Homebuilding and Land Site Investment

Historically, homebuilders bought land, achieved zoning changes, constructed houses, then sold them. But land site developers change the equation – and reduce risk.

After five full years of an economic downturn for homebuilders, sellers and buyers, the news is instead looking up in the United Kingdom. The Wall Street Journal reported in April 2013 that homebuilder stocks were up 80% over the previous 12 months, buoyed in part by the government’s Help-To-Buy schemes announced earlier in the year.

This came about six months after Reuters reported that UK home builders were sitting on land banks, much of which was purchased in 2009 and later, when the price of land had plummeted. They are now about to leverage the value of that land, pending development consent from local planning authorities, to build new homes.

But many of those homebuilders suffered quite a bit through the earlier years of the recession, with portfolios of property that included land purchased just prior to the financial crisis of 2008. That expensive land was a drag on profits – those firms that had deep pockets might have been able to afford to carry the costs, but many homebuilders (particularly smaller ones) fell out of the business entirely because of crushing debt.

Some of this recent land investing and building history helps illustrate how the business of development on raw land has been bifurcated in recent years. Instead of builders taking on the full risk of investing, building and selling, land investment specialists now undertake the first stages. In addition, real estate analysts at Savills report that the forthcoming Basel III banking regulations could constrict debt funding, which further limits how much risk homebuilders will be willing to assume. They will instead look for smaller parcels of serviced (infrastructure-built) properties.

The new approach is for land specialists, themselves or with the help of investors, to make strategic land purchases. They engage in intensive market research to identify where growth is most critical, then investigate raw land where that might be possible, taking into account seller predispositions, existing and needed infrastructure, as well as how amenable to planning changes are local planning authorities. The land specialists might (and often do) build the infrastructure – roads, water and sewer, and electrical capacity – but then sell parcels or plots to homebuilders, who have greater experience at both construction and the marketing of the built properties.

To a land site investor, the holding of property for several years before construction begins – as happened to homebuilders since 2008 – does not fit the business model. The investor’s objective is to turn the investment as quickly as possible, and to buy land in the first place that will sell at an optimal price in the near term. This is part of why land-to-build investors are coming to real estate from other alternative investment categories: If their options are hedge funds, precious metals, real estate investment trusts (REITs) or market-traded securities, the return on investment formula places heavy weight on timing. The land investor may plan to achieve a return in as little as 18 months after acquiring raw land (note: it sometimes can take five years to bring a property to market and realise the return on investment).

A key component is of course zoning changes, taking land that might be designated for agriculture or other uses and have it designated by local authorities for residential or commercial development. Homebuilders may have this capability in-house as well, or may contract it out to others. With land investment specialists, it is an essential part of the business model and a key component of achieving profitability. Relationships with local planning authorities in strategic locations certainly aid in this process.

Land investment, particularly with raw (unbuilt) properties, involves risks just as much as with other types of investment. But by controlling for factors such as land planning, and splitting the risks – and rewards – of building and selling completed homes, residential land investors mitigate those risks. Individuals who are interested in land investments should speak with a personal financial planner to determine if any particular investment fits their overall financial portfolio.