For successful financing in 2007, look at location, renegotiation, valuation and exit strategy

Scott Wicken, senior analyst, Mountain Funding LLC

As published in Scotsman Guide's Commercial Edition, December 2006.

The common adage of "location, location, location" has been a theme in real estate for generations. Given current market conditions, however, this axiom may be changing. For 2007 and beyond, in the residential-land market, the axiom may become "location, renegotiation, valuation and exit strategy."

Indeed, despite the residential slowdown, there still are opportunities for prudent lending and investing in residential-land projects. These four items will likely come to define success in such projects.

1. Location

Project location remains as important as ever to determine a development's potential for success. Because of overbuilding in many previously hot markets such as Phoenix, Las Vegas and South Florida, research and selection of location has become paramount. Markets that are ideally suited for land development are those that experienced only moderate growth in the past few years. These markets are more likely to experience little to no decline and quicker recovery times.

As the residential market has slowed, homebuilders have become more selective when considering locations to purchase land. In some cases, they are no longer purchasing land at all.

When homebuilders do seek to buy land, they will focus their efforts on fully entitled tracts and finished lots, rather than on the preliminarily approved tracts and parcels they were purchasing as recently as a year ago.

In the end, builders must consider their own inventory, market-absorption levels and the project's market conditions.

2. Renegotiation

As the prices of all the components of development projects are being driven down, we're experiencing a period of renegotiation. Homebuilders are renegotiating their land-purchase contracts and buying finished lots rather than parcels. Land-developers are renegotiating with their contractors to lower lot-finishing costs. Land-buyers are renegotiating their purchase contracts. Developers are renegotiating for cheaper financing.

The result of this activity is an attempt, it seems, to lower the overall selling prices of homes, increase absorption and eliminate inventory.

Lenders are evaluating negotiations with all parties. They must be confident that the project's finances will allow the homebuilder to provide an end product that can be sold at market-appropriate prices.

3. Valuation

The importance of thorough land valuation cannot be underestimated. A lender will raise two primary questions in the valuation of a residential-land project:

• What can a builder pay for a finished lot to sell the homes at an appropriate price for the market?
• What will it cost the land-developer to finish the lots?

The land-developer profits also must be factored into the valuation. Once these costs are determined, a lender can then derive a basic residual land value for the proposed project and can fully understand its feasibility.

Current market and submarket conditions also will factor into a project's valuation. If the project is in an area that is experiencing stagnant growth or overbuilding, allowances must be made for the development to retain its value.

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