money?

• Can you get the financing required to complete the project?

• Can you finish the job on schedule?

• Can you maintain a healthy cash flow during development?

We'll address the last four issues (and more) in later chapters, but for now let's consider the first one.

Prepare for Your Company's Growth

It isn't enough to just know where you want your business to go. You have to know how to get it there. Growth itself isn't hard. But keeping it on track takes special skill and attention. You have to keep one eye on the big picture while you watch the smallest details with the other.

Details have a tendency to take over. The expression, "The devil's in the details" is never more true than when it applies to running a growing business. Everything from interviewing, hiring and training a new supervisor to making sure you can rely on your office manager to keep paper clips on hand distracts your attention from the big picture - if you let it.

The Nature of Growth

The nature of growth is to dominate. If you take no action at all, it's still more likely that your company will grow than that it won't. That's because of another rule: The nature of overhead is to increase. If you've been a contractor for any time, you know this. And as your overhead increases, you're under pressure to take on more business (even if you don't want to) just to cover higher administrative expenses and continue to make a profit. But there's a better approach. Get expenses under control and keep them there.

Controlling expenses isn't just an accounting exercise. If you plan to move into new lines of business, to develop raw land by using other people's money as part of your financing plan, overhead is your "soft underbelly." If you fail to control overhead, you're at great risk. However, if you think of the control mechanisms as part of the business planning and development process, you stand a better-than-average chance of succeeding in your business expansion.

Not all aspects of growth are positive. You'll encounter many pitfalls while your company is growing. For example, growth often places personal demands on you that you didn't expect. You have to work longer hours, often for less income than you would receive as an employee - and all the problems are yours.

Business owners often pursue growth for its own sake, believing that growth is not only good, but necessary. You may have heard that if your business doesn't grow, it will stagnate and die. That simply isn't true. The truth is, you need to decide how large an operation you want, how much risk you can tolerate, and how much time you 're willing to spend running the business.

But once you decide to expand your business, you need to control your rate of expansion. That means you have to put on the brakes if your company's growth happens too fast and gets out of control. You might ask, "What's wrong with fast growth?" To answer that, let's look at some of the problems associated with growth.

When you decide to expand into land development, you may be concerned about whether you'll have enough new business to sustain the growth. But that isn't the problem. The business is out there. Instead, the health of your business depends on deciding which activities to encourage and which ones to avoid.

The secret is to stay focused. Don't become so involved in a scattered collection of activities that you lose touch with what you really want - to purchase and develop raw land in a way that will return the most profit.

When is the right time to grow? The best time is when the current economy, money supply, the market and your competitive position are all favorable. If they're not, you're better off waiting until the situation changes for the better. But if you think now is the time to take the leap, consider the expansion challenge.

The Expansion Challenge

Expansion isn't limited to a single direction, such as upgrading equipment, producing new products or entering new markets. Expansion often occurs in several ways at the same time. We'll look at four types of expansion: volume, people, geography and competition.

Volume

This is the most obvious - and easiest-to-understand - type of expansion. But it involves more than just higher gross income dollars. You have to watch the rest of your profit-and-loss picture, too. If your direct costs rise to a higher percentage of sales than they were before, then you can count on one thing: lower profits.

You also need to control overhead costs so their rate of increase is far less than the increase in volume, direct costs, and gross profit. While overhead expenses invariably increase with volume expansion, there has to be a limit.

Remember that it's easier to control overhead through diligent planning and monitoring than it is to cut back once expenses have raced out of control. Controlling your overhead is the real key to higher profits after expansion.

Look at the two simplified profit summaries in Figure 1-1. In Summary 1, overhead expenses are controlled well in an environment of increased sales. Net profits increase to 22.3 percent of sales. But in the second year, in Summary 2, the same volume is accompanied by significantly higher overhead expense. The outcome is a 9.8 percent net - virtually no change from the lower volume period.

In this case, increased volume is really no more profitable. Summary 2 shows how you could expose yourself to greater risk and work harder, only to realize no real improvement in your company's operations. This is the essence of profitability - you can't just look at the numbers.

Controlling expenses is where you have the best chance of increasing your return on investment (profit divided by the amount you invested). You can't do much to reduce merchandise and labor costs. But by holding down overhead, you can significantly improve your profit when volume grows.

Overhead isn't the only thing you 'II have to watch. If you plan to continue your current activities while you 're managing your expansion, beware of one common pitfall. You may have a tendency to sell more on credit as your business grows. Don't do it. Combining higher overhead and expenses with higher accounts receivable and a slower collection cycle can be deadly. You have to plan carefully to keep your cash flow in line. Otherwise it's too easy to let your overall financial health suffer while your time and attention are focused on new operations.

More volume usually means you'll need more equipment. When you spend money for equipment, you have two choices: pay cash or borrow money. If you finance the purchase, that means interest expense and monthly payments. Before you take that step, you need to be sure that the money you need will be available from operations. Will the equipment generate enough income to cover payments? Will income begin immediately? The payments will! And is that income going to be regular or seasonal?

Equipment only generates income to the degree that it reduces labor costs. For example, a new piece of equipment may let two workers do as much as four. This cuts labor costs in half. So you can easily measure equipment productivity by comparing operating costs for current equipment against those for new and improved equipment, then balancing that against reduced labor costs.

The answer to the question of whether to lease or buy equipment depends on current need and future plans. If you expect to use a piece of equipment over many years, it makes sense to buy it. Leasing is expensive because you 're paying for time as well as equipment in exchange for a smaller investment up-front. But if the equipment is something you won't need beyond the short term, a one- to three-year lease may make more sense.

When you take on larger projects, you may be forced to stockpile materials. Perhaps you won't be able to find materials in the volume you need on a dependable schedule, so you 'II need to order more at one time. That usually gives you the benefit of a discount. But there's a downside. You have to pay for the inventory, you have to find a secure place to store it, and you have to insure it.

People

To support an increase in volume, you usually hire and train more people. You'll need more supervisors, office and accounting help and consultants (estimators, engineers). This means more expense. As your staff increases, you'll need more office space as well as temporary buildings at the development site. It also presents the potential for conflicts between you and your new staff about operating methods. You'll need better internal organization and scheduling to keep your trade workers busy every day.

Geography

All communities are limited in terms of how much construction volume they can support. Your competitors will always take their share of the local market. So when you grow, you may have to branch out to neighboring communities.

If yours has been a small company where you've supervised the job sites yourself, you may find that quality declines and work goes more slowly when you're not always physically present on the job.

Some of the disadvantages of working at a remote site are obvious:

• Higher cost to operate vehicles - fuel plus wear and tear

• Travel-time costs for employees

• Delivery charges for supplies and materials may increase

• You may have to use new, more expensive, or unfamiliar sources for services, materials and equipment

You can estimate pretty accurately what those will cost. But there are other risks that can be more expensive and harder to judge. Your presence on the job may diminish as administrative tasks take more of your time. That may translate to lower productivity by your crews, less efficient field supervision, and poorer workmanship.

It doesn't matter how diligent and trustworthy your site managers are. The fact remains that remote projects are rarely as efficient, profitable, or produced at the same level of quality as those you oversee regularly and personally. And this deterioration in operations (and profits) can become worse the farther your operation is from your home base.

Be sure to take these things into account when you consider the location for your development activities.

Competition

This is a two-edged sword. When you move into a new area or adopt new lines of business, you're confronted with a new set of competitors. These may be larger, more experienced and better financed than you are. Their proven track record might put you at a disadvantage when you approach lenders.

You may also find that businesses who didn't see you as a competitor before (when you were smaller), will now. They'll probably step up their own marketing efforts to "keep you in your place."

The best way to mitigate these challenges to expansion is to be very thorough when you prepare your market study. You'll need this document when you're ready to face a lender, and it will help you now to crystallize your plans for expansion. We'll discuss this in detail in the next chapter.

The Financing You Need

But let's return to the questions at the beginning of this chapter.

How Much Do You Need?

Unless you have a lot of ready cash available, financing is essential for any sizable expansion. You'll need money for the obvious things like land acquisition, surveys, reviews, permits, materials, consultants and labor - and don't forget related working cash for overhead, equipment and facilities, not to mention your own living expenses.

The amount of money you need to raise is related directly to the cost of the development. As obvious as that statement is, many people seem to forget it when they apply for a loan. Some people begin their quest for financing with the question, "How much will the lender let me have?" That's the wrong question, because it lets the lender dictate the size and scope of your development plan. That's your responsibility, not the lender's.

How Will You Use It?

When you approach a lender or investor, your task will be to show how you plan to use borrowed funds to develop your project. The size and scope of the project have to make sense. If you can demonstrate that your development has a market and is likely to be profitable, then the lender's risks are small, and so are your own.

How Can You Get It?

Think about this early in your expansion-planning stage. You might consider venture capital or taking in a partner. You may need to combine financing from many different sources to get what you want. For example, you may work with a mortgage broker to locate long-term financing for land acquisition and development, and with a commercial bank for a series of short-term working capital loans - the ones you'll need to pay the day-to-day bills.

In the early stages of development, you'll need a source for short-term financing through loans or a line of credit. It doesn't really matter how long your development project will take. You'll need flexible financing to help you during the time when expenses are high, and the income stream hasn't started flowing.

Find the Answers

Finding the answers to those three questions is the subject of the rest of this book. First, you'll learn how to approach the political aspects of land development, determine the extent of the available land inventory in your region, and analyze your market for potential buyers.

Then, based on that analysis, you'll learn how to zero in on your best development option and locate an appropriate site.

Finally, we'll cover the details of developing your project's business plan, finding the right sources for financing, presenting your plan to potential lenders or investors, dealing with objections to your plan, and managing your expansion successfully. Let's get started!

Getting Financing & Developing Land
by Michael C. Thomsett

You know how to build quality houses – maybe you’ve been doing it for a few years, and even made a tidy profit. But the real money is in buying raw land and developing it. You may want to start small with a few spec homes built on land you purchase. Or, you want to take on something larger, like a small business park or a tract of homes. But first, you have to create a market study, select the site and convince a lender, investor or a partner to back you in your plan. It’s a major leap and requires business and planning skills that you don’t necessarily pick up with the ability to build.

Land development takes a higher level of planning and financing – not to mention some genuine political savvy. It’s a daunting task, but this new manual walks you through the entire process:

There are forms and checklists to help you in your planning, and a sample business plan designed to help you sell your idea to lenders and investors. These are included on a CD-ROM as Word files you can customize to fit your own circumstances, and PDF files you can fill out in Acrobat Reader (included) and print.

You may face obstacles along the path to successful land development, but this book can help you navigate around them. It includes practical advice on conquering local opposition, dealing with no-growth advocates, and overcoming environmental issues. If you’ve done your homework, if you’re well-prepared, and if you can approach each situation you face methodically and intelligently, your chances of becoming a successful developer are increased tenfold.

Michael C. Thomsett has been a consultant for numerous construction and engineering firms over the last 20 years, specializing in introducing practical business systems for builders and contractors. He is the author of over 50 books on business and finance, and more than 500 articles in national trade and business magazines.

His other books for builders include:

Contractor's Growth and Profit Guide.