Sometimes the best deal you can find to build houses or rental properties includes the use of underdeveloped property. Underdeveloped properties are typically raw lots or land that hopefully has reasonable access to utilities. While these properties are typically pushing rural boundaries, you can sometimes find underdeveloped lots within city limits. In this article, I will discuss a personal example of using underdeveloped property and the steps you will need to take if you also choose to purchase and develop an underdeveloped property.
A Personal Example:
A while ago, we bought an underdeveloped lot that was previously a construction yard. The lot was 1.75 acres, priced at $40,000 (market value at the time), and had some great benefits, as listed below:
- Located on an accessible street in the middle of town
- Contained utilities (including sewer, water, cable, and power)
- Large enough for two fiveplexes (10 front doors in total, $4,000 value per front door)
Along with these benefits, however, we weren’t sure what we were getting into. For example, could there be:
- Underground tanks
- Hazardous materials
- Old utility lines
- Old concrete footings, etc.?
In our case, we had to deal with the last potential risk: old concrete footings. At the time that we bought the lot, we had no idea that there would be old concrete footings, but as we began to dig to put in our own footings, we had to put in some extra work to deal with the old footings. This wasn’t a huge deal, but it goes to show that underdeveloped land runs some risk. The big idea here is that you need to be prepared to handle the unknown, and the best way to do that is through a series of questions that you should ask and procedures that you should follow in the due diligence stage. Let’s explore this more in the next section.
When Purchasing Underdeveloped Land:
If you find yourself in the position to purchase underdeveloped land, you should first ask yourself this question: is there a reason that this property hasn’t been developed already? As you think through this question, there are a few levels of insurance and due diligence that you can explore to help you make a decision on whether or not to purchase the land. I’ve listed a handful below:
1. Property Disclosure / Seller’s Disclosure
Most states require this level of disclosure. In this process, the seller has to tell you every bad thing that they know about the property. If you find something in this process that scares you, you don’t have to proceed with buying the property.
In the case that you discover something about the property that the seller honestly didn’t know about, you may still have a bit of recourse to get out of the deal. If the seller misrepresented the property during the disclosure, then you would have full legal recourse to pursue the damages of the misrepresentation.
2. Environmental Study
These studies are broken into different levels of complexity. In phase 1, you can have someone come out to look at the land and conduct some environmental testing. After the testing, you will be given a report that either clears the property or lists concerns. If the study finds some questionable aspects of the property, you can plan accordingly to deal with them, or you can get out of the deal. Typically, when an environmental study is ordered, the buyer will have to pay for it, so it’s important to make sure that you’re serious about wanting to buy the lot before you waste your money.
It’s important to note that the environmental study can also be negotiated in the offer and acceptance stage as a contingency before closing the deal. Usually this means that you will be given 90 days or so to complete the study.
3. Figure Out Utilities
If utilities are already on site on the underdeveloped property, this is a win! Before closing, however, you need to figure out where those utilities are and how you will get them on site, if they’re not already there. Running utilities onto your property can be quite expensive and a big headache, so I would be careful about whimsically pulling a number out of the air and guessing what that cost would be. I would encourage you to meet with a respected utility and/or civil engineer or a site utility contractor to create an accurate estimate for that expense.
If it turns out that dealing with utilities will be extremely costly, you may want to consider increasing the density of your project to increase cash flow or taking on a partner to help share some of the financial strain. Either way, the process of figuring out utilities is essential before closing on a piece of underdeveloped land.
4. Contact a Civil Engineer
Once you’ve created a decent pro forma and checked out environmental/utility concerns, you’ll probably want to contact a civil engineer. It can be helpful to send information about the property to the engineer, including the types of units you want to put on the property, and then ask him or her how many units you’ll be able to fit on the land (unit density).
The last thing you want to do is think that you can fit 10 units on a property, create a pro forma from this guess, and then realize you can only fit 7 units on the property. This is why consulting with a civil engineer is so valuable. After you get your engineer’s feedback, you should make adjustments and true up your pro forma.
5. Check Zoning
It’s extremely important that you check what zoning the underdeveloped property has for the local city or municipality. For example, the city may have the property zoned for industrial use, and you may not be able to build houses on it without entering into a rezoning process. Rezoning is often a difficult and painful process. If you ever want to see a good catfight, go to your local city’s planning meeting when a new project is going into an old area and the residents are against it. I promise you, you will need to take a couple of Tylenol after you leave!
Zoning issues can be another contingency in the deal. If necessary, you can ask your seller if you can wait for the city’s approval on rezoning the property before you go through with closing the deal. Also, you may ask the seller to get the property rezoned for you so he or she has the burden of dealing with the city.
After walking through each process I listed above, you can move forward in your pursuit to purchase the property. Commonly, there are expenses that go along with this due diligence that may or not be recoverable. These costs are often called pursuit costs and need to be factored into your risk assessment and your long-term proforma when valuing your deal. After you go through your due diligence process, purchase the property, and undergo large-scale development, the actual construction can begin. Let’s discuss large-scale development next.
When Developing Underdeveloped Land:
After purchasing a piece of underdeveloped land and zoning it properly, it’s likely that your city will require you to take your project through large-scale development. The requirement for this development will vary from city to city or state to state. Sometimes, if you choose to only build one home or some other building that won’t disturb the land too much, your city may allow you to bypass large-scale development, but this varies depending on where you are. More often than not, however, a piece of underdeveloped land will be subject to large-scale development.
A large-scale development will look at the following things:
- How you plan to use the property.
- How you plan to deal with stormwater runoff.
- How your project will impact the area (streets, sidewalks, traffic control, street lighting, etc).
- Utility connections, drainage systems, street protocols, fire hydrants, etc.
- Proper construction documents, including specs and standards for all materials that will be used.
Importantly, a good engineer is essential in getting your large-scale project approved with the city. There are hundreds of details outlined in your plan, and no matter how great your plan is, you should expect some pushback from the city. A good engineer will know how to navigate such a pushback and can help you tune your project even further to reach approval.
After walking through the above steps and getting your plan approved with the help of an engineer, you can then begin construction.
In Summary:
- There are some great deals to be found in underdeveloped property, but they require a thorough process of due diligence. The last thing you want is to sign up for an unknown amount of risk.
- Sometimes you will encounter a pursuit cost, or the money required to investigate and (hopefully) confirm the purchase of underdeveloped land. This may or may not be recoverable.
If you work through your due diligence and end up purchasing a piece of underdeveloped land, you will likely be required to complete a large-scale development plan. During this process, it’s critical that you work with a good engineer to help you see your plan to completion.