Transcript Chapter 14 - robertrooks.org

Chapter 14
The Economics of
Development
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I. Basics of Property
Development
A developer adds value to land by improvements
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A. Categories of Development

Development falls into three major
categories:
1.Residential Development
2.Nonresidential Development
3.Public Works Development
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B. Redevelopment

REDEVELOPMENT is developing what had
previously been developed by modification,
restoration, or by demolition and new construction

Redevelopment means replacing a property’s current
use with a more profitable one
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C. Growth Affects Development

A single real estate development can change the
character of a community and the direction of its
growth

Industrial growth will thwart better quality homes from
being built but will attract other similar uses to the
area

A major new industry will bring in supporting industries
and increase the demand and the price for industrial
sites
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D. Development and the Economy

A single development can have a significant effect on
the economy of a community by itself, as well as a
cumulative effect with other developments

Besides affecting jobs and population growth directly,
there is an indirect benefit as to support businesses
and personnel
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II. The Development
Industry
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A. Small Developers

The DEVELOPMENT INDUSTRY is made up of
builders and subcontractors who are often in and out of
business due to changes in the market

Many firms operate as limited liability companies (LLCs)
or corporations so that bankruptcy will not affect the
principal’s other assets

Due to the proliferation of small builders, costs are
higher than they would be if there were just a handful of
large builders and a more standardized product
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B. Giant Developers

Some builders are giant corporations listed on the New
York Stock Exchange

These large building firms, however, are NOT so much
a revolution in technology as they are in management

A VERTICAL CONGLOMERATE is a very large
company that owns the companies that supply it and
that it supplies
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C. Risks of Development

Political Risks

Economics Risks

Risks of Nature

Physical Risks

Labor Risks

Material Risks

Judgmental Risks
Developer risk is greater
in small and midsize cities
because the marketplace
will be more easily
saturated than in a larger
community
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D. Taxes and Land

High property taxes on land encourage development

High holding costs force owners to either develop
land or sell it
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E. Community Tax Benefits of
New Developments

Many developers must dedicate land for community
use and pay many types of fees, which benefit the
community

The tax burden borne by new homes is proportionately
higher than borne by existing property
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III. The Development
Entrepreneur
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The Development Entrepreneur

An ENTERPRENEUR is a person who builds and
owns his or her own business

An entrepreneur makes things happen

When a project is developed, the possibility of profit or
loss is accepted by the builder/developer
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IV. Dangers of Growth
Limitations
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Dangers of Growth Limitations

In some cities, voter initiatives can put limits
on the number of building permits allowed for
an entire city

Growth limitation rulings can be economically
disastrous for developers

No growth ordinances can make economic
developments of large parcels impossible
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V. Billboards and
Development
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Billboards and Development

Strong public sentiment exists against billboards

Many communities are working to eliminate billboards,
which they equate with blight

Besides aesthetics, billboards create a safety problem by
distracting drivers

Developers are now incorporating billboards into their
redevelopment projects

Without the millions of dollars from billboard advertising,
many redevelopment projects would not be feasible
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VI. Speculator’s Risk and
Development
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Speculator’s Risk and
Development

SPECULATORS are people who take on large risks
with real estate investments and developments

During boom periods, many new subdivisions were
sold out by speculators, even before the models were
completed

Builders customarily take reservations before
completion
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VII. Profit
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Profit

Developers utilize:




Capital
Labor
Land, and
Management
to develop a finished product for which the selling price
will hopefully exceed the total required expenditures,
equaling PROFIT

A developer’s profit must NOT only provide for a
reasonable return on the investment of time and
money, it must also be enough to offset the risks
involved
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A. Markup

MARKUP is the percentage added to cost to determine
sale price

“10,10, and 10” system is used by many small builders
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B. Time and Money

The more time it takes to complete a project, the
more money it takes

Unexpected political delays cause builders to plan
higher markups

Inflation during the approval process can result in
a significant increase in the final costs
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C. Labor

Projects can fall behind schedule when there is an
inadequate supply of skilled labor available

When increases in costs can be readily passed on to
purchasers, builders will pay higher wages
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D. Land Costs

The value of land is directly related to the future use of that
land and the agricultural use sets the floor on land value

EXCESS LAND is land that does not contribute to the value
of the project

A GORE is a triangular-shaped lot
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E. Site Selection

When selecting a site, a developer will analyze the
location and add up the costs of development for the
proposed use

If it is not profitable, the developer will sell that site and
purchase one more suitable for the intended use

LOCATION ANALYSIS is an individual economic
study to determine the profitability of a development by
considering proximity of buyers to their markets,
services, employment, transportation routes, shopping,
customers and parking
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F. Bargain Lots

A poor location (bargain) could mean that a
property will take many more months to sell or rent
than a property in a better location
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G. The Principle of Contribution

The principle of contribution is that an amenity
should NOT be included unless the increase in rents
or value justifies the expense
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H. Who to Target

A developer should aim the project at those who the
developer believes will be the eventual renters or
buyers

This applies to likely needs and economics
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I. Design Decisions

Generally, people like cutting-edge designed homes,
but they feel more comfortable buying something that
looks more like what they are used to
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J. Feasibility Studies

The FEASIBILITY STUDY is essential in the
decision process for a successful developer

The study ties together in a single document the
economic considerations of development including:








The site
Design/engineering
Approvals
Improvement costs
Financing
Time
Cash flow analysis
Marketing, Competition, Profit
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VIII. Financing the
Development
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A. Credit

The availability and cost of credit have far more
lasting effects than simply affecting development
decisions
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B. Cash Flow Analysis

Developers must analyze their cash needs for the total
time period of each project

CASH FLOW ANALYSIS is the analysis of when cash
is received and paid so cash loans can be arranged if
there is a temporary deficit
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C. Project Financing

Developers of projects for sale should consider
permanent financing as well as construction loans

Having permanent financing allows a developer to
keep title to a project, and hold or later resell, rather
than be forced to sell in an unfavorable market
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D. Packages for Development

Approvals are often difficult to obtain so some
entrepreneurs have taken to packaging projects
with approvals for developers
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IX. Recreational
Developments
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Recreational Developments

RECREATIONAL DEVELOPMENTS are projects
that consist of recreation facilities

Boating developments have terrific demand

One of the easiest ways to create value is to build
a lake
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Chapter Summary

Basics of Property
Development
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Categories of Development
Redevelopment
Growth Affects Developments
Development and the Economy

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The Development Industry
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Small Developers
Giant Developers
Risks of Development
Taxes and Land
Community Tax Benefits of New
Development


The Development
Entrepreneur
Dangers of Growth
Limitations
Billboards and Development
Speculator’s Risk and
Development
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Chapter Summary (cont.)

Profit
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
Markup
Time and Money
Labor
Land Costs
Site Selection
Bargain Lots
The Principle of Contribution
Who to Target
Design Decisions
Feasibility Studies

Recreational Development
Financing the Development
◦
◦
◦
◦
Credit
Cash Flow Analysis
Project Financing
Packages for Development
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