Case Study 10: Land Development Project

At every state of the market, there are strong points and weak points. Regardless of a market’s current state, it’s important to take a step back and look at the available opportunities. Sometimes it’s better to wait for the market to turn or correct itself, but there are other times where it’s smart to get involved and make a deal. Let’s look at an example below:

In 2007 when the market crashed, everyone was scared of housing. There was a massive devaluation and deflation of properties, banks were calling notes, and people were going bankrupt. It was a horrible situation. 

Before the market crashed, in many areas, land developers had over-built lots. At the time they were built, lots were typically going for $50,000+, but after the crash, many were worth only $15,000 or less, leaving the developers over-leveraged and with an excess of lot inventory. Unfortunately, a lot of developers went bankrupt because of this. A side note—this is the tough thing about land development: it’s incredibly risky if the market changes. There is a long lead time involved (a year or more) to buy the land, go through planning, and perform construction. This leaves a lot of time for the market to change while developed inventory is still in the works. 

As developers tried to recover from the crash, banks were telling them that they had to put some cash in if they wanted to keep the lots. Most developers were unable to make payments on the land, so they had to walk away. As a result, there was an abundance of inexpensive lots circulating around. I remember lots selling for as little as $3,000 a piece—and these were regular, 8,000-10,000 sq. ft. lots. The cost to develop a lot is typically $20,000-25,000, so the ability to purchase lots for much less than that was a win.

Several years later, starting in 2012-14, lot prices started to go back up. Now, the lots that were sold for $3,000-5,000 years earlier were now worth as much as $20,000. In these cases, the people who had lots would use them as equity to build houses with no (or very little) money down. Because these people had cash on hand to buy cheap lots during the recession and had market savvy to turn those lots into rental properties, they were able to emerge from the recession in a pretty good place. 

For a more specific example, let’s take a closer look at an opportunity my company encountered around this time. Please note that I share this example to highlight the importance of following the market and capitalizing on opportunities.

In the early 2010s, we bought some lots for $12,000 and $18,000 and were able to build some strong rental properties on them. Below is the financial breakdown of one of these properties:

Finished Appraised Value: $159,000

Down Payment: $18,000 (in this case, it was lot equity only)

Amount Borrowed: $127,200

Monthly Rent: $1,250

Monthly Payment: $742

Monthly Free Cash Flow: $248

There are several advantages to this deal. Because I had paid cash for the lot, I was able to use it as equity, and it functioned as my down payment—only 11%! Additionally, the bank I worked with gave me a loan that was 80% of the finished appraised value, which was a huge advantage. Some banks won’t loan on the finished appraised value and will only loan on the actual construction cost—it’s important that you have enough market and relational savvy to find a bank that will work with you on this. Finally, I had a great general contractor that I knew could get the construction done at a fair, fixed price and with high quality. 

All this to say: sometimes just being aware of market opportunities is pretty powerful. Beyond awareness, it’s also essential to have a good relationship with a general contractor to help build on lots for a fixed, quality price, as well as a good relationship with a realtor who can help navigate deals. Oftentimes, the relationships around you can help you gain access to more opportunities. At the same time, however, you have to be able to maximize those opportunities and hone your investment skills. Watching the market and knowing how to take advantage of what deals may present themselves is often difficult and requires lots of hard work and due diligence. I do think that in almost every market, there are opportunities if you are willing to put in the hard work of looking for them. I would also say that the scenario that I described above was probably a once-in-a-lifetime event. I’m not sure we’ll ever see real estate devaluation to that extreme again. That’s largely due to banking standards changing so radically after the 2007 recession.