Chapter 14The 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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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

B. Time and Money

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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

C. Labor

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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

D. Land Costs

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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 siteDesign/engineeringApprovalsImprovement costsFinancingTimeCash flow analysisMarketing, Competition, Profit 33

VIII. Financing the Development

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The availability and cost of credit have far more lasting effects than simply affecting development decisions

A. Credit

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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

B. Cash Flow Analysis

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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

C. Project Financing

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Approvals are often difficult to obtain so some entrepreneurs have taken to packaging projects with approvals for developers

D. Packages for Development

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IX. Recreational Developments

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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

Recreational Developments

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Basics of Property Development◦ Categories of Development◦ Redevelopment◦ Growth Affects Developments◦ Development and the Economy

The Development Industry◦ 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

Chapter Summary

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Profit◦ Markup◦ Time and Money◦ Labor◦ Land Costs◦ Site Selection◦ Bargain Lots◦ The Principle of Contribution◦ Who to Target◦ Design Decisions◦ Feasibility Studies

Financing the Development◦ Credit◦ Cash Flow Analysis◦ Project Financing◦ Packages for Development

Chapter Summary (cont.)

Recreational Development

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