Investors looking at development opportunities may face obstacles this year as speculation about a recession looms and interest rates rise. The market uncertainty and shifting demand could cause extensive delays or abandoned developments. Property developers, who are the parties that oversee the project, will need to make tough decisions ahead.
If you’re thinking about investing in a development project, there can be higher returns, but a lot more risk too. In this article of the series, “Making Investing Decisions in Today’s Real Estate Market,” we’ll go over some of the factors that need to be weighed as you consider development investments. (See the first, second, third, and fourth articles of the series.) Keep these in mind as you peruse land for sale.
Look at entitlement requirements: Getting entitlement refers to the legal process you’ll need to go through to obtain a city’s approval for your project. Some places, such as New York City, grant a right of development which allows you to build without seeking entitlements. Still, there could be a variety of issues and complications that arise. You might face restrictions in historic districts or neighborhoods near transportation infrastructure, which could ultimately make it difficult to build. Bring in zoning and transactional counsel when going through the approval process. To avoid risk, you might look for projects that are already fully entitled.
Be aware of environmental issues: Is it possible to build on the land you buy, based on the soil’s consistency? Will your project interfere with environmental codes in the region? You’ll need a Phase 1 Environmental Site Assessment, which will research the history of the project. If there is reason to believe that contamination is possible, you may need a Phase 2 Environmental Site Assessment. This step involves soil samples. Gather good counsel for this, as making a clean environmental report (or at least capping the exposure) will be essential in a contract.
Recognize capital for development is key: Even if you create a timeline for your business plan, delays for approvals and supplies could lead to long wait periods. Unexpected costs might increase your forecasted financial needs. If you are not properly capitalized, and you borrow money or commit to paying returns to a group of investors, it could drain the cash flow of the project.
That said, some savvy investors do look to get sites tied up, meaning they put soft deposits on contracts that are contingent on approvals. If you’re able to do this, and you’re willing to speculate the cost to get entitlements and approvals, that could be a way to come out ahead. You might sell or flip the contract to get a return. (However, remember there is no guarantee in this space!)
Know that lenders will be careful: Getting financing can be especially tough in today’s market. Lenders tend to be very cautious about the riskiest types of real estate investing, meaning they will often only look to provide construction financing for the most experienced and credited developers. Oftentimes, the construction loans require personal guarantees. For a private individual, this could be catastrophic if the project falls through. It’s essential to consult your attorney before moving forward. Also check with a mortgage broker to understand the realities of financing in today’s market.
Ask about incentives for development: If your city or state offers assistance for projects, it can open doors to opportunities and ease the cost burden. In some markets, these perks are virtually a requirement to get started. For instance, with the current land prices in New York City, it can be tough to make the numbers work for rental development without a tax abatement. Other municipalities might have pilot programs or incentives based on your project’s plan to support public infrastructure.
In certain pro development markets, such as Houston, it could be easier to build. However, that also creates a chance for a neighboring developer to step in and compete with your project. Oftentimes it’s helpful if there’s income in place, such as from a parking operator or short-term retail tenants. In these cases, make sure the leases are all cancellable so they don’t hold up your development.
Finally, remember that when you’re investing in a development project, it’s not a question of where the market is today. You’ll want to be looking two to three years down the road, when the project is ready to bring to market. It can be difficult to predict the future, but if you’re in a supplied constrained market and you deliver the right product at the right time, it can lead to a very successful project.