Real Estate Marketing & Beyond
Ask Brian is a weekly column by Real Estate Expert Brian Kline. If you have questions on real estate investing, DIY, home buying/selling, or other housing inquiries please email your questions to [email protected].
Question from James in TX: Hello Brian, my brother and I inherited a 40-acre piece of property recently. It’s a flat piece of property less than a mile outside of a small town with a population of about 12,000 people. Many more people live in the surrounding area on acreage or at least large lots that have been individually developed. We don’t have a use for the 40-acres now or in the future. However, we would like to maximize the value. We’ve watched the population of the area grow for the past 15 years. We think there might be good money to be made by developing the acreage into a residential development with large lots (1/2 acre each). We know that we have a lot to learn before taking on this venture and that we’ll need to raise money. To get started, we just want an answer to a basic question. How do real estate developers make money? Thanks in advance.
Answer: Hello James. In short, property developers make their money by maximizing the value of the land they are working with. You’ve stated that your goal is doing this by developing residential houses, so I assume you know that the property is zoned for this. Otherwise, you need to start by looking into whether the zoning can be changed. Many rural areas limit how small you can subdivide property along with having “use” restrictions. A successful developer doesn’t try to fit a square peg into a round hole. That means not trying to develop something that has too many unknown variables. It’s a step-by-step process that when followed correctly will result in a handsome profit.
With that said, a 40-acre development would be considered a moderate project in areas with a larger population but is a large project according to the way you describe the surrounding area. Because you will have to bring in other investors, I suggest you begin by engaging a real estate attorney to decide how to structure the business. It could be you and your brother operating a business entity such as an LLC that takes the largest risk. Since you already own the land, that should serve as your primary investment in the project and satisfy other investors who will insist that you have skin in the game.
Most investors still won’t put money in the deal until zoning laws are aligned with the project and permits are available. This requires you, as the developer, to perform due diligence that also includes market analysis and Pro forma financial reports to entice early investors. Investors will most likely be equity partners that own a substantial portion of the end profits. Your equity in the land will be your primary source of profits from the project. The developer typically collects developer fees as the project progresses that range from 5% to 10%. Many developers continue as property managers until all the houses are sold. All of this requires an individual developer to hire a team of specialists to bring the project to fruition (architect, civil engineer, general contractor, project manager, realtor, etc.). According to the National Association of Home Builders (NAHB), developers average about $3 million in gross profit on $16.23 million in revenue. That's an 18.9% percent profit.
Once you have the zoning and permits squared away, the next step is typically a survey to establish the exact outer boundaries of the land being subdivided. From this, a plot plan is created. The level of detail required for a plot plan varies from county to county and is based on the proposed use of the land. At this point, rezoning may be required. Getting zoning changes can range from a mere formality to an impossible obstacle. At a minimum, it requires presenting your plan to the zoning board and public meetings at which time nearby landowners can ask questions and voice their approval or disapproval. Then the Zoning and Development Board requires time to conduct a review, including impact studies to determine suitability. At that point, you obtain approval, rejection, or approval with modifications.
With approval or based on modifications, the developer subdivides it into smaller lots to develop and sell the lots individually. Costs for developing the land include hard costs such as clearing and grading the land and putting in utilities and roadways. There are also soft costs for legal fees, financing fees, and design/engineering fees. Some developers will build houses on the improved lots while others will just sell the lots for individuals to build on.
James, because you and your brother appear to have limited knowledge in all of this, I strongly suggest that you hire a top-notch project manager with experience. In 2021, the average land development project manager salary in the US was $99,100 according to the Economic Research Institute. Most development project managers have either a Bachelor's or Master's degree in related studies (civil engineering, development planning, finance, business management, or a real estate degree). Primary responsibilities include:
The best project managers have strong professional and personal connections. These relationships include a wide range of professions such as brokers to sell plots, title agents to help with transactions, attorneys for development related legal matters, real estate investors, and anyone else who can contribute to making your project more efficient, successful, and profitable.
James, I hope this is enough to get you started in the right direction. I also hope your ambitious project turns out well.
A ton more information could be included here. Please add your comments.
Our weekly Ask Brian column welcomes questions from readers of all experience levels with residential real estate. Please email your questions or inquiries to [email protected].
Brian: I would strongly suggest that before they spend any money on engaging a real estate attorney to assist with structuring the business that they perform (or have performed) a preliminary market study. If they lack the capability to do it themselves then they should contact a local real estate broker who has experience in residential development, either as a participant or as a broker for the land. All to often I see land owners assuming that their family tract has some appropriate use other than which it has been used in the past and waste substantial money chasing an unrealistic goal. Even if there is demand for residential development, it might be easier and far safer to sell the ground at pre-development value to an experienced developer or, if they wish to participate in the potential profit, consider a joint venture or an equity "kicker" on the back end. .
Daniel
Thank you for commenting. That is sound advice.
Brian Kline