How to be a Successful Developer

How to Be a Successful Developer

How to Be a Successful Developer Formerly titled Investing in Land

Ralph R. Pisani Robert L. Pisani

No part of this publication may be reproduced or transmitted in any form or by any means, electronic, or mechanical, including photocopy, recording, scanning or any information storage retrieval system, without explicit permission in writing from the Author. © Copyright 1989 by Ralph R. Pisani and Robert L. Pisani First e-reads publication 1999 www.e-reads.com ISBN 0-7592-1023-3

Ralph Pisani dedicates this book to his wife Barbara, who refuses to accept the idea that there are limitations to the things he can do. Robert Pisani dedicates this book to his mother, Elizabeth.

The authors would like to thank the National Association of Home Builders for permission to reprint Figures 3.1, 5.1, and 9.5; and Warren, Gorham & Lamont for permission to reprint Figure 4.2 from Real Estate Investor’s Deskbook by Alvin Arnold.

Foreword

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Foreword

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he real estate developer is the quintessential entrepreneur. The word “entrepreneur,” like the word “enterprise,” comes from an old French word meaning “to undertake.” This etymology accurately describes the goal of the real estate developer/entrepreneur: to undertake the development of property. Successful developers/entrepreneurs are often identified by their personality profile, which can be summarized as follows: Self-reliance. Developers are an autonomous lot. They believe in themselves and the right to guide their own destinies. They are more comfortable giving orders, and have more faith in those orders, than receiving orders from others. Leadership. Because they are self-reliant, developers tend to be leaders. Most developers are either sole proprietors or the principal owners of their company, and they know the buck stops with them. They are take-charge persons, preferring to make their own decisions. Propensity toward risk. Since there are many factors that go into the success and failure of each project, developers must have a tolerance for uncertainty. Developers examine the risks (financial, political, legal, and economic) in each project, evaluate the probability of success, and minimize the chances of failure by reducing risk whenever possible. Developers, however, are not crapshooters.

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Opportunity seekers. Successful developers carefully evaluate the market place, seeking opportunities in the form of market niches not exploited by previous developers. Achievement motivation. Developers are driven by the desire to succeed. “Success” can come in many forms: money, power, respect, fame. Action and goal oriented. Because they are driven to succeed, developers are action and goal oriented. They have a clear idea what they need to do, and the self-discipline and perseverance to direct all their efforts toward the completion of the project. As with all entrepreneurs, developers are “psyched” to believe that they alone can achieve the goal and grab the brass ring. There is not only the prospect of profit but also the psychological gratification that comes from building. Mere possession of some or all of the above traits, however, does not guarantee success in real estate development. Ralph and Robert Pisani’s pragmatic book identifies and clarifies the issues developers must face when they consider developing a parcel of raw land. This volume can be used as a checklist to guard against pitfalls, reduce risk, and identify the barriers that must be overcome to successfully complete a development venture. Still, a successful development is not easy to come by. Before a single bulldozer arrives at the site, a developer will have spent hundreds of hours choosing the land, determining its use and potential market, assembling a professional team, securing the financing, obtaining government approvals, and marketing. For thoughtful, informed developers the goal—a development which is a credit to the community and a profitable venture—will be more than worth the effort. William Zucker Founder of the Real Estate Center at The Wharton School Professor Emeritus, The Wharton School University of Pennsylvania

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Preface

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Preface

M

arcus Licinius Crassus was said to be the richest man in ancient Rome. He counted as his friends and enemies the greatest men of his time: Caesar, Pompey, and Cicero. Fifty years before the birth of Christ, Crassus amassed a fortune so great that, in the words of the biographer Plutarch, “the greatest part of Rome, at one time or other, came into his hands.” How did he become so wealthy? Crassus was no fool. He was a real estate developer. Ever since Crassus, real estate development has been dogged by the myth that it is a game played by very rich people. Today, visions of Donald Trump making big stake deals often come to mind when people think about real estate developers. People also have an image of developers as devils from out of town who descend on quiet rural communities, buying large tracts of land from poor farmers, taking no interest in local concerns, and putting up acres of ugly buildings that create traffic, water, sewer, and other public service problems. The truth does not support these images. I1 was not at all wealthy when I began in real estate development, nor were most of the people I knew who 1 “I” refers to Ralph R. Pisani, who was the developer of most of the projects cited as examples in this book.

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were involved in the business. And while development, like all businesses, does have its share of shady operators, the vast majority of developers are not devils (I had my horns filed down long ago). Americans have always had a fascination with real estate and real estate development. Go to a party, and chances are a few people will be huddled in a corner earnestly discussing land investments. I am often approached by doctors, lawyers, bankers, and others with investment capital. They all want to be developers. They sense that people are making money in the business, but just can’t figure out how. Unfortunately, more than a few have launched themselves into real estate development without doing their homework. Lured by constantly appreciating land values and fabulous tax advantages, thousands of individuals who knew nothing about development went into the business in the last two decades. Many made huge sums of money, some were modestly successful, but many lost their shirts and were confounded. I wrote this book so that those interested in real estate development as a business would be more successful than confounded. My purpose is to enable anyone interested in development to: 1) recognize that there is still plenty of room for fresh faces in real estate development; 2) find out how the business works from the viewpoint of a practitioner; 3) present information that will enable the reader to make informed development decisions; and 4) show how, using myself as an example, one can make a modest personal investment and start on the road to financial independence. Ultimately, I would like to leave the impression that real estate development is still the quickest, surest, and most exciting way to acquire wealth in America. I am one of the fortunate ones; starting with a modest investment in 1968, I have through a combination of hard work, luck, and sheer nerve amassed a considerable sum of money entirely from real estate development. Along the way, I learned not only how to develop land and put up buildings, but also the subtle art of getting what I wanted. I learned how to talk a skeptical banker into lending the money for my projects, how to obtain approval from a hostile zoning commission, and how to calm the fears of those who were afraid that my development would lower the quality of life in their neighborhood. This art, the psychology of development, is as important as the actual mechanics of the business. There are many developers who are as well versed in the mechanics of development as I am but have never fulfilled the success potential of the business because they never learned the art of persuasion. Part of this book concerns this art, because if you do not have it, you will not be as successful as you could be. While this book began as an introductory text for my students at the Wharton School, I also wrote this book for those who are peripherally

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involved in the development business, such as real estate brokers, bankers, lawyers, accountants, municipal officials, engineers, architects, interior designers, and others who may be familiar with one part of the business but are not sure how that part fits into the whole. Those who would like to be passive investors in development ventures sponsored by syndicates, joint ventures, and real estate investment trusts but feel they need to learn more before they make their investment will find here an overview of the fundamentals of real estate development. Finally, those readers plagued by locust like developers in their own communities who want to learn how and why development occurs will find lots of information here. A few words about terminology. The phrase “land development” has a specialized meaning in real estate development. It refers to the process of constructing infrastructure facilities such as water, sewer, and streets, and not to the actual process of erecting buildings. In this book, however, unless otherwise noted the terms “land development,” or just “development,” and “land developer” or “developer,” refer to the entire spectrum of real estate development, from land speculation through construction. RALPH R. PISANI ROBERT L. PISANI New Hope, Pa. Philadelphia, Pa. March 1989

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Acknowledgments

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Acknowledgments

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uch of this book was inspired by William Zucker, Professor Emeritus and founder of the Real Estate Center at the Wharton School of the University of Pennsylvania. This book began as an introductory course on real estate development which the authors taught for the past several years to MBA students at Wharton. In preparing the curriculum, we realized that there were no general interest texts specifically on development that our students could use. There were technical manuals on construction and land use management, zoning, sales and marketing, environmental issues, real estate investment and related matters, but nothing specifically to introduce students to the parts of development and how they relate to one another. We therefore had to develop our own course of instruction. Bill Zucker spent many hours going over the details of the course with us and, when we suggested that it might be made into a book, encouraged us to begin the process. We are grateful to the many people who agreed to be interviewed and to those who took the time to review draft chapters, particularly: Scott A. Williams Meridian Bank Philadelphia, Pa.

Boris S. Lang Atlantic Financial Bala Cynwyd, Pa.

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Acknowledgments

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Bob Moore Planning Commission Bucks County, Pa.

Ed Schlaner, P.E. Martin Schuler Engineers Allentown, Pa.

John Carson John Carson & Associates Doylestown, Pa.

Richard Bickel Delaware Valley Regional Planning Commission, Philadelphia, Pa.

John R. Pomponio Environmental Protection Agency Philadelphia, Pa.

Richard Elkman Group Two Philadelphia, Pa.

Clyde Waite, Esq. Stief, Waite, Gross and Sagoskin Newtown, Pa.

John Hoch Penn Title Insurance Company Allentown, Pa.

Berel Altman Altman Brothers, Inc. Glenside, Pa.

Janis Gibson Warren, Gorham & Lamont New York, N.Y.

Arthur Sasso The Jason Group New York, N.Y.

Al Marmero Summit Homes, Inc. Cherry Hill, N.J.

Stephen Harris, Esq. Harris and Harris Warrington, Pa.

Morton L. Olshan Mall Properties, Inc. New York, N.Y.

Roger Wells Roger Wells, Inc. Haddonfield, N.J.

Jerrold Berman Summit Homes, Inc. Cherry Hill, N.J.

Special thanks must also go to the staff of the National Association of Home Builders, especially David Seiders, Gopal Ahluwalia, Robert S. Villanueva, David L. Ledford, and Michael S. Carliner, who made themselves available for interviews and offered their considerable insight into the homebuilding industry. We would like to thank Kathy Coon and Ida Weingram of the Jenkins Memorial Library in Philadelphia, the librarians at the Lippincott Library of the University of Pennsylvania, the Free Library of Philadelphia, and the National Association of Home Builders for their research assistance. Our lit-

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erary agent, Richard Curtis of Richard Curtis and Associates, provided us with much-needed advice and encouragement. Our editor, Michael Hamilton, cheerfully guided us through the publishing maze. Becky Tribull, our executive secretary, patiently typed the first drafts and handled many of the administrative tasks associated with the production of this book. For help with the literary aspects of the book, we would like to thank our copy editor, Eugene O’Leary; Art Spikol for his columns in Writer’s Digest; and William Zinsser for his book, On Writing Well. Finally, our wives, Barbara and Suzanne, offered us their patience, understanding, and advice. R.R.P. and R.L.P

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Table of Contents Chapter 1

Chapter 2

Real Estate Development: Getting Rich in America

1

Why Real Estate Development is an Attractive Business Leverage Taxes Demand Self-employment Personal Satisfaction The Players in Real Estate Development

1 2 3 3 4 4 5

A Brief History of Real Estate Development

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Development in the Ancient World Development in Europe The Growth of the Cities The Growth of Capitalism Rural Development in Europe Urban Development The Victorian City Development in the United States The Urban Sprawl: New York The Growth of Fifth Avenue

7 9 9 10 11 12 13 13 14 15

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New York’s Early Development Projects Later Developments in New York Development of the Suburban Ideal The First Suburbs Other Factors in the Success of the Suburban Ideal The Coming of the Automobile The Rise of Federal Influence in the Housing Market Development after World War II Summary Chapter 3

Myths and Facts About Real Estate Development Four Myths about Real Estate Development Eleven Commonly Asked Questions about Real Estate Development

Chapter 4

16 17 17 19 21 21 22 24 26 28 28 29

Forty Factors to Consider When Acquiring Land

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Three Starting Principles Where to Find Land Land Acquisition Study Property Inventory Environmental Analysis Utilities Regional Inventory Government Regulations

44 44 46 46 49 52 54 57

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Chapter 5

Chapter 6

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The Development Decision Land Acquisition Study—Bucks County, Pa. Property Inventory Environmental Analysis Utilities Regional Inventory Government Regulations The Development Decision

59 63 66 67 68 69 70 71

Financing

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Residential Mortgage Fundamentals Residential Mortgages The Secondary Mortgage Market Financing Land Acquisition An Example Financing Construction Sources of Construction Financing Obtaining a Construction Loan Long-term Financing Real Estate Development Partnerships

73 74 75 77 80 81 82 86 96 99

Retaining the Professional Team

101

Finding Professionals The Initial Interview Negotiating the Contract The Building Professionals Lawyers

101 102 103 106 106

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Chapter 7

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Appraisers Accountants Insurance Brokers Architects Title Insurance Companies Land Planners Surveyors Engineers General Contractors and Construction Managers Environmental Consultants Real Estate Agents Professional Team Management When Serious Problems Develop

106 107 107 108 109 109 110 110

Zoning and Subdivision

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Zoning: A Brief History Planning Commissions Innovative Zoning The Rights of Developers Zoning and Subdivision: The Rules of the Game Know the Land Know the Regulations Know the Players Zoning: The Fundamentals What Zoning Regulates How Zoning Changes Are Made

117 119 119 121

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111 112 112 112 113

123 123 124 125 126 126 127

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Obtaining a Change in Zoning 128 Appearing before the Zoning Board 129 Subdivision 130 The Subdivision Process 132 Appearing before the Planning Commission and Governing Body 133 Building Codes 133 Chapter 8

Chapter 9

Environmental Issues

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Anti-Pollution Laws The National Environmental Policy Act Clean Air Laws Clean Water Laws Hazardous Waste Laws Noise Laws Environmentally Sensitive Areas Wetlands Floodplains Coastal Zones Endangered Species Erosion and Sedimentation Control The Environmental Audit

137 137 137 138 139 141 141 141 142 142 143 143 144

Construction Management

146

Project Delivery Hiring a General Contractor Hiring Your Own Construction Superintendent

146 147

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Design/Build Cost Management Cost Estimating Cost Control Scheduling Quality Peace of Mind Chapter 10 Sales and Marketing Building for a Market How to Conduct a Market Study Population Growth Statistics Housing Inventory Housing Characteristics Employment Statistics Family Income Analysis Comparables Absorption Rate Deciding What to Build Hiring Realtors Chapter 11 The Settlement

150 152 152 154 159 164 164 167 167 169 170 170 171 171 171 172 175 176 177 193

The Settlement Players The Buyer and the Buyer’s Attorney Buyer’s Title Insurance Company Buyer’s Mortgage Company Seller and Seller’s Attorney Real Estate Agency xix

193 194 194 194 195 195

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Seller’s Lender Prior to the Settlement At the Closing Chapter 12 Getting Started

195 195 206 208

The Four Main Players in the Development Business Land Speculators Land Subdividers Land Developers Builders A Review of the Development Process The Development Concept Market Study Site Selection and Preliminary Feasibility Study Land Acquisition Study Retaining the Professional Team Financial Feasibility Study Obtaining Government Approvals and Refinement of the Plan The Development Decision Infrastructure Development and Building Developing a Sales Program Sale and Settlement What It Will Take for the Small Developer to Succeed in the 1990s Bibliography

208 208 209 210 210 212 212 212 212 213 213 213 214 214 214 214 214 215 219

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Men honor property above all else; it has the greatest power in human life. Euripides (C. 400 B.C.) The spirit of property doubles a man’s strength. Voltaire (1764) Ninety percent of all millionaires become so through owning real estate. More money has been made in real estate than in all industrial investments. The wise young man or wage earner of today invests his money in real estate. Andrew Carnegie The fortunes of the future will be made in real estate. John D. Rockefeller

How to Be a Successful Developer

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Real Estate Development: Getting Rich n America WHY REAL ESTATE DEVELOPMENT IS AN ATTRACTIVE BUSINESS

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dmit it! Americans honor and respect success. Horatio Alger ranks with George Washington in our national mythic consciousness. Moreover, we love and sometimes exalt the progeny of success: money. There are few businesses in the United States that offer as many rewards and opportunities as real estate development. But it wouldn’t be such an attractive and lucrative business if it wasn’t for one fact: development is first and foremost about land. Why is land so special? Will Roger’s advice, “Buy land, they ain’t making any more of it,” contains all of the reasons why land is a good investment. Those reasons are: Land is unique. No parcel of land is like any other parcel of land in the world. It is unique in its physical location, as well as its physical characteristics. This is why “location, location, location” are often cited as the three most important factors in real estate in general and development in particular.

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Land is indestructible. You can mine land, blow it up, move the dirt, but you can never destroy the surface of the earth. Think about it: homes, cars, factories, humans, everything else decays and falls apart, but “the earth abideth forever,” in the words of Ecclesiastes. This is why land has always been considered such good collateral, and why lenders consider it a good investment. People come and go, but the land is always there. Land is immobile. You cannot pick up land and move it anywhere. You cannot lose it, steal it, or hide it. You never go looking for a piece of land you own and say, “Gee, it was here yesterday.” Your land is always where you saw it last. Uniqueness, indestructibility, and immobility are the distinguishing features of real estate. What about development, which is the specific branch of the real estate business that constructs buildings? In addition to the factors discussed above, development has the following specific features that make it an attractive proposition. Leverage This is the primary advantage of development. Leverage is the use of other people’s money to make money for yourself. When a house is built today, chances are that at least 75 percent of its total cost (including land, construction, marketing, overhead, etc.) is financed by somebody else, usually a commercial bank or savings and loan association. In return, you pay interest to the lender. A lender will allow you to use leverage because the property that you are developing should rise in value through the fruits of your labor. You can be assured that your lender will use your developed property as collateral on your loan, so if you go broke your lender will foreclose on property that is worth more because of your efforts. This is the advantage developers have over other manufacturers—land is unique and, if it is built to a specific market, should not be difficult to sell. By contrast, the manufacturer of plastic balloons does not have this advantage. A lender will not lend as much to the balloon maker as he would to the developer, since what would a lender do if he were to foreclose on a million balloons? Lenders also invariably have the first lien on a property, which will give them comfort but not a total guarantee that they will be paid in the event that you go broke. Leverage is important to the profitability picture of development. For example, the profit for a small developer is typically between 10 and 20 percent of the sales price of a house. You may say that 10 percent is not a great

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return, given the risks inherent in development. You may think you can make at least that much by playing the stock or bond market, and you may be right (but we wouldn’t bet on it). The main difference, however, is that when you play the stock or bond game, you are using your own money, while with the development game you are using someone else’s money. An example can illustrate the difference. Suppose you built a house and sold it for $100,000. Assume that $85,000 represented the total cost of building the house (land, construction, interest, overhead, etc.). Assume further that you obtained a loan for 75 percent of that $85,000 from a commercial bank, so that your actual investment was only $21,250. Since you sold the house for $100,000 and it cost you $85,000 to build, you made $15,000, or a 15 percent net profit. But wait—you only invested $21,250, so your actual profit (your return on investment) is 70 percent ($15,000 return ÷ $21,250 investment = 70 percent return on investment). How did you make that much money? You used leverage. Had you taken that $21,250 and invested it in the stock market and received a 10 percent return, you would have only made $2,125. You made seven times that much in your development deal. The real skill, however, is to be able to build that house for $85,000 and to find someone who can pay $100,000 for it. This is the challenge of development—building profitable, affordable housing by containing costs and building for a market. Both of these issues will be discussed in later chapters. Taxes In the past, developers were able to deduct interest and depreciation on their projects. Tax shelters were major incentives for being in rental real estate. The Tax Reform Act of 1986 shifted the developer’s investment strategy from tax shelter losses to making a profit. For the homebuyer, however, the greatest tax advantage is still intact-the power to deduct mortgage interest on first and second homes. This alone will continue to fuel new home sales for many years to come. Demand There is a constant demand for new construction in this country, for two reasons: a growing economy needs new buildings, and old buildings wear out. Housing, shopping centers, schools, office buildings, and industrial facilities all get old and need to be replaced. An estimated 100,000 to 400,000 homes are lost each year to aging, fire, flood, and other hazards and need to be replaced. Population increases also add pressure to build. While the U.S. population is growing at a slow rate, there has been an increase of about 1.3 million new

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households each year because of changes in lifestyle that have occurred over the past two decades. The traditional family (father who works, homemaker mother, children) now comprises only ten percent of all the households in America. Divorcees, single-parent households, unmarried couples with and without children, healthy retirees, and singles have caused demographic changes in the United States that greatly affect development. The migratory nature of the American population and the increase in second homes also add to the pressure for new development. Age groups also will play a significant role in development. For example, the baby boom generation born between 1946 and 1962 helped fuel a rise in first-home buyers during the 1970s and early 1980s. Now that baby boomers are older and have children, they need bigger houses. These “move-up buyers” will be an important segment of the home-buying public in the 1990s. First-time buyers will decrease. Empty-nesters are one of the hottest age groups in housing today. They are retirees, moderately affluent, in good health, with their children grown. They are eager to live in an active community with recreation and low maintenance and without the stigma of an old-age home. As discussed in the Sales and Marketing chapter, many developers now build their houses toward lifestyle and age segments in addition to income brackets. Self-employment Most of us are required to earn a living. Some are content to work for others. Many, however, view self-employment as the ultimate way to earn a living, knowing that for better or worse they are the masters of their own destinies. Each year, hundreds of thousands of people pursue this dream and start their own businesses. If the epitome of success is to be your own boss, love what you do, and earn tons of money doing it, then development offers the best of all possible worlds. Personal Satisfaction Real estate development provides a tremendous feeling of accomplishment. It is a creative process that begins with locating a parcel of land and ends with the construction of a building. Developers are a vital link in the economy of the United States, providing infusions of capital into the economy via jobs and materials. There are hundreds of economic and social effects that occur when a home, office, or factory is constructed and sold. The total value of all construction activity in 1987 was roughly $440 billion, about ten percent of the Gross National Product of the United States. For this reason, the construction industry has often been referred to as the backbone of the economy.

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THE PLAYERS IN REAL ESTATE DEVELOPMENT There are four main players in real estate development: speculators, subdividers, land developers, and builders. Speculators buy raw, undeveloped land, hold onto it, and sell it at a later date for a profit. They do nothing to develop the land. The speculator presumably knows that land values will rise in an area in a short period of time. The reason could be a new employer, shopping mall, or interstate highway. Regardless, land speculators (and developers in general) always try to buy in the direction of growth. The advantages of land speculation are costs lower than development and high potential gain. The disadvantages are that raw land generally does not produce income, financing is difficult to obtain because nothing is done to improve the land, and future increases in value, needed to make the investment pay off, may or may not materialize. Subdividers buy raw land and, if not zoned for its best use, attempt to change the existing zoning to a higher and more valuable use or density. One example is to buy land zoned residential and attempt to have it zoned for commercial or industrial use. Subdividiers also seek to divide the land into blocks, building lots and streets in accordance with government regulations. Like speculators, subdividers gamble that the land they buy will be ready for development soon. Subdividers reduce their risk by doing market studies that decide if development is likely in the foreseeable future. Subdividers can buy from land speculators or from private individuals. They will usually sell to a land developer or a land developer/builder. Land developers install water, sewer, utilities, streets and curbs. These improvements are called “infrastructure.” The land developer must first obtain all government approvals, notably zoning and subdivision approvals. They may try to do this themselves, or they may buy a parcel from a subdivider who has already done the work. Builders erect buildings on the property—homes, apartments, stores, factories. They are the final participants in the development process. Note that, with the exception of speculators, each of the players adds value (and profit) to the land at each successive stage. For example, obtaining zoning and subdivision approval is a major challenge. Many developers are not enthusiastic about dealing with government agencies. Consequently, they will gladly pay a premium to a subdivider to buy land that already has approval to build. Similarly, many land developers do not want the added responsibility of being a builder, so they sell their improved lots to builders. The most profitable procedure is to perform the entire operation: buy land, get zoning and subdivision approval, put in infrastructure, and build. Not only does the value of the project increase with each step, but you will be able to

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obtain more attractive rates of financing if you are the builder as well as the land speculator, because a house is better collateral than land alone. While the decision to become involved in all the four stages may seem enormous, the risks can be minimized if you have done your homework, made decisions based on facts, and surrounded yourself with competent professionals. Each of these players can be active in all the markets for development: residential (both owner-occupied and rental), commercial, and industrial. While the principles discussed in this book apply to all of these markets, the emphasis will be on residential development because in our opinion it offers the aspiring developer the best chance to enter the business. Before you become a developer, it would be wise to learn about those who came before you. You may be surprised to learn that real estate development is an ancient business.

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A Brief History of Real Estate Development

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he Tower of Babel was the first large-scale development project in recorded history. It was a failure. Why? Poor materials? Opposition from environmentalists? Union strife? The Bible hints that there may have been serious zoning irregularities that caused the project to be shut down by the Powers that Be, or that air rights may not have been properly purchased. Regardless, we can assume that the developers, who not only lost their license to build but were also scattered abroad and had their language confounded, fell into despair. Undoubtedly, it was their last project. This story illustrates an important point: real estate development has ancient roots. Whatever your interest in development, it’s important to know its history as a means of understanding where it is today and where it is going in the future. In this chapter we will demonstrate the crucial role development has played in the growth of the city, the evolution of capitalism, and the shaping of the American dream. DEVELOPMENT IN THE ANCIENT WORLD The history of development is bound up with the history of the city, for prior to the advent of the city (about 3000 B.C.) land had little meaning as a measure

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of wealth. It was in abundance and other means existed to measure wealth, such as the amount of cattle owned by an individual. The first large-scale buildings in ancient times were owned by the king: the granary, the temple, and the palace. Around these monuments, the first cities began to coalesce. By 2500 B.C., all the features of the city were clearly visible: streets, marketplaces, walls, central authority. Houses were built, and proximity to certain monuments and natural features (such as a river) became important. In sum, land began to have value. At first, the king owned everything and granted land to his subjects in reward for services. Soon a complicated system of land transfer developed with detailed laws concerning private property, as illustrated by the Code of Hammurabi around 1700 B.C. Real estate development was well established in Rome by the time of Julius Caesar. The Roman citizen looking for a stable investment invariably chose land. Statesmen such as Cicero promoted the sanctity of property as the bulwark of a sound society. Cicero practiced what he preached; his principal source of income came from rents he collected on land he owned outside of Rome. Since land was considered the best investment, it was common for Romans of Cicero’s class to engage in land speculation. Cicero’s lifelong friend Atticus, to whom he addressed a series of famous letters, was a developer who had invested in a large, slave-manned cattle ranch in Epirus (Greece) and who was actively involved in buying and selling houses in Rome. By 100 A.D. Rome had a population of about 1,000,000. The intense demand for food meant that large profits could be made by investing in agricultural land outside the city. Several ancient authors tell of fortunes made by producing vegetables, flowers, wine, chickens, honey, eggs, birds for the table, and even floor tiles. While rural development was considered an honorable and desirable way of attaining wealth, urban development was frowned upon. During the days of the Empire, Rome suffered from terminal overcrowding. While the 2000 patrician families could and did enjoy beautiful homes, complete with indoor plumbing and heating, the middle class (officials, merchants, and small-time employers) lived almost exclusively in dingy apartments. Since Rome was the place to be, rents averaged four times higher than in other towns in Italy, resulting in immense rewards for developers. For the lower-class workers, though, living conditions were abominable. There were 46,000 tenements in ancient Rome, many containing 200 people. The erection of a tenement was a very profitable enterprise for both the contractor and the developer. With no building codes, contractors often built flimsy structures of several stories, and more than once entire buildings collapsed. The satirist Juvenal declared that these miserable buildings “shook with every gust of wind that blew.”

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Two of the most famous developers in antiquity were Damassipus and Crassus. Damassipus amassed a fortune by buying land along the Tiber River and then subdividing it for sale to others. Crassus, who was introduced in the Preface, was more unscrupulous. He boasted that he never spent money building, since it was more profitable to buy old properties damaged by fire, perform minimal repair and rent them out. This was a far safer bet than putting money into costly new construction. Crassus, recognizing the risk of losing a large investment in new construction to fire, often said, “Those who are addicted to building will undo themselves soon enough without the help of other enemies.” Since Rome was perpetually short of places to live, it was easy to charge exorbitant sums for anything with four walls. Although profits were great, the risks were even greater, due largely to the frequent outbreaks of fire. The ruins of Rome, such as the Colosseum and the Forum, give the impression that the city was built of stone. In fact, Rome was primarily a city of wood, and fire was an ever-present danger. Disasters such as Nero’s fire in 64 A.D. only exacerbated the housing shortage and increased the influence developers had on the populace. The absence of fire insurance kept many people away from urban land speculation. One ancient author recorded a conversation that took place on the Esquiline hill in Rome as a group watched a fire. A man commented, “The returns from urban property are great, but the risks are far, far greater. If there was some remedy, something to prevent the houses of Rome burning so readily, I assure you I would have given up my estates in the countryside and purchased urban property.” With the fall of Rome in the fifth century, the Dark Ages began. It was not a good time to be a developer: money was scarce, barbarians burned even the best neighborhoods, and there was a general exodus to the countryside, where land was cheap. With the odds against them, developers retreated, and awaited the coming of capitalism. DEVELOPMENT IN EUROPE The Growth of the Cities About 1000 A.D., throughout Europe security increased, food became more plentiful, and trade expanded. Most of the land during this period was controlled by feudal lords, who had serfs farm the land in exchange for a large portion of whatever was cultivated. Serfs, however, lived in poverty, and as the Middle Ages wore on the feudal lords began to look for more profitable ways to maintain their armies and increase their revenues. To accomplish this, they became developers, turning some of their rural lands into urban areas by granting charters to create cities. The city dwellers were given

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rights to self-government, to hold markets, to coin money, to be tried in local courts, to bear arms, and to hold fairs. Many were also granted the privilege to build walls, which created a limited space that immediately became valuable. Since these emerging cities greatly fostered trade, artisans and traders flocked to them. The lords collected rents from this emerging class of bourgeoise. By developing the towns, the lords not only made money on the rents, but also peripheral activities that went with it, such as bridge tolls. They even tried to attract settlers in pioneer towns by giving tax rebates if a house were built. In this manner, 500 new towns were started in northern Europe alone in the 11th and 12th centuries. The Germans were especially enterprising. Their lords, eager for new land and wealth, swarmed into thinly populated eastern Europe during the 12th century. In order to establish the new towns and attract recruits to them, the princes hired public relations people called locatores. These locatores were responsible for planning the layout of the new villages and then advertising their virtues to the rest of the world. They went to established towns of western Europe and hung up posters urging people to come to the new towns: Come then, you Saxons and you Franks, you Lotharingians and you Flemings, and do deeds to win salvation for your souls and a corner of the best land in the world.

Not only did the locatores lay out the towns and advertise them, they transported the new emigrants to the site, assisted them through the first harvest, and helped them build churches and other essential buildings. As a final inducement, most town charters contained a clause that made serfs free men if they lived in the new city for a year and a day. In return, the locatores received part of the land, a share of the rents, and certain hereditary posts. In sum, the locatores were developers, architects, and real estate agents all rolled into one. All this in the 12th century. The Growth of Capitalism In time, the power of the feudal lords eroded as allegiance to the cities became more important than allegiance to the lord. It is in the free cities— Venice, Florence, Bologna, and others—that capitalism first appeared in the 13th century. It grew out of the expansion of credit and the use of interest (initially opposed on religious grounds), and the development of novel banking and accounting techniques such as letters of exchange and double-entry bookkeping. Toward the end of the fifteenth century, several events occurred which gave impetus to the capitalist tide sweeping Europe, including the develop-

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ment of the printing press, improvements in metallurgy, the use of carts in mines, and, perhaps most importantly, improvements in the construction of ships and navigational techniques which opened up new trading routes to the West and the East. The discovery of America in 1492 offered the countries of western Europe unparalleled opportunities to expand their supply of precious metals. Sugar cane, used to make sugar, molasses, and rum, also vastly increased the wealth of western Europe. The increase in commercial activity created new capital which sought a safe investment outlet. One development was the organization of the first companies. Derived from the Latin words cum, or “with”, and panis, or “bread”, the new “companies” were associations in which everything was shared—bread, capital, and risks. Often these first companies were maritime firms with only two people, one partner who remained on the spot while the other went with the ship to make sure the goods were delivered and payment in the form of gold or silver or a tradable commodity were received. Very quickly, however, these companies became far more intricate, admitting foreign partners and money from depositors. This period also saw the development of the first limited partnerships and joint stock companies. Rural Development in Europe Investing in international trade was far riskier than today, and considerable efforts were made to find a safer investment outlet. Many simply hoarded money and precious metals, but even then there was an aversion to letting money lie idle. Land was a natural choice for the entrepreneur seeking a reasonably “safe” investment: land tells no lies is an old proverb that was well known to Europe’s early capitalists. An Italian merchant wrote to a friend in 1408: “I advise you to buy some estates and I do so again even more pressingly if possible. Land has at least the virtue of not being exposed to risks of the sea, or an unscrupulous factor [broker] or a merchant company or a bankruptcy.” Many heeded this command and invested in land. Vineyards were a common investment, especially in regions in France and Italy where wine was long an export commodity. But vineyards were an exception; in general, land speculation outside of the major cities was difficult because the value of land increased only slowly and could not be recovered without difficulty or loss. When the Tiepolo Pisani bank failed in Venice in 1584, the estates which had stood guarantee for it were sold only slowly and at a loss. Still, change did come; by the 18th century, fedualism was giving way to tenant farming and sharecropping. Tenant farmers, the middlemen between the field laborers and the landlords, quickly became entrepreneurs, making them natural allies of the rising capitalists in the cities. Many bought estates during this period to take advantage of the rise in agricultural prices. Crop

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specialization (in wine, wheat, oil, etc.) also helped the development of capitalism, because these became cash crops that required large organizations to maintain distribution channels. By the middle of the 18th century, the value of rural land had become indisputable. In 1762 a French writer named Despommier wrote a book entitled How to Get Rich Quick in Farming—and it became a best-seller! In 1784 another French book, How to Increase and Preserve Your Property, or The Rules of Estate Management, also became a best-seller. Land speculation had finally arrived in Europe. Urban Development The 18th century was a golden era for developers. Their success was due to three developments: the rise of capitalism, the growth of cities and suburbs, and changes in social attitudes and technology. The rise of capitalism meant that many in the emerging middle class were able to afford their own dwellings, and despite the threat of pestilence there was an undeniable improvement in the quality of life in these medieval cities. A notable change was the gradual development of a sense of privacy. Throughout much of the Middle Ages, one room served the function of kitchen, dining room, bedroom, and meeting place. In pre-Napoleonic Europe, about 75 percent of the population lived in one-room hovels, usually shared with unrelated individuals and animals. Another 15 percent lived in the castles and manor houses of the landed gentry and the bourgeoisie, where any notion of privacy was impossible. As time passed, individual rooms came into existence for specific purposes, notably the dining room and the bedroom. Developers gradually created more spacious housing to suit the aspirations of the growing merchant classes. At the same time, improvements in technology took place. Heating arrangements improved as the open hearth gave way to the fireplace. Glass windows were common by the 16th century. Transportation improved; by the 13th century, paving was common in the major cities such as Paris and Florence. The private bath began to appear as early as the 13th century, and public bath houses also became common once again. Public water works, largely absent since the rule of Rome, began to reappear. Water, however, proved to be a persistent problem; then as now, availability of water and food limited the growth of many towns. To relieve congestion and overcrowding, suburban regions were developed, providing more opportunities for developers. Another important change was the attitude the new capitalists brought to development. The feudal system had looked upon land largely as a stewardship; leases of 99 or even 999 years were common. To the new capitalists, however, land was a commodity, and once the concept of land as a saleable

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asset won out over stewardship the value of land was limited only by supply and demand. When the population of European cities increased in the 17th and 18th centuries, the value of land soared. Unencumbered by zoning regulations and building codes, developers could do whatever they wished, limited only by the availability of land and their inclination to make a profit. Open spaces were utilized for building. When open spaces were no longer available, denser uses were designed. Developments went up: five, six, and seven story buildings became common by the 17th century. The medieval custom of erecting a house of stone began to disappear. Since wood was cheaper than stone, took up less space, and was easier to construct and replace, it became the dominant building material during this time. The Victorian City By the beginning of the 19th century, the merchants had become industrialists. The switch from a rural agricultural base to an urban industrial one was striking: by 1871 the world of industry, trade, services, and offices accounted for nearly 80 percent of all employment in England. Industrialism was to raise the standards of living for many in the growing middle class, but it was also to produce the industrial city: hopelessly overcrowded, polluted, and congested. In many respects the standards of living in the 19th century cities were lower for the masses than life in earlier centuries. The main elements of the industrial city were the factory, the railroad, and the slum, and since each of these elements required vast tracts of land, no one could do anything without talking to those who controlled the land. In this environment, the land developer could profit to an even greater extent than in previous centuries, for by now dense urban environments had become the norm. It was a period of vast urban improvisation, when housing was in such demand that there was little need or time to consider matters of style or quality; the important thing was to build. At the same time the incomes of the upper classes were rising but their standards of living were falling because of the poor conditions in the cities. Many fled to the suburbs, and again the developers prospered. The horrors of the Victorian city inspired a backlash in the form of tighter economic, social, and legal controls. By the turn of the century, most European countries had extensive restrictions on urban and suburban growth, a policy which was to remain essentially unchanged down to the present day. DEVELOPMENT IN THE UNITED STATES It was left to America to fully utilize modern development practices, for one of the ideals upon which America was founded was the right to own and fully

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utilize land. A century after the founding of the United States, Walt Whitman articulated this principle: “A man is not a whole and complete man unless he owns a house and the ground it stands on.” Early settlements in America were established on land claimed by the King of England who in turn granted charters to companies and individuals. These companies and individuals in turn distributed the land to other individuals, usually with an obligation to pay an annual rent. By 1700 most of the land was owned outright in the form of freehold estates. The fact that so many people owned land, which was considered the foundation of wealth, played a large part in the development of our egalitarian institutions. “If the multitudes are possessed of real estate,” wrote John Adams, “the multitude will take care of the liberty, virtue and interest of the multitude in all acts of government.” From the very beginning, Americans sought land. The Treaty of Paris (1763) enabled England to obtain from the French all of Canada and that part of Louisiana east of the Mississippi. We kept going after we gained our independence, buying from anyone we could: we obtained the Louisiana Purchase from the French (1803), Florida from the Spanish (1819), Texas (1845) and the Southwest (1848 and 1853) from the Mexicans, the Northwest from the English (1846), and Alaska from the Russians (1867). Today, there are over 2.25 billion acres of land in the United States. In America, land was plentiful, and this was enough to entice hundreds of thousands of Europeans to this country. The right to own land and dispose of it as one wished was a cornerstone of the American ideal from the beginning. It is not too strong a statement to say that America was founded as a proposition in real estate development. The Urban Sprawl: New York City Every city in America owes much of its growth to land speculation and development but one in particular—New York—epitomizes the power of real estate development. New York City was a sleepy little town for the first 150 years of its existence. It was badly damaged during the Revolutionary War, but quickly recovered and became the financial capital of the new country by the early nineteenth century. Most of the early buildings in the city were row homes. First appearing in Philadelphia in 1691, by 1800 row housing was the dominant form of housing in that city as well as New York, Boston, and Baltimore. Front and side yards were almost nonexistent and since backyards were often garbage dumps, the concept of using them for social functions was unthinkable. Manhattan began to grow rapidly about 1800. Because the city did not have a street plan, it grew chaotically until 1811 when the city adopted its

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first urban plan, a gridiron design which divided the city into north-south and east-west streets. The adoption of the grid plan delighted the developers in New York, since it made development easier. Since most of Manhattan north of Fourteenth Street (and all of Brooklyn and the Bronx) was open fields, speculation was rampant. One of the earliest and most successful developers was John Jacob Astor. He began acquiring land north of Chambers Street in 1810, and shrewdly purchased large amounts of additional land at cheap prices during the Panic of 1837. By 1840, he was worth more than $40 million, with most of his wealth based on real estate. The Growth of Fifth Avenue Little was done with the city plan until 1824, when the lower part of Fifth Avenue was completed. Two years later, Washington Square was completed; it was previously a potter’s field and public execution ground. The first residents of Fifth Avenue were wealthy merchants who owned the factories in the lower part of the city. By 1838, the Avenue was completed to Nineteenth Street. The next major development was Madison Square in 1847. For the next several decades, it drew the growing business elite of New York. Famous hotels such as the Fifth Avenue Hotel and the Hoffman House were situated on the square and provided a convenient meeting point for the city’s elite. The growth of Fifth Avenue is an excellent example of the inexorable progress of urban development. In its early days, it was exclusively the province of the rich. After the Civil War change came rapidly, first in the form of upscale commercial enterprises and hotels, then in the form of large commerical concerns, and finally in the form of immigrants working in the garment district. Each of these changes was bitterly opposed by the elite, especially the last. The garment industry was originally based in the Lower East Side, but its growth was so rapid that by the turn of the century it was already in control of large areas around Madison Square. The growing power of the lady garment workers’ industry, which desperately needed large amounts of commercial space, made it feasible for developers to buy the lots of the wealthy and build factory lofts on them. By the time Madison Square Garden opened in 1890, the area was almost entirely commercial. The wealthy, having lost their battle to keep Fifth Avenue, were forced uptown, where they staked out some 30 blocks on Fifth Avenue from 60th to about 90th Street, where many remain to this day. It is ironic that the city’s most powerful citizens, who were so eager to go to the defense of capitalism and free enterprise, were themselves overtaken by the spirit of free enterprise in the form of hotels, shops, and, finally, garment factories. This state of

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affairs later caused many of the wealthy to ally themselves with urban planners to advocate the first comprehensive zoning ordinance in the nation, which was passed in New York in 1916. New York’s Early Development Projects The development of Fifth Avenue mirrored changes that were occurring in most American cities during the early 1900s. These changes came from the desire to separate commercial from residential areas and the poor from the affluent. Developers responded to the need for more land, first by building reliable transportation to the outer reaches of the city, and then by buying and subdividing farms in the outlying communities. Even at this early period, lower New York was congested, a fact which was not lost on developers like Samuel Ruggles. The land between 19th and 23rd Street, Broadway and Second Avenue, was known as the Gramercy Farm when it was bought by Ruggles in 1831. Ruggles divided the farm into 108 lots, and turned 42 of those lots into a private park. His goal was to lure the wealthy out of their homes in lower Manhattan to an area built exclusively for them. To add to the exclusivity of the development, Ruggles provided each of those who bought one of the remaining 66 lots a key to the locked park, a tradition which continues to this day. Gramercy Park was an immediate success; notables such as Mayor James Harper (of the publishing house), Vincent Astor, and the Steinway piano family all bought houses on the park. The success of Gramercy Park was not lost on developers, and the push was on to build housing for the affluent outside of the city. Situated directly across Manhattan on the East River, Brooklyn was a logical choice for development. It was a backwater town for most of its early history; as late as 1800 it had a population of less than 2500, mostly farmers. A developer, Hezekiah Beers Pierrepont, saw great potential in the little village and began buying large amounts of land, including 800 feet of frontage on New York harbor. Pierrepont was a close friend of steamboat entrepreneur Robert Fulton, and Pierrepont shrewdly calculated that Fulton’s invention would enable regular ferry service to operate between Brooklyn and Manhattan. When, in 1814, Fulton inaugurated the world’s first regular ferry steam service between Beekman Slip in Manhattan (immediately renamed Fulton Street) and Brooklyn, the value of Pierrepont’s holdings in Brooklyn skyrocketed. By 1820, Pierrepont was busy building exclusive residential housing along the waterfront, which he named “Brooklyn Heights” and advertised as having “all of the advantages of the country with most of the conveniences of the city.” Brooklyn went from 7000 inhabitants in 1820 to more than a quarter million by 1860.

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The success of Brooklyn underscored the importance of reliable public transportation; without it, there was little chance that any development project would be successful. Later Developments in New York Meanwhile, New York City was about to experience another jump in population with the arrival of the modern apartment house in the 1870s. Apartment living was considered promiscuous prior to the Civil War, but when developer Rutherford Stuyvesant built elegant apartments on 18th Street, equipped with a private concierge, the elite flocked to his building. By the 1880s multiunit buildings were being built by the hundreds in New York, Philadelphia, Boston, Chicago, and Baltimore. This period also witnessed the birth of the skyscraper. It was made possible by two advances in technology: the invention of the elevator and the steel-frame building. Elisha Graves Otis demonstrated the world’s first commercially feasible elevator at the Crystal Palace Exhibition in New York City in 1853. The first elevators were installed in a department store in 1857, but they only became popular when the Equitable Building was built in 1870 at the then radical height of seven stories. The first steel-frame structure in New York was the Tower Building at 50 Broadway, which was built in 1888 and demolished in 1914. It was 11 stories tall. By then, the limits of the traditional masonry bearing wall had been reached. The highest masonry wall building was 16 stories, built in Chicago. The steel frame freed developers from height limitations and made the skyscraper feasible; the elevator made it accessible. Other fortuitous developments occurred at about the same time: electricity (beginning about 1883), plate glass (1881), and the telephone (1870s). Development of the Suburban Ideal Development in rural areas was given a boost in the early and mid-1800s by three factors: the feeling that city life was unhealthy and undesirable, the growth of the ideas of privacy and the sanctity of the family, and the growth of reliable public transportation. About 1840, Americans began showing a preference for detached housing and for life outside the city, fostered partly by the European romantic movement and American writers such as Washington Irving and James Fenimore Cooper. The country was no longer viewed as wild, barren, and inhospitable. These writers emphasized the beauty of the streams and fields of the country; to them, the city was the source of physical and spiritual corruption.

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Privacy became important as the nuclear family began to develop, largely as a refuge against a difficult and demanding world. This development was a boon to developers, since it also reflected the desire that different rooms should serve different functions, requiring more spacious houses. The most important factor, however, was public transportation. Prior to the 1820s, public transportation was erratic and unreliable. The primary mode of transportation for short trips was horse-drawn carriages, while stagecoaches were used for longer trips. In 1829, Abraham Bower introduced the first regular urban transportation system in the United States when he began a horse-drawn carriage line that went up and down Broadway. Named the “omnibus,” it quickly spread to other cities. The omnibus, however, did not provide a smooth ride over the cobblestoned streets of New York, and in 1832 the horse-drawn streetcar began operating on rails. By 1837, the railroad itself was in downtown New York; in that year the York and Harlem Railroad offered regular service to 125th Street, leading speculators to believe that the area, already known as Harlem, would soon become fashionable as a summer resort. By 1843, the railroad reached New Haven, Connecticut. The population of the intermediate towns (Rye, Tarreytown, New Rochelle) grew rapidly after the introduction of rail service. By 1900 the United States had more miles of railroad track than the rest of the world combined. The horse-drawn streetcar and the omnibus had a serious drawback: they both relied on animal transportation, which was slow, inefficient, dirty, and subject to diseases. The cable car was an improvement, since it utilized moving cables. First used in the 1880s, it soon fell into disfavor, since capital expenditures were enormous and it was difficult and inefficient to operate. It was not uncommon for the conductor to be unable to release the trolleycar from the cable, so that the car was dragged down the street until the entire system was shut down. Today, only San Francisco retains the cable car. The first commercially viable electric streetcar service opened in Richmond, Virginia, in 1887. Because it could carry more passengers than the horse-drawn streetcar and omnibus, the fare dropped from a dime to a nickel. Within a decade, the electric streetcar, also known as a “trolley car,” replaced the cable car and the omnibus in all major American cities. Developers utilized the electric streetcar to increase the value of their lands. Coney Island, at the far end of Brooklyn, was a major attraction and its success was partly due to its ease of access by streetcar. Chevy Chase, Maryland, was built by Senator Francis Newlands in 1893 on land greatly increased in value when Newlands was granted a charter to run a streetcar line up Connecticut Avenue from Washington, D.C. The Massachusetts Street Railway Commission summed it up in 1918: “It is a well-known fact that real

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estate served by adequate street railway facilities is more readily saleable and commands a higher price than real estate not so well served.” The electric streetcar was the culmination of 50 years of technological progress. The middle decades of the 19th century witnessed enormous changes in modes of transportation for urban inhabitants throughout the United States. Americans were on the verge of abandoning a slower way of life and moving toward a national temperament that emphasized change and mobility. Developers and their clients were the big winners, since the availability of mass transportation greatly enhanced the values of outlying properties. The First Suburbs In 1852, Llewellyn S. Haskell, a prosperous pharmaceutical merchant, began to purchase land in West Orange, New Jersey, about 13 miles from New York City. His aim was to create a picturesque community for wealthy merchants who commuted to New York. By 1856 he had accumulated over 400 acres, and had hired a famous land planner, Alexander Jackson Davis, to plan the community. Christened Llewellyn Park, it is generally acknowledged to be the first planned suburban community in America. Llewellyn Park was characterized by two features—the curvilinear road and a common open space. By the mid-19th century, the gridiron plan was beginning to lose its appeal, especially in the new suburban communities. Llewellyn Park abandoned the gridiron by making the roads conform to the natural contour of the hill on which the site was located. Haskell also created a fifty-acre “Ramble” in the middle of the development intended as a natural area. Though a calculated gamble because of its size and cost, Llewellyn Park was an immediate success. It gave an enormous boost to developers concerned about the cost and exclusive nature of such planned communities. It is still in existence today. Not all subsequent experiments were as successful, however. One partial success was Riverside, a planned suburb of Chicago created by Frederick Law Olmstead and Calvert Vaux, the designers of Central Park. Designed with the large lots, curvilinear roads and open spaces that characterized Llewellyn Park, Riverside was not a financial success because of scarce capital caused by the Great Chicago Fire of 1871 and the subsequent financial crisis. Though it was not a success for Olmstead and Vaux, it was later completed and is often cited as their finest attempt at a planned community. They later went on to design Yonkers and Tarreytown, New York. A clear failure was Garden City, New York, comprised of 8000 acres in Hempstead, Long Island, purchased by Alexander Tunney Stewart in the 1870s. Stewart made a fortune by opening the world’s first department store

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on the corner of Broadway and Chambers Street in 1846. He was convinced he could make a profit as a developer by following the example of Llewellyn Park and developing homes only for wealthy buyers. However, Stewart’s plan differed from Llewellyn Park in several respects, which proved to be disastrous. First, he continued to use the gridiron plan, though slightly modified. Secondly, instead of selling his property he rented the houses at annual leases of $250 to $1000, under the mistaken belief that this would better enable him to control the quality of tenants. In fact, all such applicants went through a rigorous screening procedure to examine their financial, family, religious, and social status. While this is illegal today, there was nothing to prevent this procedure from being utilized in the 1870s. Garden City was a complete failure. Twenty years after its completion, only 30 of its 60 homes were rented. Not until land was offered for private ownership did Garden City begin to move, and then it was long after Stewart had died. The example was not lost on developers, and no further talk of renting property to affluent suburban buyers was heard. Working-class developments were also built, though they were smaller and often unsuccessful. Mount Vernon, New York, is one example. It was developed out of 367 acres in Westchester County, directly north of New York, by a cooperative association known simply as Industrial Home Owners Society Number One which consisted of middleclass New York residents who could not afford housing in the city. They constructed 300 homes, each on a quarter acre. Eventually, it was a success, though not for the original developers. Hard times in the 1850s forced many of the original settlers to sell their homes to affluent people seeking to flee New York, completely changing the character of the community. By 1880 it was a small city and there was little to distinguish it from the other communities around New York City. Another example is Vineland, New Jersey, founded in 1861 by Charles Landis. Landis was one of the first to profit from the mistakes of earlier suburban developers. He bought adequate land to assure complete control and developed housing that would attract an economic mix of families, thus avoiding reliance on the preferences of any one group. He made careful plans for the development of schools, churches, and commerce, factors some of his predecessors had overlooked. Most importantly, he sold, rather than rented, all his housing. Vineland, New Jersey, was (and still is) a success because Landis carefully planned the community and worked within the existing demands for land and housing. These early pioneering efforts at suburban development were important because they offered the buyer an alternative to dense urban development and living on a farm. They created a complete environment outside the city with many of the amenities of the city but still maintained a tranquil lifestyle.

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The suburban ideal was off and running; in the final quarter of the 19th century, small towns near Philadelphia (Darby, Overbrook, Ardmore, Haverford, Bryn Mawr), Chicago (Lake Forest, Evanston, Highland Park, Aurora), and New York (Scarsdale, New Rochelle, Rye, Bronxville) were created. The residents of these “railroad suburbs” comprised a mixed socioeconomic group, half affluent commuters and the rest individuals who found local employment providing gardening, repairs, and other domestic work. Other Factors in the Success of the Suburban Ideal The balloon-frame house was a major factor in the growth of the suburbs. It began to replace the heavy-timber frame house as early as the 1830s. It was lightweight and easier to build than the timber frame. Its weight rested on two inch by four inch studs spread 16 inches apart, and on the floors, which acted as a platform. Though flimsy in appearance, builders soon learned that it had strength far beyond the capacity of the wood studs. The balloon houses made generous use of the newly invented machine nail, a breakthrough that greatly reduced the cost of building. Three other factors contributed to the suburban ideal: the growth of savings and loan associations during the latter part of the nineteenth century, which allowed investors to borrow against the value of their shares at low interest rates; the centralization of street administration with the municipal government, which occurred about 1900; and the rapid expansion of public utilities that occurred at about the same time. But the most important factor in development was the availability of cheap land. Even in the cities, land was not extraordinarily expensive. One study estimated that in 1900 a typical price for a building lot was $500 or less, with an average of $150. With prices like these, the sales target was often the little man: “$50 CASH WILL BUY A LOT,” went one advertisement in Louisville in 1871; “BE ON HAND, BUY A LOT, AND IN THE COURSE OF A FEW YEARS YOU WILL BE RID OF HOUSE RENTS AND EXACTING LANDLORDS.” The American dream was built on cheap land. The Coming of the Automobile The next major influence in development was the automobile, and its impact would exceed that of the electric streetcar. Its assimilation into American society was astonishing; in 1898 Literary Digest stated confidently that the automobile would never “come into as common use as the bicycle.” In 1905, there were 8000 registered automobiles in the United States; by 1925, there were nearly 18 million. Developers, in conjunction with auto manufacturers, lobbied municipal officials for road improvements, on the theory that such improvements would pay for themselves by increasing property-tax revenues

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along the route. As with electric streetcars, the value of land held by developers also increased once the roads were improved. It was not uncommon for developers in the 1920s to advertise their properties in terms of distance from the nearest improved roads. The next step was the limited access highway. Two early examples are the Long Island Motor Parkway, the world’s first thoroughfare solely for the automobile, completed in 1911, and the Bronx River Parkway, begun in 1906 and completed in 1923. The availability of the automobile, coupled with a period of increasing wages, made the 1920s a golden decade for developers. This was a period of rapid growth for the suburban communities. The automobile opened up vast amounts of land for development by making it easy to get to previously remote sites. The electric streetcar greatly increased mobility and the value of land in outlying areas; the automobile was to have an even greater impact. Public transportation increased the value of land only in the immediate area surrounding the source of the transportation; higher land values were confined to a “finger” about one-half mile on either side of the tracks. The automobile abolished the developer’s need for additional public transportation by making Americans instantly mobile. Higher land values were no longer confined to the imaginary “finger;” instead values expanded to cover ovals or even circles from transportation or employment sites. Previously undeveloped land instantly became prime residential sites. New homes were begun at a rate of 883,000 per year for the seven-year period between 1922 and 1929, more than double that of any previous seven-year period. The suburbs were the prime beneficiaries of this activity: between 1920 and 1930, the suburbs of the 96 largest cities grew twice as fast as the core communities. The automobile also had an effect on the size of the growing American suburban community. Because it opened up vast areas for development, the price of land was lower in areas only accessible by car. With cheaper land, developers increased lot sizes; the average size rose from about 3000 to 5000 square feet in areas served only by automobile. The greater lot size changed the style of housing, shifting from extravagance and toward utility for the masses. One-story homes with low-slung roofs and car ports became the most common form of suburban dwelling. This so-called “ranch house” remained the model until after the Second World War. Another popular building form was the bungalow, which was one-anda-half stories. The Rise of Federal Influence in the Housing Market Everything fell apart with the Great Crash of 1929. Between 1928 and 1933, the construction of residential property fell by 95 percent, and expenditures on

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home repairs fell by 90 percent. By 1933, half of all home mortgages in the United States were in default. Faced with ruin, developers lobbied the federal government for help in the form of mortgage programs and aggressively promoted a new invention: the model home, a completed and furnished sample home that the buyer could inspect. Every new development had one, and they became indispensable in promoting those homes and their new technology. It was one thing for stocks to fail; it was another thing for the housing industry to fall apart. Even Herbert Hoover declared that home ownership was “the foundation of a sound economic and social system and a guarantee that our country will continue to develop rationally as changing conditions demand.” Hoover convened a National Conference on Home Building and Home Ownership in 1931, out of which came a philosophy that would dominate building to the present day: the creation of long-term, amortized mortgages; encouragement of low interest rates; government aid for low-income families; and the reduction of home construction costs. With the help of the National Association of Home Builders, Hoover began programs to encourage home ownership. His ideas proved unworkable, however, and it was up to Franklin Roosevelt to put these ideas into successful practice. Roosevelt’s most important housing programs were the Home Owners Loan Corporation (HOLC), created in 1933, and the Federal Housing Administration, created the following year. HOLC was created to refinance mortgages in danger of default or foreclosure. Its greatest achievement was the introduction of the longterm selfamortizing mortgage, which was characterized by uniform payments spread over the life of the mortgage. This has become such a feature of modern life that it is hard to believe it is barely 50 years old. Prior to World War I, mortgages were generally objects of suspicion, and well-to-do families bought their homes outright. During the 19th century, it was typical for the borrower to pay only interest on the loan on a yearly basis, with the principal due in one lump sum at the end of a specified period. During the 1920s five- to tenyear mortgages were common, though the loan was often not fully paid off at the time of the final payment. Renewal of the loan proved to be a problem in periods of tight money. Under HOLC, the loans were fully amortized and payments were extended to about 20 years. The most important development was the creation of the Federal Housing Administration. Its original purpose was to put the construction industry back to work. Supplemented by the GI Bill of 1944, which helped 16 million veterans purchase homes, the FHA was and is the greatest single influence on American building in the last 50 years. The FHA insured long-term home mortgage loans made by private lenders. Prior to the FHA, first mortgages were generally limited to one-half

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to two-thirds of the value of the house. Thus, most people seeking mortgages had to put down at least 30 percent of the value of the house. Loans secured by the FHA were for about 90 percent of the value of the house, so down payments of more than 10 percent became unnecessary. Because FHA insured the loans, there was little risk to the bankers, so interest rates fell by two or three points. As a result, the number of housing starts rocketed: from 93,000 in 1933 to 332,000 in 1937; 458,000 in 1939; and 619,000 in 1941. By the end of 1972, FHA had insured 11 million new home loans and 22 million home improvement loans. Thanks largely to the FHA, home ownership went from 44 percent in 1934 to 63 percent in 1972. The FHA influenced the mass exodus to the suburbs immediately before and after World War II. The inner cities were the losers, however, as much inner city land did not qualify for FHA loans. To correct this, Congress created the United States Housing Authority in 1937 to develop public housing projects. The history of that effort is long and complicated, but public housing projects are generally looked upon as noble failures, largely because the location of the housing was invariably in the poorest section of the cities and because suburban areas refused to have anything to do with public housing. Development after World War II The War temporarily slowed down new construction starts, while the birth rate began to climb dramatically. By the time 16 million GI’s returned home, the country was in the midst of a housing crisis. The GI Bill created a generous mortgage program for veterans; it also created tremendous opportunities for developers. The post-World War II developers were of a different breed than their predecessors. Prior to World War II, it was extremely rare for a developer to buy land, lay out streets, build houses, and then finance sales to the occupants. Rather, most developers hired a civil engineer to draw up a plan, pressured the municipal government to put in streets, and then sold the land to buyers who would themselves subdivide and build. The post-World War II developer had new materials, new power tools, and new government assistance at his disposal. As a result, the large-scale developer was born. Throughout this era, no developer was bigger or more famous than Abraham Levitt and his sons, William and Alfred. The Levitts had been active in development before the war, building war worker’s homes in Norfolk during the war. However, it was not until they bought 4000 acres of potato farms in Long Island that they began to grow. Their formula for this new community, named Levittown, was: keep it simple. After clearing the land, building materials were dropped off at exact-

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ly 60 foot intervals. All houses were built in the same manner, with exactly 27 distinct steps in the entire process. Crews were trained to specialize in only one job. The firm made its own concrete, owned its own lumber company, and preassembled parts in its own shops. Lot sizes were 60 x 100 feet. Each house had a 12 x 16 foot living room with a fireplace, a bath, two bedrooms, and a kitchen in the front. Pricing was as simple as the construction: $7900 for the basic “Cape Cod” design, no down payment, no closing costs, no hidden extras. At their peak, the crews produced 30 houses a day; Levittown, New York, eventually encompassed 17,400 houses and over 80,000 residents. William Levitt, who was now in charge of the company, repeated the same formula when, in the early 1950s, he bought former broccoli and spinach farms in lower Bucks County, Pennsylvania. That new Levittown eventually encompassed 16,000 homes. Levitt did it again in the 1960s when he built a third Levittown near Willingboro, New Jersey. Levitt was the most widely copied and respected developer of his time. In a phenomenal career that spanned more than 50 years, he erected more than 140,000 houses. He was to the mass-produced suburban house what Henry Ford was to the automobile. He was not the originator, but he popularized a style and method of production that was immensely successful. Henceforth, most American homes would have central heating, indoor plumbing, telephones, automatic stoves, refrigerators, and washing machines. Levitt’s Cape Cod houses were very popular, but other styles appeared with equal faddishness: the colonial, the split-level, the ranch. All were situated on lots of similar size, usually one-fifth to one-tenth of an acre. Most houses lacked local design influences; it became increasingly difficult to tell whether one was in Dallas or Boston. A second feature was the total dominance of the detached house in American building: between 1936 and 1956, about 97 percent of all new single-family dwellings were completely detached. The FHA was essential to the success of developers like Levitt. Once a “commitment” was obtained from the FHA to insure the mortgages, it was easy to leverage that “commitment” with lenders to obtain advances as the work commenced. In this manner, the government took most of the risk. Behind the new suburban utopia was the automobile. The automobile lobby pushed relentlessly for improved roads and in 1956, succeeded in passing the Interstate Highway Act. Eventually the interstate highway system encompassed 43,000 miles of limited access highways stretching from coast to coast. The power of the automobile was pervasive in the 1950s, when America created a “drive-in culture” that had as its symbols the garage, the motel, the drive-in theater, the gas station, the shopping center, and the mobile home. The suburb had finally achieved full autonomy from the inner city.

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The cities, however, were big losers. Eighteen of the nation’s 25 largest cities suffered a net loss in population between 1950 and 1980; by contrast, the suburbs gained more than 60 million persons. The process of urban decline in fact began in the 19th century. For example, the population of center city Philadelphia began to decline as early as 1830 as manufacturing moved into the inner city area and residents fled to Northern Liberties or the Spring Garden area. In New York City, the original part of the city below Canal Street also began to lose population at this time, for the same reason. Massive annexations of suburban regions in 1854 (for Philadelphia) and 1898 (for New York City) prevented these cities from losing population and gave the illusion of growth. However, as these annexed areas aged, they too lost population. Some of the decline has gone full circle, with many inner city areas in the Northeast United States being repopulated by bands of urban pioneers. And so the cycle begins again. SUMMARY Our purpose has been to demonstrate that real estate development is an ancient enterprise. Private developers were already a well-known part of the commercial landscape in the Rome of Julius Caesar’s day. Real estate development was given an enormous boost when trade and commerce increased about the 11th century A.D., leading to the development of the modern cities of Europe. New concepts such as credit greatly expanded the capital that was available for trading and land acquisition. The discovery of the New World also increased capital. This greater wealth, together with changing social mores such as the development of privacy, caused a boom in development. Government controls on development were implemented in the 19th century in reaction to the horrors of the Victorian city. The miracle of housing in the United States is that it is and has been a great deal. Many factors have come into play to make it a great deal: enormous amounts of land the high per capita wealth of our citizenry relatively inexpensive public and private transportation facilities inexpensive modes of building production, as characterized by the balloon frame house the active involvement of government, providing the necessary infrastructure, assisting in the sale of houses through guaranteed mortgages, and providing tax deductions for mortgage interest the nature of the capitalist

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system as practiced in this country, which emphasised minimal government intrusion into property rights Another important feature was the pivotal role developers played in the development of the cities and suburbs. Unlike Europe, they were not passive observers prevented by law from engaging in development. They not only developed, they pressured municipal officials for services to their developments, pressured streetcar owners into extending their tracks, and sought to arrange financing for their customers. They did everything they could to allow the American public to own its own housing.

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3

Myths and Facts About Real Estate Development

F

ew businesses generate more hype, myth, and mystery than real estate development. Let’s confront some of these misperceptions. FOUR MYTHS ABOUT REAL ESTATE DEVELOPMENT

Myth #1. Real estate development is only done by big companies that employ hundreds of people. The homebuilding industry is dominated by small companies who employ fewer than ten people. The average member of the National Association of Home Builders builds about 15 homes a year. A recent survey conducted by the Association revealed that half the builders build in one county only, onefourth in two counties, and only one-fourth in three or more counties, indicating that most developers stay in relatively small areas that are familiar to them. Eighty-eight percent of those surveyed were either the principal owner (51%) or the sole owner of the company. Development companies are frequently a family affair, with 37 percent of the firms having family members as paid employees.

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Myth #2. There is no way I could become a developer unless I had extensive experience in the construction business. Everyone starts somewhere, and providing you are willing to risk some of your own (and your lender’s) money, have a thoughtful project backed up with believable market data, have hired competent professionals and are able to convince a lender to back you, there is no reason why you cannot get started in real estate development. Myth #3. The 1986 Tax Act destroyed development as a profitable investment. While the 1986 changes in the tax law eliminated some of the financial advantages of development, it did not eliminate any of the reasons for owning and buying a house. There are three main reasons that home ownership remains an attractive proposition. The American dream. Americans have always sought to own the roof over their heads, and today people more then ever want to own their own homes. The challenge has been to build houses that are affordable to the greatest number of buyers and still profitable for the developer. Tax deduction. A quick look at the 1986 Tax Reform Act reveals that while the government was striking down every possible loophole, it left intact the deduction of mortgage interest on first and second homes. There is a great message in this Act: don’t tread on American homeowners. Appreciation. In most markets, housing continues to appreciate in value, providing an excellent hedge against inflation. Not only do homebuyers reap the benefits of a tax break, but the value of their homes continues to increase. Myth #4. Development can be stopped by restrictive zoning laws. One of the biggest myths about development is that it occurs at the whim of local officials. Irate citizens who wish to stop development in their community by electing no-growth candidates to local political office soon discover that municipal officials are bound by law to accommodate growth. They can manage and control development, but they cannot stop it. ELEVEN COMMONLY ASKED QUESTIONS ABOUT REAL ESTATE DEVELOPMENT How profitable is real estate development? This, as they say, is the $64,000 Question. On average, most small developers make 10 to 20 percent net profit of the sale price on their projects. Large developers may realize less profit, but often pay themselves large salaries along

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the way. It is important to distinguish between net profit, which is the profit that the project makes, and return on investment, which is the profit you make on your investment. Because of leverage, they are not the same. Because of the risk and work involved, return on investment is invariably higher than 10 or 20 percent, often exceeding 50 to 100 percent on a successful project. It is not uncommon to hear of fabulous net profits of 100 percent or more, particularly in hot markets or on land speculation deals, but these are the exceptions rather than the rule and the risks are invariably high. What form of business ownership do development ventures take? There are several forms of ownership that development ventures can take, often determined by the amount of equity needed for the project. Sole proprietorship. In a sole proprietorship you are the exclusive owner of the business and raise money for your ventures on your own, either through owned assets or borrowing from friends or relatives. You reap all the profits and incur all the risks. Any borrowing from a lending institution is essentially personal borrowing, since you will be personally liable if the project fails. General partnership. If you lack personal assets or a proven track record in business, it is not likely that a lender will back your project. Developers who lack assets usually bring in partners to provide financial backing. Some general partners will be content to lend money at prevailing interest rates, but most will insist on owning shares in the business commensurate with the money and experience they bring to the project. General partners share in the day to day operations of the business and in all management decisions. All general partners are personally liable if anything goes wrong with the project. Limited partnership. A limited partnership has two classes of partners: general and limited. Limited partners have a restricted role in the business. Their participation is usually limited to investing money and they have no say in the day to day management of the company, which is run by the general partners. The shares in a limited partnership are divided as the partners agree, subject of course to the prevailing law. One of the advantages of being a limited partner is that liability is limited to the amount put into the partnership, plus any assets that the company may have accumulated. There are also tax advantages and depreciation allowances that can be taken. The main disadvantage is that limited partnership shares are very difficult to sell, since there is no substantial secondary market for them. In addition, changes made in the 1986 Tax Reform Act eliminated some of the tax advantages of limited partnerships. Corporation. Corporations sell shares in their company in order to raise operating capital. Each shareholder owns a piece of the company, and can vote to elect the board of directors, which manages the company. The chief executive officer carries out the policies of the board. While the principal

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shareholders normally control the corporation, their control is subject to the laws of the state in which they are incorporated. Corporations can be publicly traded, which means any outsider can buy stock in the company, or it can be a closed corporation, in which case the stock is not traded publicly and is usually owned by only a few investors, often family members. Most development corporations are closed corporations. One of the disadvantages of corporations is double taxation, which occurs when corporate profits are taxed and then taxed again when the profits are distributed as dividends to shareholders. To avoid double taxation, many corporations are formed as “S Corporations,” which permit them to retain a corporate form while at the same time passing through profits to the shareholders without themselves being taxed. The main advantage of a corporation is that the liability of each shareholder is limited to the value of stock owned. While this provides protection against certain creditors, you should not kid yourself into believing that you can set up a development corporation that will completely shield you from personal liability. Unless the corporation has sufficient capital, no lender will provide construction funding unless one or more of the major shareholders signs a note personally guaranteeing the loan. In other words, the lender will insist on being able to reach your personal assets in the event something goes wrong. However, the corporate structure does permit you to limit liabilities in other areas of business. There are other advantages of a corporation, including the ability to set up a corporate pension plan. The majority of development ventures are set up as corporations. Joint Venture. You may approach any group of people or companies and ask them to go into the development business with you. A relationship with some other person or company for the purpose of developing a single project is known as a “joint venture.” Of course, you can approach these same people and ask them to lend you money at an agreed-upon rate of interest. This is the traditional form of financing development, using pure debt. More and more, however, investors will help finance a real estate venture only if they can have a piece of those “fabulous” development profits. This is known as “equity participation.” These terms are discussed in greater detail in Chapter Five. Whichever form you decide upon, it is imperative that you consult with an attorney experienced in development ventures. The attorney will be able to advise you as to the best form your business should take. How much money does it take to get started in the development business? It depends on what and how much you want to build and how you structure the business relationship. Let’s assume that you are a sole proprietor (that you own the

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entire business by yourself) and that you want to build one house. A lender might provide a construction loan covering 65 percent of land costs and 100 percent of construction costs, plus a calculated interest reserve. The rest, usually referred to as soft costs such as legal, engineering, insurance and general administrative costs, you may have to provide yourself. This is your equity in the project. By way of example, one of the authors recently built a house that sold for $170,000. Thirty thousand dollars of that (about 18 percent) was pre-tax profit. The bank provided a loan of $120,000, and the author had to come up with the additional $20,000, or about 15 percent of the cost of the job. That $20,000 went for up-front costs that included a portion of the land acquisition, settlement expenses, and the construction mortgage fee. In this case, a parcel was purchased that had already been zoned and had roads and storm water drainage systems installed. An artesian well was dug on the site and a septic system was used for sewage disposal. The number of houses you can build will depend on the demand for the type of housing you are seeking to build, your liquid assets, and your willingness to personally guarantee the loan. Note that your ability to come up with your own cash for the project increases your leverage; the more cash you have, the more a lender will lend. Is my liability limited to just the equity I put into the project? No. Assuming you are the sole proprietor or a general partner in the project most lenders will require that you be liable for 100 percent of the money lent you, especially if you are just starting in the business. They will make you liable in two ways. They will obtain a first lien on your project, so if you default on the loan they will be able to have clear title to the property. Since you put work into the project, its value will have increased. In addition, they will seek to encumber enough of your assets (and your partner’s assets) to recover whatever money they loaned to you should something go wrong. The exception is limited-partners, which by definition can only be liable for the amount of money they put into the project. Aside from the financial risks, are there any other risks associated with development? Risks fall into all sizes and categories. In addition to financial risks, several other types of risk can be identified: economic risks, political risks, risks associated with the actual development (physical costs, natural hazards), and legal risks. Economic risks involve changes in the marketplace and the economy that can adversely affect your project. For example, a major employer in the neighborhood may pull out, dramatically affecting demand for housing. Or competitors may move in and flood the area with the same housing you have

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built, decreasing your overall share of sales. Changes in the interest rate can dramatically affect home sales. Each one percent increase in the interest rate prevents several hundred thousand buyers from owning a home in America. Political risks include difficulties obtaining zoning, subdivision, and building permits. When you seek approval to build on raw land, you must obtain the approval of the local municipality. Depending on where and what type of project you are building, you may also require the approval of certain state and federal authorities. During each of these stages, you run the risk that your proposal may hit a snag. Risks associated with the development of the project include physical risks, cost overruns, and natural hazards. Physical risks exist because there may be problems with the land that prevent development—the slope may not be right, the soil may not be suitable for development, and there may be environmental complications such as wetlands, toxic wastes, etc. Cost overruns can be a major problem in development. During the 1960s and 1970s, inflation greatly increased land, material, and labor costs. Inflation has abated during the 1980s. However, material and, to a lesser extent, labor costs have continued to rise slowly. Land prices in hot markets in the Northeast United States and California have skyrocketed. Delays, particularly in obtaining materials and those caused by subcontractors (work not done on time, having to redo work, etc.) will also increase costs. The result is that cost control has firmly entered the lexicon of every developer. The reason to control costs is very clear: if costs exceed those anticipated, you either take less profit or raise the price of the house. However, home prices have increased so much in the past 20 years that even small price increases are enough to reduce the pool of potential buyers. Natural hazards are a major headache to developers. Time is money, and a major storm, flood, hurricane, or soil problem can significantly delay a project, since many different subcontractors must be notified about the delay. Legal risks include problems with obtaining clear title to the property and risks that arise from the physical hazards of construction. It is not unusual to have some form of lien, encumbrance, tax, easement, or other cloud on the title to a property. It is up to you, your attorney, and your title company to determine that you have a clear title. Fortunately, most risks can be managed by using sound planning techniques. Changes in the marketplace can be anticipated by a thorough market analysis to reveal employment trends as well as the progress of competitors. Changes in interest rates can be addressed by building only as much housing and infrastructure as can be absorbed in a short period of time. In addition, new mortgage instruments have been created recently, notably the adjustable rate mortgage (ARM), for those willing to assume some of the risk of high rates in the future to buy housing now. Political risks can be minimized by having a thorough knowl-

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edge of local zoning and subdivision regulations, retaining knowledgable legal counsel, and knowing the key players and the attitude of the community toward development. Physical risks can be reduced by conducting a thorough land acquisition study (discussed in Chapter Four) before you go to settlement on the property. A number of cost control measures, such as value engineering (discussed in Chapter Nine), are now a regular part of the development equation. Natural hazards are difficult to predict, but thinking developers always assume there will be some delays caused by natural hazards and make sure construction schedules are flexible enough to deal with them. Legal risks involving the purchase of property are addressed by a thorough study of the title and the purchase of title insurance. Accidents and injury are addressed by instituting a clear safety program with your crew and by obtaining adequate general liability insurance. One way developers minimize risk is to take out options on the land, or purchase subject to contingencies. An option means that you have an exclusive right to purchase a parcel of land at a future date, which will allow you adequate time to investigate whatever physical, financial, or legal risks that may exist. You can insert contingencies in the purchase agreement that would make your purchase dependent on obtaining all government approvals and adequate financing. These issues are discussed in Chapter Four. Another way to deal with risks is to pay someone else to worry about them. For example, many developers deal with political risk by buying lots that have already been zoned and approved for subdivision. Much of the physical risk can be reduced by buying land that has already had the infrastructure installed. At each point, you surrender some of your profits in exchange for reducing certain risks. A third method is to limit liability through the form of ownership. For example, corporations and limited partnerships both provide protection against certain financial losses and liabilities. Every developer is aware of these risks, and each takes different steps to deal with them. There is also the issue of how comfortable you are with risk, which will be discussed below. The point is not to let risk deter you, but to enter the job aware of the degree of risk and with a thoughtful plan ready to implement. Doesn’t the fact that homebuilding is cyclical make it a feast or famine business? The housing business is a cyclical one, alternating between periods of oversupply and undersupply. Most housing cycles look like this: • In response to external factors (faltering national or regional economy, high interest rates, oversupply, etc.), housing demand slips, leaving developers with a large inventory of unsold houses.

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• Developers decrease building activity in an effort to sell off the existing stock. • Eventually, the stock of existing housing becomes depleted, and the demand begins to exceed supply. • Prices increase in response to increased demand, and developers increase building activity. • At some point a perfect balance between supply and demand is reached. In response to competitive conditions, however, developers keep building, leading to an oversupply, and the cycle starts again. Figure 3.1 outlines new housing starts over the past 17 years. Many of the ups and downs in housing starts in this period are directly attributed to the availability and cost of mortgage money. For example, the two low points in the chart, representing 1974-1975 and 1981-1982, were both periods of high interest rates. Since that time, two developments have occurred that may help stabilize mortgage rates. One is the deregulation of thrift institutions, which will enable them to more effectively compete for a share of the mortgage market. The other is the explosive growth of the secondary mortgage market, which is discussed in Chapter Five. Almost two-thirds of all home mortgages now end up being sold by the original lender to packagers who put together pools of securities that are backed by mortgages. These securities are then sold to investors on the open market. This has brought vast amounts of new capital into the mortgage business from

Figure 3.1 Private housing starts 1960-1987

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sources that never invested in mortgages before, thus helping to stabilize mortgage interest rates. Lenders have also offered the consumers a wider variety of mortgages to suit their needs. For example, Adjustable Rate Mortgages (ARMs) have allowed buyers to purchase mortgages with shorter term and lower interest rates that bear a risk of rate increases in the future. This is not to say that interest rates no longer influence home buying decisions. They do, and a significant rise in interest rates will invariably cool off even the hottest market. But deregulation, the secondary mortgage market, and creative home financing have combined to help stabilize mortgage interest rates. In addition to the cost of money, supply also determines the pace of new home starts. Some residential markets have become overbuilt in the past several years, while others are still very hot. However, even overbuilt markets have niches which a developer, armed with a thorough market study and a business plan, could exploit. Learning to identify market niches and building for a market are discussed in Chapter Ten. While cycles are part of the development business, they should not deter you from entering the business. Thinking developers have always adjusted to swings in the marketplace by slowing down the pace of construction and finding market niches that are not overbuilt. The skill lies in anticipating these swings and not being left with an inventory that you cannot sell profitably. Even with the cyclical swings, real estate has proven to be a profitable investment over the years, consistently outperforming other investments such as stocks and bonds. How do you decide where and what to build? Determining what to build, and indeed whether to build at all, is a crucial part of the development process and is discussed in Chapter Four. It starts with a marketing study that determines the kind of housing buyers want and the price range they can afford. Once a site has been selected, the old adage “location, location, location” is often the most important feature in the success of a development. Proper zoning and other government regulations are also important in determining feasibility. In a survey in the July 1987 issue of Professional Builder the largest developers in the country listed the following factors as important in determining the feasibility of a project: Percentage Listing Component Important

Component Location/access Market absorption estimates

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Net profit Potential risk Return on investment Availability of utilities Financing sources Cash flow Project pro forma Labor availability Required capital Range of results Other

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28 22 18 14 12 10 8 4 4 2 24

Smaller developers will be more concerned with return on investment, financing sources, and cash flow. The style of house that is built depends on the physical features of the land, zoning, and the specific market you are building for. While these features change from location to location, today’s homebuyers are often as interested in purchasing a lifestyle as a house. Buyers look carefully at recreational, shopping, and educational facilities, and it is common for developers to stress the community as much as the house. Larger developers have been building planned communities that have all of these features built in. What components go into determining the price of a home? The formula is simple: cost + profit = price of house. The cost of a house is broken down into two parts: hard cost and soft costs. Hard costs are the actual costs involved in construction, notably labor and materials. Soft costs are everything else, including financing, sales and marketing, interest, and overhead. An old rule of thumb in development is the “25-50-25 rule.” Under that rule, 25 percent of the total sale price of the house goes to raw land and land improvement costs, 50 percent to hard cost (labor and materials), and 25 percent to everything else, such as overhead, debt service, sales and marketing, and profit. In the July 1987 issue of Professional Builder, the largest developers in America, on average, broke down the price of a home approximately as follows: Raw land Land improvements Materials Labor Overhead

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14.5% 11.5 24.3 20.3 7.6

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Financing Marketing and sales Advertising Profit

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4.3 6.1 3.1 8.3

These figures are not absolute and they can vary from place to place and developer to developer. What other issues face developers today? The biggest challenge is building affordable housing. Housing costs have increased three times faster than income over the past 15 years. The crisis in lowincome housing is already well known: according to the National Association of Housing and Redevelopment Officials, the number of low-income households (under $10,000 per year) has increased by three million over the course of the last decade while affordable rental units have decreased by two million. One effect of this crisis is the waves of homeless people who are now inhabiting parks and city streets across America. As many as two-thirds of this group are lowincome people who have seen affordable housing eroded by decay or gentrification. With no place to go, they have been forced onto the streets. Less publicized is the crisis in middle-income housing. Today, the median price for a new home in United States is about $110,000. Assuming that the house is financed under a traditional 30-year mortgage, a family would require a gross income of about $55,000 a year to afford the house. Yet the income figures gathered by the Census Bureau indicate that only 20 percent of all the households in the United States make $50,000 or more a year. If you are building housing within a few thousand dollars of the median price range, 80 percent of the families in America may be excluded from buying your product. The initial cash outlay required to buy a home is also a problem. Ten percent down is usually required to purchase a house, plus closing costs. Often, the home buyer needs a minimum of $15,000 or more in cash to buy a house. This may not be a problem if you are selling your old home and have equity that you can use, but lack of cash often prevents the prospective first-time buyer from buying. As a result, fewer first-time buyers are able to afford a home. For decades, the entry-level home buyer was the backbone of the residential construction business. By 1983, however, first time buyers were split fifty-fifty with other home buyers, and by 1986 the number of homes sold to first-time buyers declined to 35 percent. To respond to this challenge, developers have grappled with the five evils that have driven up the cost of housing: land costs, overkill government regulations, inflation, interest rates, and construction costs. Developers have sought to limit the amount they spend on raw land and land improvement

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costs to roughly 25 percent of the sale price of the home. However, in hot land markets land costs can go to 35 percent and even higher, thus driving up home prices. In 1984, the President’s National Urban Policy Report found that in extreme cases local regulation can add 25 percent to the cost of a house. Reducing regulation is difficult, since it must come through negotiation, one community at a time. Inflation directly affects costs and interest rates, but it has abated considerably in the 1980s, though concerns exist that it may rise rapidly during the 1990s. While high interest rates are a concern, the mortgage market has stabilized considerably in recent years. The developer is thus left with controlling costs as the best way to keep housing in an affordable price range. Cost control has become an issue in virtually every segment of the construction market, from land acquisition to labor and materials, overhead, sales and marketing, and financing. Cost control will be discussed in a later chapter. What kind of personality does it take to succeed in development? The public has an image of developers as bold, audacious, and thick-skinned. While it is true that there are many legends in the development business who became famous because of their personality and their willingness to take great risk, the average developer does not need to be famous or a great showman to succeed. While there are no psychological tests available to determine if you have the personality to succeed, there are certain characteristics that are common to most successful developers. The following questions should enable you to examine your personality to determine if it meshes with that of the successful developer. Are you a “take-charge” kind of person? One of the hallmarks of successful developers is a tendency to “take-charge.” They are most comfortable when they are making the decisions and do not hope that someone else will make them for them. They are like this for two reasons: developers are an independent lot, and they have so much personally at stake that they must be involved in the daily decision-making. Examine yourself. Do you have a strong belief in your own abilities and the desire to guide your own life and make your own decisions? Or are you more comfortable if you work for someone else and have them make the decisions? If you cannot make a hard decision, than development may not be for you. Are you a doer or a thinker? Many, perhaps most, of us are doers rather than thinkers. We do not like to sit around analyzing what we should be doing, or read a book to learn how to

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do it: we just like to do it. This is fine if you are learning how to change a tire, but it can be disastrous if you are a developer. Developers spend a lot of time in analysis, discussions, and negotiations that precede development. Examine the titles of the chapters in this book. Only Chapter Nine discusses construction. If your attitude is “Look, I don’t need all that garbage, I just want to build something that is profitable,” then you should reevaluate your interest in this business. If, on the other hand, you are comfortable with doing research and know how to calmly and objectively analyze a business decision, and yet do not suffer from paralysis by analysis (the opposite condition), then this business may be suitable to your temperment. How comfortable are you with risk? All of us take risks every day. The mere act of getting out of bed entails the risk that we may slip and permanently injure ourselves. Yet, we get up and do this every day, even though we know it can happen. Why? Because we know the degree of risk involved in getting injured is very small; we are willing to take the risk. All business ventures entail some degree of risk, though the risks here are financial, not physical. For the conservative investor, government bonds are thought to be the most risk-free form of investment. Not surprisingly, the degree of return is smaller compared to other business ventures. In other words, there is a relationship between the degree of risk of any financial investment and the rate of return: the higher the risk, the higher the rate of return. This relationship is expressed in Figure 3.2. The question of risk affects how comfortable and successful you can be in development. Some people hate risk of any sort: they keep all their money in

Figure 3.2 The risk-return relationship

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a five percent interest bearing bank account, and fear to move it anywhere else. Even government bonds strike them as risky. The same people are likely to be nervous with debt; even a home mortgage makes them nervous, and they are never really comfortable until they have no debt at all. If you are this type of person, chances are development is not the business for you. Development has a higher degree of risk than investing in government bonds, but the return on investment is correspondingly higher. Because of this, developers are often characterized as risk-takers. This is true, but unfortunately it gives the image of the developer as a gambler, when actually thinking developers are much more like calm, pokerfaced accountants. To say that risk is higher in real estate development than in other ventures does not mean there is no way to minimize risk. How good are your negotiating skills? Negotiation is the heart of development. Developers negotiate everything— raw land acquisition; retaining lawyers and others on the professional team; obtaining financing, zoning, and subdivision; construction details; etc. A good part of the developer’s time is spent on the phone negotiating details of the deal. Negotiating skills are thus essential in the development business. Many developers, in fact, love the art of negotiating and often find it more stimulating than the actual construction. The most important aspects of negotiation are a thorough knowledge of the items to be negotiated, knowing how much you are willing to give in return for what you want, being aware of the other party’s position and what they are willing to concede, and retaining enough flexibility to negotiate an agreement that gives both sides what they want. Fortunately, negotiating is an acquired skill, and there are dozens of books and courses that teach the fundamentals. Do you have the support of your family? Most people who enter the development business for the first time will need the strong support of their families. Your spouse will probably be asked to sign several documents indicating personal liability in the event something goes wrong, and you will be borrowing large sums of money that may at first seem intimidating. Unless you have the trust and love of your family, the pressure may be more than you can take. Make sure that your spouse fully understands what you are doing and the risks involved—this is not a time to be uncommunicative. What else does it take to succeed in development? The other major factor associated with success in development is sound management. Volumes have been written on how to be a successful manager in

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general, but the following eight principles are especially important to the owner of a small development company: Start small and minimize your exposure. Keep a low overhead-employ as few people as possible. Develop accurate market data—build for a market. Be politically savvy. Establish good relationships with lending institutions. Contain costs. Plan for the unknown. Hire the best help you can afford. These principles are discussed in detail in Chapter Twelve. Now that some of your questions have been answered, let’s get into the fundamentals of the development business. It all starts with finding the right property.

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4

Forty Factors to Consider When Acquiring Land

T

he most important factor in the development business is land. The first step toward finding and acquiring the right parcel is to conduct a market study to determine what demand for development, if any, exists in your area. We will be highlighting residential development in this book, although the essential concepts also hold true for commercial and industrial development. In the market study you will examine current and planned residential construction within a radius of several miles from your proposed site. The age, income, profession, and growth patterns of the population, the ability of the area to absorb new housing, the receptiveness of the municipality to development, whether already completed projects are selling, and other factors will have to be considered. The details of a market study are discussed in Chapter 10. The next three steps, the location of a suitable parcel of land, the negotiation of price and conditions, and the preparation of a land acquisition study

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(sometimes referred to as “due diligence”) to determine if the parcel can be developed for your intended use, are the subject of this chapter. Note the order: study the market, find property, negotiate purchase terms, and study property. Developers do not buy properties and then create a use for them. Note too that you will negotiate price and conditions at the same time as you conduct a land acquisition study. While it is dangerous to purchase land without a land acquisition study, there is also a danger in delaying the negotiating process: you may lose the sale to a competitor. The idea is to simultaneously negotiate and perform your study. THREE STARTING PRINCIPLES There are three principles that every budding developer should adhere to. First, buy in your own backyard. Stay in an area that is familiar to you, one which you have lived in or visited many times. You must be knowledgeable about the geographic, political, social, and economic issues in your area, since all of these factors affect land values and marketability. Your knowledge of local conditions will be supplemented by an organized market study, but no market study can substitute for intimate, first-hand knowledge of a community. Second, always buy in the direction of growth. Go to the county library or municipal offices and examine the master plans that have been developed. Trends will evolve that will indicate directions of growth. At the same time, if available, purchase aerial photographs of the area you are investigating— often it will be possible to see the direction of growth from the air. Third, start small. Try building one, two, or three single-family homes. Go through the entire process of negotiation for the land, land acquisition study, approvals, and building. See what it is like. The experience will teach you invaluable lessons about development without the risks and headaches of a large development effort. If the process agrees with you and you have made a profit, you can go to a larger job. If you go through this and you have not made a profit, stop and go no further until you have thoroughly analyzed the reasons for your failure and have taken steps to insure that it will not happen again. WHERE TO FIND LAND Your familiarity with the area and the direction of growth, coupled with a market analysis, should assist you in determining what type and price of housing can be profitably built. The next step is to locate raw land for development. Newspaper listings are the most widely used source for buying land. Real estate offices are next. It is a good idea, if you are serious, to establish a rela-

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tionship with one or more reputable real estate agents who can keep you apprised of properties with development potential. While newspaper advertisements and real estate agents are easy sources to utilize, everyone else is also using them. If you are in an area where competition for land is keen, you will have to be more aggressive to uncover any hidden gems. Get in your car and start driving around. Remember, you are looking to buy in the direction of growth and you are staying within a geographic area that is familiar to you. You will come across “For Sale” signs on raw land that is listed with local real estate companies. Make a note of properties with potential for the development you have in mind so you can call the agents later. Next, look for sellers who choose not to list their property through a realtor and simply place a sign on the property. Again, make a note of those properties that interest you and call the owner later for details. Finally, look for properties that are not for sale but have clear potential for development. When driving around, then, you are not just scouting for “For Sale” signs; you are looking for any property that fits the initial criteria you are looking for: proper size, shape, price, conditions, zoning. Once you have found several of these properties, go to the county tax assessor’s office and learn how to use the tax maps. The maps will tell you the owner’s name and address, size of the land, zoning classification, taxes, buildings on the land—everything you would initially want to know about the land except the price and conditions. Most assessors will also keep a history of previous sales. Examine the maps carefully for other parcels that fit the development criteria you have established. If the facts and figures make sense, be aggressive. Contact the owners, and if they are interested, make them an offer. You will be turned down many times, but you will be surprised how many people might be willing to sell, and that one deal you make could be the sweetest one of your life. Banks are another good source for land. They have land because of mortgage defaults and because they handle estates for individuals. Visit your local bank and ask to see their real estate owned (REO) list. These lists are normally not advertised and you may be able to find a suitable piece of property at a good price. Auctions are another source of candidates for land acquisition. The most common form is the municipal auction which takes place because of foreclosure for nonpayment of taxes. A visit to the local tax assessor’s office will reveal which properties are scheduled for auction. The federal, state, and local governments own more than 25 percent of the land in the United States, and it is occasionally offered for sale to the public. The Bureau of Land Management of the U.S. Department of the Interior is

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responsible for the sale of public lands. Excess land is usually sold at auction or by sealed bids. Most of the land available is west of the Mississippi, and therefore of little value to developers in eastern states. The Farmer’s Home Administration of the U.S. Department of Agriculture and the Internal Revenue Service also have properties that they foreclose on and occasionally offer for sale. State government land is also more available west than east of the Mississippi; you can contact the state land commissioner in the capital of your state to find out about available properties. LAND ACQUISITION STUDY Once a potential site is located, the land acquisition study can begin. The land acquisition study can be divided into six categories: Property Inventory Environmental Analysis Utilities Regional Inventory Government Regulations Development Decision These categories are themselves divided into about 40 sub-categories, listed in Figure 4.1 and discussed below. Property Inventory Legal description You need an exact legal description of your land. A legal description will positively identify the boundaries of your parcel in a manner that avoids confusion with other properties. In the United States, there are three methods used for legal descriptions: metes and bounds, rectangular survey, and lot and block. A metes and bounds description relies on reference points to describe a property, beginning with an identified point such as a tree, stone, or distance from a surveying section. The property is then described by moving from one reference point to another in a direction referenced to a physical object or as degrees, minutes, and seconds of angle from north to south. This is the oldest method of property description in the United States and is most commonly used in the eastern part of the country. The second method, rectangular survey, was created by Congress in 1785 to facilitate the easy sale of land. It divides land into square grids running north-south and east-west, six miles on each side. Each 36-square mile grid is

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Figure 4.1 Forty factors to consider when acquiring land

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then broken down into smaller and smaller squares and rectangles until an exact description of the property is achieved. This is the most common method of land description west of the Mississippi River. The final method, lot and block, is a simplified way of identifying parcels by providing lot numbers that identify individual parcels within blocks. You will want to hire a surveyor to create a new plot plan and legal description. Walk the borders of the land, then criss-cross it in order to familiarize yourself with its physical features. Size of property You need to know the exact size of the property, and what percentage of the property is devoted to non-usable areas such as rights of way, steep slopes, and flood plains. Your civil engineer will provide this information. Current use of land and income produced What is the current use of the land and how much income, if any, does it produce? Has any part of the land been leased? Is there insurance on the property? When buying a parcel which includes existing buildings such as a farmhouse, barn, storage shed, or cottage, consider the effect of the existing building on the proposed development. Often the ability to subdivide and sell the existing buildings will improve the cash flow and profitability of the project. At other times, the building may impede development to the extent that demolition will be necessary. Title Retain a title insurance company to conduct an informational title search to determine if the seller is the sole owner of the property. The most common form of property ownership is fee simple, which means that the seller has unqualified ownership. If the property is not fee simple, the elements of the title that are excluded must be carefully examined to determine if they hinder or prevent development. The title search will also reveal any encumbrances against the property. Liens You must know if there are any existing mortgages on the property or any other form of liens, such as tax or mechanics liens. If there are, you must work out an agreement with the seller concerning their payment. Easements and rights of way The title search will reveal if there are easements or rights of way on the property. You will need to provide easements for all utilities for your project.

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Restrictions What legal restrictions would prevent you from developing this site? Is there a local moratorium on certain development, or architectural or building restrictions? What legal restrictions are there such as setback requirements, environmental restrictions, historic building zones, height and lot size limitations, and occupancy limitations? A visit to the local municipal offices will answer these questions. Assessments Determine if there are any recent improvements to the property, such as paving or sewerage. If there are, determine if balances are due and who will be responsible for payment. Property taxes A visit to the county tax assessor’s office will reveal the total annual taxes and the tax rate. Determine if there are any unpaid taxes. Examining the tax base is also a part of your market analysis, since it is a good way of determining the overall economic health of the community. Environmental Analysis Obtain an aerial photograph of the parcel. An aerial view puts the parcel in perspective and aids in visualizing topography, road access, community facilities, and the direction of growth. Ground pictures should also be obtained. Microclimate While it is important to know the climate in your area, you really want to know the microclimate—the climate in the immediate vicinity that directly affects your parcel. You will need to consider: Sun. The direction and angle of the sun is important when configuring buildings. Passive solar heating in the winter is considered a big plus by many home buyers. The location of recreational items such as patios and swimming pools will often be based on sun orientation. Wind. Wind transmits heat, cold, noise, and odors. Remember that it can change direction with the seasons. However, it can be altered to a certain extent by the creative use of vegetative windbreaks and proper building orientation. Rainfall. Rainfall can be a critical factor, since many municipalities require that water runoff be no greater than before the building of the project.

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Some municipalities require construction of retention basins to hold water runoff. Water There are two types of water of concern to the developer: surface and subsurface. Surface water includes lakes, ponds, streams, wetlands, and flood plains. Surface water is mapped by the U.S Geological Survey. Subsurface water is usually expressed in relation to the water table, which is the point at which soil becomes saturated. It is important to know the depth of the water table, especially if you are constructing a basement, because water tables of less than eight feet can require the installation of costly pump operations to keep cellars and foundations dry. Information on subsurface water is usually derived from the Soil Conservation Service. Flooding is the most serious surface water problem a developer will face. Proximity to a body of water is aesthetically pleasing and enhances land value. There has been a tremendous increase in the number of residences built in flood plains, which are areas susceptible to flooding. Today, there are over six million homes built on flood plains in this country. The National Flood Insurance Program was created by Congress to insure buildings constructed in these low areas. To qualify for such insurance, however, local governments must enact comprehensive plans to regulate building in flood plains. Absent this insurance, most lending institutions will not finance development. Nearly half of the states and thousands of local municipalities have now enacted flood plain regulatory plans. The local municipality can provide you with a copy of the local flood hazard boundary map to determine if you are in a hazardous zone. Drainage patterns must also be carefully considered. You and your civil engineer should examine the existing and proposed topography maps to determine drainage patterns. Most soil erosion regulations require that the amount of storm water runoff after the project has been completed be no greater than that which existed before the project was begun. It is important to know the existing drainage patterns, and to use them in creating your own internal storm water drainage system. Your engineer will determine the size of reinforced concrete pipe and of the retention basin, using the area to be drained and the velocity of runoff water as criteria. Vegetation An aerial photograph plus a walk-through of the site will reveal the type and amount of vegetation on the ground. During construction it is best to leave existing vegetation, such as meadow fields, undisturbed to avoid creating erosion problems.

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Most builders retain as many trees as possible, since they add beauty and value and prevent erosion. Mature trees in good locations can add five percent or more to the lot value. This is not always the case, however, since many trees do not lose their leaves in winter (screening out sunlight) or drop unwanted foliage, such as berries or cones. Smart developers are familiar with the shade trees in their area and use trees to provide shade and aesthetic value. Topography and land survey Topography affects location of buildings and roads, water runoff, and visual characteristics of a site. A licensed surveyor will perform a land survey and prepare a two-foot topographical map of the property. Often, a survey of the property is available, but it is a good idea to have it done by your own people to determine if the boundaries have been properly identified and if there are any boundary disputes. You can obtain a topographical map from the local planning commission prepared by the U.S. Coastal Geodetic Service showing 20-foot contours that will reveal slopes and drainage patterns. While the best development site is perfectly flat, it is also the most boring. Gently rolling, well-drained land is best. The optimum grade is two to eight degrees; less than that requires increasing the grade for runoff. Eight to 15 degrees is still feasible but the grading costs rise in direct proportion to the grade. Above 15 degrees is normally not feasible for development. However with architectural design, the ingenious use of engineering, and the largescale movement of earth (called “cuts and fills”), even a steeply sloped site can be transformed to meet the needs of the developer. Soil Many developers overlook the importance of a comprehensive soil survey. Not all soil is created equal, especially for development purposes. Building on soil that is unsuitable for development can lead to big headaches, including frost heaving, flooding, and drainage problems. It is essential to know what is beneath the topsoil—clay, sand, rock, and loam all affect the cost and feasibility of a project. Fortunately, the U.S. Soil Conservation Service rates soil under three classifications: slight, severe, or moderate, depending on the type of soil and development that is planned. For residential development, the factors that are considered include the type of soil, depth to bedrock, seasonal high water table, slopes, and frequency of flooding. The Conservation Service has prepared soil maps for each county or municipality in the United States, and you and your engineer should consult them carefully.

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It would also be wise to consider retaining a drilling company to take core samples of the soil at various locations to determine the presence of rock or high water tables which could increase costs. If you are planning to install septic tanks you will also want to have a percolation test to determine whether the soil can support such a system. External factors (noise, odors, vistas) Until you have spent time at a site at all hours of the day and night, you may not be aware of noise sources. The most notable sources are planes, trains, trucks, and farm machinery. How irritating these are depends on the individual. If there is a strong source of noise pollution in the immediate vicinity, you may want to have an audio engineer provide a decibel study. There are federal, state, and local regulations governing noise pollution. The maximum decibel level is determined by the allowed use of the land, with residential uses requiring the lowest levels and industrial uses permitting the highest levels. Odors must also be considered, especially when your parcel is near farmland or an industrial site. A careful study of adjoining land uses, combined with walking the site at different hours of the day and night, will reveal whether odors are a problem. Vistas should also be considered. Traditionally, the highest ground has been the most desirable for residential development as well as the most profitable, often commanding ten to fifty percent more than a similar site with no view. Utilities You should obtain a Utility Locator Map from the Department of Public Works that will reveal existing water, sewer, and power transmission lines, as well as all utility easements and rights of way. Water Determine if there is a water line on or near the land. Examine local water needs and determine if a moratorium is being considered. While most projects will hook up to existing water lines, you should examine any water rights that accompany ownership of the land. Communities without public water systems must allow a developer to provide a private well system. Sewer Most municipalities require public water and sewer treatment facilities as a condition for approval of multi-density housing. Evaluate the sewer facilities in your area. Generally, there are two types—septic tanks and sewage treatment plants. Consult with municipal officials to see if you can hook into the

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local treatment plant and what the cost will be. While public water and sewer lines serve the best needs of the environment, on-site artesian wells and septic systems are always more cost-efficient from the buyer’s point of view, even after considering the higher installation costs. Unfortunately, septic systems can pollute groundwater and contaminate a water acquifier, so many communities restrict their use. Occasionally a state environmental resources department declares a moratorium due to an overloaded treatment plant. This creates great difficulty and cost to a developer who already has sewer connections confirmed and paid for since the project must now wait until the problem is resolved. The location of existing sewer and water lines is important since you will be required to bear the cost of bringing the lines to your project. Electric and gas Electricity and gas are the primary sources for heating and air conditioning. While most developers assume that public utility companies are required to provide these services, this is not the case. Applications must be prepared and the location and distance of existing utilities must be determined. Utility companies and the developer, working with local subdivision regulations, will establish if these lines can be installed overhead or must be placed underground. Underground lines are preferable for aesthetic reasons. However, the cost for trenching underground lines is borne by the developer, while poles for overhead lines are normally paid for by the utility company. If gas is available, compare the operating cost of gas and oil. Thanks to the oil embargo, the heat pump has assumed a major role in planning heating and air conditioning systems. A heat pump uses a compressible refrigerant to transfer heat from the ground or air into a building. Oil-fired systems are still being used and, depending on cost and availablity, crude oil often produces lower heating costs. According to some heating experts, a heat pump with an oil-fired backup furnace is the most economical system to operate. However, depending on where you live, it may be the most expensive to install. Telephone and cable TV In some areas, the electric company will coordinate the installation of lines with the telephone company. However, it is a good idea to contact the telephone company and provide them with the size and number of units of the project. In underground installations, the telephone line is usually installed in the same trench as the electric lines. Since the breakup of AT&T, the regional telephone companies have begun charging for installation of interior telephone jacks. At the same time, dereg-

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ulation gave the developer the right to choose an independent electrician to install interior lines. Many municipalities have entered into agreements with one or more cable televison companies to provide cable TV service. If your community includes cable TV, check to determine which companies are franchised and inform them of your project. Since their success depends on increasing the number of subscribers, they often will contribute to trenching costs for the privilege of servicing your proposed community. They may volunteer to provide cable TV outlets in three or four locations throughout the house. Solid waste disposal Solid waste disposal is a major community problem in the United States. Many communities now refuse to allow land fills within their communities. Alternative methods such as recycling, incinerators, and trash-to-steam plants have also met with resistance. It is important to ensure that solid waste disposal facilities are available. It is also important to ensure that your project is not near or on a landfill site. Regional Inventory Evaluating your project in a regional context is an important part of a land acquisition study. You should obtain a regional map that is small enough to clearly show your property but large enough to evaluate existing and proposed roads, commerce, schools, shops, public transportation, etc. Ideally, the distance from work should be no more than 40 minutes, from school and local shopping centers no more than 10 minutes, and from regional shopping centers no more than 20 minutes. However, most developers are happy as long as their development is close to these specifications. Remember if you buy in the direction of growth, these facilities will increase as the population increases. Adjoining land use The use of adjoining land will affect the desirability of your project. If properties bordering the north, south, east, and west are developed, you will know the adjoining land uses. However, if any of these areas are vacant, examine the zoning map to determine their existing or proposed uses. While it would be incompatible to have industrial uses located near a residential subdivision, this occasionally occurs when a municipality permits spot zoning. A municipality is empowered to grant zoning changes when an applicant claims hardship and provides some evidence to support the request. Tax maps, which can be examined at the local tax assessor’s office, will identify the adjoining property owners. Often you will be responsible for

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informing them of the date, time, and place of any public meeting dealing with your proposed subdivision. Offer to meet with this group and answer any questions before the public meeting. Tax maps will also reveal the existing undeveloped parcels and any past development. Community facilities Gathering information about the community will assist your sales and marketing program. For example, tennis courts, health clubs, theaters, golf courses, parks, libraries, and other forms of recreation should be highlighted in a sales brochure. Where will people vote? Who will people consult over complaints about municipal services? Locate shopping centers along with other convenience stores such as dry cleaners, drug stores, etc. Schools The location of every public and private school within bussing distance should be noted along with the grade span and enrollment information. Pay careful attention if your proposed community is to appeal to families with school-aged children. Often a strong public school system will tip the scale in favor of a development located within that school district. Emergency services Locate the fire station. This is especially important if the community does not have a public water system with pressurized fire hydrants within 300 feet of your proposed buildings. In the absence of public water, a municipality often will permit any available supply of water, such as a lake, stream, swimming pool, or filled detention basin, to be used for fire fighting purposes. The availability and location of fire fighting equipment will be a factor in determining insurance rates. If a public water system exists, you will be required to install fire hydrants. The location of police stations and hospitals should also be noted. Statistical information regarding the frequency of burglary, theft, and vandalism will help avoid construction theft and determine if potential buyers will be dissuaded from buying by high crime rates in the community. Surface transportation Location, size, and condition of streets feeding onto your site are important, since the value of the property will be influenced by the ease of travel to and from work, school, shopping, recreation, etc. The distance of major commuter routes, such as limited access highways, should be investigated. A trip to the county planning commission will reveal existing and proposed commuter routes. The state and federal highway depart-

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ment can provide information on the traffic generated on these roads. This information will also give you a good idea of existing patterns of development. Once the major highway locations are ascertained, examine the secondary roadway structure which will lead buyers to or near your site. Are they congested? Does the route lead buyers through an attractive, scenic area? Are there any truck weight limitations? Are the roads maintained by the state or local government for snow removal purposes? What is the condition of the roadway surface? Now examine the road leading directly to the site. Is it easy to find? Can you post signs along the way to direct buyers? Will an acceleration or deceleration lane be required at the entrance? Do local traffic patterns interfere with easy access to the site? Must the buyer drive past competitive sites? Public transportation Years ago, the success of most suburban development was directly linked to the quantity and quality of public transportation. Public transportation again became important during the oil shortages in the 1970s. Automotive congestion also played a role in reviving the interest in public transportation. Unfortunately, most commuter rail systems in the United States suffer from disrepair, high fares, and poor service. Bus service extends to the fringe areas of metropolitan centers, but service to the outlying suburbs is sporadic and often non-existent. While the automobile is the most important means of transportation today, do not overlook the value of public transportation. It can add five to ten percent to the value of your project, especially if you intend to sell to older and middle- to lower-income people without private transportation. Existing and proposed land uses Most large metropolitan areas have regional planning commissions consisting of appointed officials from surrounding communities. These groups compile demographic information with respect to population, growth patterns, and existing and proposed land uses. Depending on the political climate within the region, a regional planning body can render an invaluable service. Existing and proposed land uses have a profound impact on your project, since they will affect the type of buyer that will be attracted, the traffic patterns, and the general quality of life. For example, knowing that a large national company is relocating four miles from your project can be a plus, since many new people may be moving into the region to look at your community. On the other hand, the construction of a large shopping center a half block away has pluses and minuses: the nearness to shopping is a plus, but the project may be so close that it will create undesirable traffic patterns and sig-

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nificantly affect the quality of life in your project. Other negative factors include proximity to industrial facilities, rock quarries, toxic or chemical dumps, railroad tracks, and incompatibly zoned adjoining land. All of the land uses, both existing and proposed, must be examined. Growth patterns—proposed and projected The municipal, county, and regional planning commissions are responsible for developing 5-, 10-, and 20-year growth studies of their region. These studies will reveal local attitudes toward development. Often, when communities vow to resist growth, it does not stop development but merely removes the planning process from the municipality, where it belongs, and places it in the hands of a court. Government Regulations Permits and regulations Developers must contend with regulations that require almost endless permits and approvals. You will be subjected to regulations for zoning, subdivision, building, electrical installation, plumbing, curb cuts, soils and erosion control, environmental and economic impact, and occupancy. Zoning and subdivision regulations Zoning is the process by which a municipality regulates what can and cannot be put on a parcel of land. Subdivision regulations define the process you must follow to divide your parcel of land. Not every community in the United States is required or needs to have zoning and subdivision ordinances. However, it would be rare to find a municipality located in an urban or suburban area that does not have regulations concerning development. Zoning and subdivision regulations deal with “what,” “where,” “how,” and “how many.” The “what” refers to what type of use, such as commercial versus residential uses and high rise versus single family dwelling uses. “Where” divides the community into areas which will accommodate all types of uses with a legitimate demand. “How” refers to building code regulations which control the type of materials that can be used and other factors relating to the structure and architecture of the building. “How many” relates to the density in the zoning area. There are no state or federal regulations requiring uniform nomenclature for zoning regulations. The code “R1” could mean minimum one acre residential lots in one community and something entirely different in an adjoining community. You and your engineer will need to purchase a current copy of the zoning and subdivision regulations of the municipality. Do so early in the process to familiarize yourself with those portions which relate to your

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proposed development. These regulations will also govern signs, parking, street tree requirements, etc. Ideally, you should buy land already zoned for the type of project you envision. You can buy non-conforming land and seek to have it rezoned. However, be aware of the political climate in the area before you attempt this. Many have purchased land on the flimsy assurance that a zoning change could be made easily, only to find substantial opposition to the project. To protect themselves, developers often insert a contingency clause in any purchase agreement requiring successful rezoning as a condition of the purchase, or they purchase an option that will allow sufficient time to determine if the land can be rezoned. Environmental regulations Environmental regulations play an important part in development. Federal, state, and municipal agencies have adopted regulations dealing not only with air, water, and ground pollution but also with wetlands, flood plains, coastal zones, and other environmentally sensitive areas. These rules are often adopted and included in zoning and subdivision regulations by reference or inclusion. Some communities require that you file an environmental impact statement noting construction plans, costs, use of open space, effect on roads, municipal services, and revenue generated from taxes. Local, state, and federal environmental laws must be considered to determine if there are any significant environmental problems. This subject will be discussed in Chapter 8. County and municipal comprehensive plan In Pennsylvania, as in many other states, local municipalities are required to submit a master plan to the county planning commission outlining what the community will look like in 5-, 10-, and 20-year intervals. County planners use this information to develop regional plans in conjunction with adjoining counties. This process was de- signed to alert local municipalities to the often inevitable advantages and disadvantages which accompany growth. More traffic, more schools, more police, and more fire fighting equipment are just a few of the services municipalities must plan for. The county planning commission employs professional planners which assist local municipalities to implement this process. Plan submission The zoning and subdivision ordinances will define the process by which a developer may receive permission to subdivide the property. Generally, this is a two-stage process which first requires submission of a detailed engineering plan, called the Preliminary Plan, which includes lot subdivision lines; elevations; and street, water, sewer, curb, and storm water lines. The Final Plan, sub-

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mitted after approval of the Preliminary Plan, contains additional engineering features, such as the horizontal location of the pipes shown in the Preliminary Plan. Often there is a stage which precedes the Preliminary Plan, usually called a Schematic Plan. This Plan is not required by law and does not receive approval or disapproval from the municipality. It contains a general outline of the lots and street location and is not supported by engineering data. It is intended to create early dialogue with township officials at a public meeting to determine their sentiments without the expenditure of large engineering fees. Development Decision Assessment of the land acquisition study Once you have assembled all the data, you must decide if conditions are favorable for development. How much weight should be given to each part of the study? The factors can be divided into two categories: primary, i.e., those you cannot do without; and secondary, i.e., those you would like to have but their absence would not prevent you from developing the parcel. Examples of primary factors include a clear title, no serious topographical or drainage problems, accessibility, ability to hook into water and electric lines, a feasible sewer plan, and either proper zoning or the ability to obtain necessary zoning changes. Secondary factors include vistas, sun and wind orientation, noise, adjoining uses, and community facilities. Note that “secondary” does not mean “unimportant”—any combination of these factors maybe sufficient reason not to develop even if all of your primary factors are available. While some factors are clearly more important than others, all of them need to be taken into account, individually as well as in combination. You must decide between those that present insurmountable obstacles and those that are difficult but can be overcome. In time, all developers learn how to evaluate these factors and assign each of them a mental “weight.” The attitude that you bring to these problems will also determine your responses to them: if you see potential difficulties as a challenge to you, chances are you will be able to prevail in all but the most hopeless of circumstances. If, however, each small or large difficulty does nothing but depress you, chances are you will be overwhelmed and should reconsider whether you want to be in this business at all. In the long run, patience, fortitude, a thorough knowledge of local conditions, and a strong belief in yourself will be the most important factors. Market analysis The market analysis should have been completed prior to the land search, and should have concluded that there is a demand for the type of development

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you have been investigating in the land acquisition study. The market study is discussed in more detail in Chapter 10. Development concept The nature of your development will be determined largely by your marketing study and zoning and engineering factors. Once these factors are known and you have selected an engineer and architect, you will want to provide them with your concept of the development. Your civil engineer will develop schematic plans for the infrastructure (roads, water, sewer). The land planner/architect will develop schematic plans outlining the street pattern and the architectural style of the complex. They will coordinate their efforts with the civil engineer to insure the most efficient use of the land and to insure that the project blends with the mechanical requirements, such as roads, water, sewer, and storm water. Financing Based on these sketches, you and your professional team (architect, engineer, and accountant) can develop a pro forma projection, which is an estimate of total project costs and revenues. You must demonstrate the financial feasibility of the project by showing that the total revenue will exceed the cost of land, construction, financing, sales, and marketing. You will also have to generate a cash flow analysis, which is a more detailed financial statement to show on a monthly basis where your money comes from and how it is being spent. Your ability to obtain financing (and the rate at which you can obtain it) is an important part of the development decision. Financing will be discussed in the following chapter. Negotiating land acquisition Several instruments are available to the developer to formalize the purchase of land. These include the letter of intent, option to purchase, and agreement of sale. Two other instruments, the purchase money mortgage and the land installment contract, are methods of financing land acquisition and are discussed in the following chapter. A letter of intent is an opportunity to highlight the most important terms that go into an agreement of sale without actually drafting the agreement. The logic behind a letter of intent is very sound—avoid producing a full-fledged agreement of sale until it is clear you and your seller can agree on the basic terms such as purchase price, conditions, and whether water and sewer is available. A letter of intent does not legally obligate you to buy the land but it separates the curious from the serious. It puts your seller on notice that you are in the latter category.

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An option is a device to gain time to conduct a proper land acquisition study and investigate financing without having a competitor buy the land. When you sign an option, the seller grants you the exclusive right to buy the property within an agreed-upon period of time. In return, you pay an agreedupon fee as compensation for temporarily taking the property off the market or an increased price for the property. If you exercise your option to buy the property, the money you paid to the seller is credited toward the purchase price. If you do not exercise your option, you forfeit your money (the seller may or may not keep the engineering and architectural studies) and the property goes back on the market. An agreement of sale, also known as a purchase agreement, is the contract between you and the seller setting forth the price and terms of the sale. It is legally binding and obligates you to purchase the property, subject to any contingencies in the contract. Most contracts for the purchase of land contain contingency clauses, which state that a certain series of events must occur before the obligation to buy becomes binding. Developers typically insert contingency clauses concerning adequate financing and municipal approvals. In the event that they are unable to obtain proper financing or approvals, they will not be obligated to go through with the purchase of the property. When should you utilize these instruments? When you are seeking as much time as possible to evaluate the land, you may want to begin with a letter of intent to let the seller know you are serious, then move to an option, if the seller is willing to accept this. It is advantageous for you to enter into an option, since you can gain time to study the property. The agreement can also be worded to excercise your option in stages as each phase of the project is completed. By doing this, you can ensure that there is a market for each phase and, if there is not, simply refuse to exercise your option to purchase the rest of the property. This is known as a “rolling option.” The following section discusses the purchase of property in Bucks County, Pa., with a letter of intent that outlined a purchase price subject to confirmation of public water, sewer utilities, and approval of the final plan by all government agencies. The seller, of course, will probably want to consummate the deal as quickly as possible and will prefer to enter into an immediate agreement. It would be foolhardy to enter into an immediate agreement without a thorough land acquisition study. There may be hidden problems with the site itself, or there may be (and usually is) a long series of approvals necessary to build the project. You will also want to begin investigating financing for the project during this period.

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Price and conditions Assuming the land acquisition study is favorable for development, you still have to negotiate an acceptable price. What is a “good price?” It depends upon a combination of factors, including price, interest rate, down payment, and time period. Ideally, the deal you negotiate would be at a price below market value with a low interest rate and a low down payment. These kinds of deals, while great in theory, are usually difficult to come by. It is better to go in expecting to pay a fair price with reasonable terms. To protect yourself, set limits on the price and the terms you will pay. Every developer has found a property they have fallen in love with and are willing to throw economic sense to the winds to obtain. Don’t do it! Set your upper limits and stick to them; if you cannot get a deal within those figures, walk away. One good rule of thumb is to set ratios for the price of raw land and not exceed them. Research has indicated that, on average, the price of a home breaks down as follows: Raw land Infrastructure (water, sewer, roads) Construction costs (material and labor) Soft costs (financing, overhead, marketing) Profit

15% 10 50 15 10

The actual percentages for your area are available from your local homebuilders association. The object is to keep the percentage you pay for the raw land as low as possible, since this will allow you to devote more dollars to construction costs (which will add value to the house), or, alternatively, will enable you to make more profit. Exceeding 15 percent of the sale price means you will have to lower construction costs, soft costs, or take less profit. None of these alternatives is desirable. As an example, assume you are looking at a 20 acre parcel with an asking price of $250,000. Zoning permits a single family house on one acre. Deducting for roads and open space, you and your architect determine that you can construct 15 houses on the 20 acre parcel. How much can you afford to pay for each of those lots? Suppose your market research indicates that $80,000 houses would attract the greatest market share in your area. Your calculations would be as follows:

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Percentage 15 10 50 15 10 100

Raw land Infrastructure Construction costs Soft costs Profit Total

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Amount $12,000 8,000 40,000 12,000 8,000 $80,000

You now know that the most you should spend for each unimproved lot is $12,000. Multiplying this figure by 15 lots equals $180,000. The ideal price for this 20 acre parcel is $180,000. Since the buyer is asking $250,000, you will have to engage in some serious negotiations to lower the price. If you pay more than $180,000, you will have to change the percentages for the other costs, take a smaller profit, or sell at a higher price. Only you can decide if it is worth consummating the deal. These percentages are not absolute; each developer must decide where the percentages lie and how much profit is required for the risk. In very hot land markets you may see land costs go to 35 percent of the total cost or even higher. The important point is that all developers go through this type of calculation to determine how much to pay for raw land. Go or fold At this point, you should be in a position to decide if the land conforms to your intended use and if that use is supported by a market research study. You should have some idea as to whether you can obtain the necessary financing for the project. You and the seller should have come to some understanding about the price and conditions. Now is the time when you must take all of these factors into consideration and decide if you want to buy the property. Providing that all of the above factors look reasonably good, most developers would go ahead with the purchase, if they can make it contingent upon obtaining all government approvals and financing. There is no magic formula to factor these components and come up with a decision. The main point is to never lose sight of the bottom line: can you build this project at a price that will enable you to sell it to customers who can afford to buy with a profit to you? LAND ACQUISITION STUDY—BUCKS COUNTY, PA. You now have an itemized list of things to consider when acquiring land for development. Now we will apply that list to an actual development project involving the purchase of a parcel of land to construct approximately 200

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townhouse apartment units in Bucks County, Pennsylvania. Bucks County is immediately north of Philadelphia, and is bordered on its eastern side by the Delaware River, which forms the boundary between Pennylvania and New Jersey. Its gently rolling hills have traditionally been used for farmland, but in the past two decades considerable development has occurred in lower Bucks, the part closest to Philadelphia. The year was 1973. The developer, one of the authors, had been looking for land in the vicinity of central Bucks for approximately two months, had lived in the county for seventeen years, and was intimately familiar with the pattern of growth and the local political climate. The recent completion of Interstate 95 had brought both Philadelphia and Princeton to within a 45 minute commute. This commuting time is important, since the number of people willing to commute drops dramatically if the one-way drive time exceeds one hour. A 20 minute drive to the Trenton, New Jersey, railroad station put midtown New York within a one hour train ride. There was a potentially large pool of middle-to-upper income buyers, many eager to live in the bucolic setting of Bucks County. Additionally, lower taxes in Pennsylvania gave many people now residing in New Jersey an incentive to move to Pennsylvania. The developer’s wife, who is a licensed real estate agent, came across a sign on a property located on the Delaware River near Yardley, a small town in central Bucks, offering 22.5 acres for sale and zoned for apartment units. A meeting was arranged with the owner, a kindly gentleman in his late 60s who had recently retired as a New York advertising executive. He had been approached already by five developers and had turned them all down as unsuitable to him. Part of the terms and conditions of the sale was that the buyer would purchase the house which had been the seller’s residence for 35 years. The developer would be required to grant lifetime residency rights to both husband and wife at a fixed rental rate with all maintenance and repairs to be assumed by the buyer. Because of these continuing obligations the gentleman and his wife wanted to be assured that the character of the buyer was up to their standards. To be considered, a candidate was required to produce a recent financial statement, supply a resume, provide the names and locations of all past building projects, and submit to an interview by the seller’s lawyer. If all of the above were acceptable, a candidate would be asked to submit a proposal. While the request was unusual, we went along since there was nothing to hide and everything to gain. Two weeks later, having passed the test, the following letter of intent was submitted:

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Dear ______ Please accept the following as a letter of intent with respect to the possible purchase of the approximately 22.5 acres located in Lower Makefield Township, Pennsylvania. I will consider an offer of $____per unit or $____, subject to the following terms and conditions. 1. Proposed 200 residential units. Add or deduct $____, if more or less. 2. Confirmation of public water, sewer, and utilities at the site. 3. Approval of the final plan by all governmental agencies with all approvals to be obtained by buyer. Buyer pays all approval costs. 4. Payment as follows: a)____on signing of the Agreement. b)____when all approvals have been received. 5. Prior to signing an agreement, I would like permission to perform soil and noise pollution tests at the site. 6. All of the above is subject to the preparation of a formal Agreement of Sale to be approved by Buyer and Seller. I will call to further discuss the matter. Sincerely yours, Ralph Pisani

Meanwhile, the process of investigation was begun. First the tools and materials to begin the land acquisition study were needed. Here is what was done: 1. A copy of the aerial photograph which included the property, a copy of the tax parcel map, the coastal geodetic survey map with 20-foot contour lines, and a copy of the township zoning and subdivison ordinance were purchased from the Bucks County Planning Commission and lower Makefield Township. 2. The seller was asked to provide a legal description of the property. 3. A title insurance company was asked to conduct an informational title search for any encumbrances, liens, easements, or encroachments on the property.

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4. A copy of the soils map for the area, along with a description of the soils on this particular site, was purchased from the soils and conservation district office. 5. Since the property was located in a flood plain, a copy of the Federal Flood Plain Regulations was obtained from the Army Corps of Engineers. Armed with the above materials, the following analysis was made. Property Inventory The legal description of the property revealed that with the exception of utility company easements there were no items which would impede development. There was a large single-family house with the owner occupying the first floor and two apartments on the second floor which would produce income to support a $50,000 mortgage if desired. An unoccupied cottage and a leanto garage were also located on the property. They were scheduled for demolition because of their location. A large portion of the land was being farmed for soybeans. The owner did not have a written lease with the farmer. Since the start of construction was undetermined, the relationship was continued at modest cost to the farmer and with hold-harmless agreements to relieve the developer of liability. Before the agreement of sale was signed, liability and hazard insurance for the house and land was arranged. Since the property was located on the Delaware River, riparian rights to the waterway were confirmed. The single family residence had to be subdivided from the land zoned for apartment use. A surveyor was retained to perform both the house subdivision and the creation of a new metes and bounds plot plan and legal description. The property was zoned ten units per acre. The total site was 22.5 acres. However, after deducting for the existing house, the roadway, and the utility rights of way, the net density was 195 units, or approximately 8.5 units per acre. The informational title search established that the seller was in fact the legal owner of the property. It also confirmed that there were roadway easements along with the electrical company easements, as anticipated. No other liens, rights of way, or other encroachments appeared on the search and a physical examination of the property revealed none. The township tax collector reported that there were no unpaid assessments against the property, and provided the property tax assessment value, and the county, township, and school millage rates. This information confirmed the current tax bill provided by the seller.

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Environmental Analysis The aerial map revealed the location of all trees on the property. After walking the site boundaries and criss-crossing the property it was determined that approximately 30 percent of the site had trees of various sizes and specimens and that most, especially those greater than 10 inches in diameter, could be saved by careful planning. The Delaware River was located on the eastern boundary of the property and the Pennsylvania Canal was located on the western boundary. Because these waterways were regulated by various federal, state, county, and regional jurisdictions, 44 agencies were consulted over a 4 year period to receive the approvals for this property. It was well worth the effort, however, since the project was immensely successful. Knowing that flood plain development was an environmentally sensitive issue, preliminary discussions were held with a civil engineering firm with experience in this field. They advised that Federal Flood Plain Regulations required the building pads to be elevated to one foot above the 100 year flood level. This required raising the building pads an average of 4 to 6 feet. Initially, the engineer concluded that sufficient fill would be available from the detention basin, but as construction proceeded it was necessary to bring in earth from a nearby fill site. Next, aerial photographs of the area taken during a 100 year flood, which occurred in 1955, were examined. The township zoning map was doublechecked to make sure that the township had zoned this property for apartment use. The zoning was triple-checked by a personal visit to the township manager. The manager confirmed that all construction on the site must be elevated no less than one foot above the 100 year flood level. Determining the location of this benchmark required six or seven telephone calls to various government agencies, including the Pennsylvania Divison of Dams and Encroachments, the United States Corps of Army Engineers, the Delaware River Basin Commission, the Bucks County Planning Commission, and the township zoning officer. It was clear that this particular site was zoned for apartments to satisfy the Pennsylvania Municipal Planning Code requirement that each community provide zoning regulations that accommodate all types of housing, within the framework of legitimate demand and the constraints of the land itself. Often, apartments are considered undesirable by residents who own their home. Because a flood plain was involved particular attention was paid to the regional topography. The regional storm water management system was reviewed at the Bucks County Planning Commission to assure that the development would not create any storm water run-off problems either for adjoining land owners, or for the development itself. Local regulations required that

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the amount of storm water run-off after project completion be no greater than that before project commencement. This required underground storm water pipe and the creation of a storm water retention basin. Next, the slope of the property was examined. Except for an elevated railroad trestle on the southern boundary, the property was almost level. This was not a particular advantage, however, because it was necessary to dig an enormous retention basin for storm water purposes and to truck in additional fill to raise the elevation of the building pads. The soil was classified alluvial and was subject to occasional saturation by water. Therefore fill with a high clay content, capable of being compacted to at least 95 percent of density, was required. Core samples of the soil were taken to confirm that the soil met existing federal regulations governing construction. At the time that this project was being conceived, Soils and Conservation Districts were in the process of being established in Pennsylania. The purpose of these districts is to control and minimize soil erosion and siltation, which occur when soil with vegetation is turned and disturbed. When rainfall washes onto this soil, the topsoil is washed away into lower stream beds creating erosion and eventual flooding problems downstream. It was necessary, even in the absence of soil and conservation districts, to pay particular attention to this problem because of the environmentally sensitive area involved. Although the property was bounded by two bodies of water, it was impossible to give every apartment a view of the river or canal. Two of the front buildings faced the Delaware River and were rented as soon as construction began. A club house, swimming pools, and two tennis courts were included for recreation purposes. They were unshaded most of the day to satisfy the needs of sun worshippers. The wind presented little or no problem, since the area was shielded on the south by a railroad trestle, on the west by a forested area, and on the north by an existing single-family development. Because there was a railroad nearby, an engineering firm was retained to conduct a noise decibel study while railroad trains crossed the trestle bridge. It was concluded that the noise level was within tolerable limits. This concluded the environmental resources study, and despite the concerns over the flood plain we were sufficiently encouraged to proceed with the next step. Utilities A private water company which operated under contract with adjoining municipalities drew water from the Delaware River, treated it, and made it available for consumption for domestic and fire-fighting purposes. A meeting

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with the Executive Director of this organization confirmed that adequate supplies were available and that the location of the nearest water main was about 1000 feet from the border of the property. Sewage treatment plants are generally constructed by a regional or township authority with the ability to float bonds and borrow money to build plants. The sewage in Yardley was treated by the Morrisville-Yardley Sewer Authority. A meeting was held with the Board of Directors of this agency and it was learned that sufficient sewage capacity was available at that time. However, the board advised that because of current infiltration problems a moratorium might be imposed at any time unless the infiltration source was discovered and corrected. This was noted as a potential problem. Next, the availability of energy sources for heating, cooking, and air conditioning was investigated. Electric and gas were available from Philadelphia Electric. Oil was also considered as a fuel for heating, so there was a wide range of choices. Gas was chosen for heating, to be supplied and paid for by the owners of the apartment complex. Electricity was used for air conditioning, cooking, and lighting, and was metered directly to the tenants. The upfront costs of equipment and installation which accompanies fuel must be weighed against the operating costs, which may vary from region to region. Telephone lines were installed by Bell Telephone Company, with two outlets in each apartment. At that time Bell Telephone was still part of AT&T. Adequate solid waste disposal facilities were found to be available. Regional Inventory The property was bordered on the east by the Delaware River and on the west by the Pennsylvania Canal. The southern boundary consisted of a railroad trestle bridge crossing the Delaware River. Beyond the bridge was a vacant parcel zoned for low density development. On the northern boundary was a row of single-family, detached homes fronting on a public street. The borough center, convenient shops, and the Yardley railroad station were located within walking distance. In sum, the uses of the property were compatible with the adjoining property uses. Next the names of all adjoining property owners were reviewed with the sellers to learn which owners would be dissidents and which would be allies. All in all, this land was beginning to look like a winner. There were major road arteries and shopping centers nearby, good schools, professional police and fire departments, first class hospitals within 15 minutes, a railroad station going north to Princeton and south to Philadelphia within ten minutes walking distance, compatible adjoining land uses, and a municipality that, while not overjoyed with the project, was cooperative as long as the rules and reg-

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ulations were followed. Beyond those advantages, it was clear that the immediate area was poised for tremendous growth. Government Regulations It was apparent by the past public action of elected officials that they were not enthusiastic about development in general and apartment complexes in particular. Therefore very close attention was paid to assure all regulations were followed and all permits were properly filled out. Because of the environmentally sensitive location of the land, the onerous approval process required four years, during which the following fortythree agencies advised, directed, delayed, regulated, counseled, assisted, and hindered the project: Lower Makefield Planning Commission, Lower Makefield Supervisors, Lower Makefield Park and Recreation Board, Lower Makefield Zoning Hearing Board, Lower Makefield Sewer Authority, Lower Makefield Fire Department, Lower Makefield Solicitor, Yardley Borough Council, Yardley Sewer Authority, Yardley Borough Engineers, Yardley Solicitor, Morrisville Regional Sewer Authority, Taxpayers Association of Letchworth Avenue, Bucks County Planning Commission, Bucks County Tax Assessors, Bucks County Recorder of Deeds, Bucks County Conservancy, Bucks County Prothonotary, Bucks County Health Department, Bucks County Historic Properties Section, Delaware River Basin Commission, Pennsylvania Soil Conservation District, Delaware Valley Regional Planning Commission, Pennsylania Department of Environmental Resources, Pennsylvania Department of Dams and Encroachments, Pennsylvania Housing Finance Agency, Pennsylvania State Department of Geology, Pennsylvania State Park Commission, Pennsylvania Department of Community Affairs, Pennsylvania Department of State, Pennsylvania Department of Transportation, Federal Insurance Administration, Environmental Protection Agency, Conrail, Department of Housing and Urban Development (HUD) Equal Employment Opportunities Section, HUD Fair Housing Section, HUD Environmental Impact Section, HUD Labor Relations Section, U.S. Department of Labor, Army Corps of Engineers, Federal National Mortgage Association, and the U.S. House of Representatives. Obviously, this was not a typical approval process, which normally takes six to nine months. It should also be noted that this project was conceived in 1973 and constructed between 1976 and 1978. Under current rules and regulations construction in the flood plain would be prohibited by both federal and Pennsylvania environmental laws. The township zoning and subdivison regulations were examined to determine the percentage of land permitted for buildings and for impervious sur-

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face coverage. Most zoning and subdivision regulations require minimum amounts of land to be left as open space. In this case, the land fronting the Delaware River and the Canal, the retention basin, and the spacing of the buildings provided adequate open space to conform with the township zoning and subdivision regulations. The Development Decision With the property inventory, environmental analysis, availability of utilities, and the regional inventory all being positive, we went ahead in spite of the onerous government regulations and approval process. The market analysis indicated the project had excellent prospects for success. The project, which was named “Belmondo on the Delaware,” is located in Yardley in Lower Makefield Township, which has always been considered an upper-middle class community. Development demand for single-family, detached homes in the neighborhood had been rising since 1965. In 1973 there were no major apartment complexes in the area. The absence of apartments was certainly not due to lack of demand, however, since it was apparent that moderate-priced apartments would be popular and the community was desirable. It came time to negotiate the price and conditions. Most people suffer from the impression that negotiation is an art that requires the wisdom of Solomon, the political skills of Machiavelli, the oratorical skills of Rev. Billy Graham, and the bland mask of a poker player. Dozens of books have been written on the subject depicting negotiating as a subtle skill that once acquired insures future success in all matters, including career, love, marriage, and parenting. That of course is nonsense, but you will fare far better in the development business if you become a student of the art of negotiating, which ultimately involves becoming a student of the human condition. Any endeavor which seeks to change one person’s view to another person’s view involves a combined social and emotional process. Simply stated, negotiation is the communication to another person of what you want from them and what you are prepared to do for them in return. It sounds simple and it is, if at the outset you recognize that the entire matter is one of give and take. The seller made it clear that the price was not negotiable. This was not an obstacle, since the asking price was reasonable and comparable to prices in adjoining communities. There was a great deal of negotiation regarding the settlement date. The seller insisted on a date one year from the signing of the agreement, with two six-month extensions. At that time, there was no way of knowing the process would take nearly four years, but we were cautious about committing to an outright purchase without approvals in hand. Finally, it was agreed to pro-rate increases in price if the settlement did not take place with-

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in two years. The price was to increase every six months beyond the two year period, but in no event was the settlement to take place later than four years from the date of the signing of the agreement. We were satisfied because we would not be required to come up with the cash if approvals were delayed. The seller was satisfied because he was being compensated for any delays in settlement beyond the two year period. In this chapter, we have attempted to take the mystery and guesswork out of land acquisition, and apply a systematic approach which includes study, research, and legwork. When you have followed this approach four or five times, you will develop intuition that, early in the process, will eliminate the pursuit of hopeless and unfavorable parcels of land.

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Financing

I

f the Lord’s Prayer had been conceived in the real estate environment of modern-day America, the phrase “Forgive us our debts, as we forgive our debtors,” might have read, “Bless our debts and praise our debtors.” Most of us have borrowed to purchase a home, a car, furniture, a vacation, or just household items. We live in a society whose economy is fueled by credit purchasing. Development is no exception. It hinges on the ability to borrow money. Borrowing money, in fact, is the principal method of making a profit in development. Developers are concerned with two types of financing: short-term construction loans and long-term permanent mortgages. In the first part of this chapter we will introduce the basics of real estate financing. In the second part we will discuss methods of financing land acquisition and in the third part methods of financing construction, including the details of applying for a construction loan. RESIDENTIAL MORTGAGE FUNDAMENTALS Most real estate financing deals are accomplished through a mortgage loan. There are two parts to a mortgage loan: the mortgage, which pledges the property you

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are purchasing as security for the loan, and a promissory note (in some states it is known as a bond), which is the promise to repay the debt with interest. In place of mortgages, some states utilize the deed of trust, where a third party, known as the trustee, holds the title to the property until the loan is paid off. Both mortgages and deeds of trust are controlled by the law of the state in which the agreement is entered into or the state in which the property is located. Most of these documents, however, contain similar language, stating that the property is security for the loan and the borrower (known as the “mortgagor”) agrees to pay the lender (known as the “mortgagee”) the principal with interest over a stated period of time. If you do not adhere to the terms of a mortgage, you are in default. Once in default, the lender has the right to foreclose on the property. Though procedures differ from state to state, foreclosure in any state involves filing legal papers against the borrower with the county clerk to notify the public that there is an action pending on the land. A public foreclosure sale is held, and the lender receives the proceeds from the sale. Fortunately, there are legal mechanisms to allow borrowers to correct defaults, the most important of which is the right of redemption. This provision grants a borrower on property used for residential purposes the right to recover land prior to a foreclosure sale if it takes the necessary action to cure the default. The borrower can still recover land sold at a foreclosure sale by paying the foreclosure price and any incidental costs within a fixed period of time after the foreclosure sale. Residential Mortgages There are four mortgages in residential development: FHA, VA, conventional, and construction. The first three are available to the buyer of your housing. The fourth, a construction loan, is a loan made specifically to engage in construction and is discussed later in this chapter. FHA and VA mortgages In the previous chapter we discussed the creation of the Federal Housing Administration (FHA) during the Depression in 1934 and the subsequent creation of the FHA-insured mortgage. Under this arrangement, the borrower pays a fee that is 0.5% of the unpaid balance to the FHA to insure those lending the money to your home buyers against any losses on the loan. FHAinsured loans are insured only to a certain value; however, the amount varies from region to region. The Veterans Administration, under an act passed in 1944, will guarantee a loan to a veteran up to a certain percentage of the loan. FHA and VA insured mortgages have a number of advantages that make them attractive to buyers, principally a long repayment period (20-30 years) and small

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down payments, typically three to five percent. However, there are several disadvantages for both the buyer and the developer, including long waiting periods while the loan is processed and much red tape. The advantage of small down payments has been eroded in recent years by the advent of Private Mortgage Insurance (PMI), which permits borrowers of conventional mortgages to place down payments as small as FHA and VA loans. Today, only about 15 percent of all residential mortgages involve FHA-insured and VA guaranteed mortgages. Developers seek FHA and VA approval for their site when the sale price is at or below the FHA-VA lending limitations and the buyer may not qualify for a conventional mortgage. Conventional mortgages Conventional mortgages are the most common form of real estate financing in the United States. They are usually obtained from a savings and loan association, commercial bank, or mortgage bank, and are neither insured nor guaranteed by the government. Many conventional mortgages are covered by private mortgage insurance (PMI) issued by companies such as the Mortgage Guarantee Insurance Company (MGIC) and the Investors Mortgage Insurance Company (IMIC). Many lenders require PMI when down payments are less than 20% of the value of the property. The Secondary Mortgage Market There are two marketplaces for residential mortgages in the United States: the primary and the secondary market. Lenders in the primary market receive the original loan application, analyze it, and issue the loan commitment. These include savings and loan associations, commercial banks, and mortgage banks. Most primary lenders, however, do not hold onto the loans they make but sell them in the secondary market. The secondary market provides liquidity for the original lender, and a source of additional funds to make more loans. Most buyers in the secondary market are large institutional investors such as pension funds and insurance companies. Several federal agencies facilitate this market by purchasing blocks of loans in the primary mortgage market and selling them to investors. The investors can buy whole mortgage loans, ownership shares in a group of loans (known as “participations”), or mortgage-backed securities (securities backed by a pool of mortgages). The three principal agencies in the secondary mortgage market are the Federal National Mortgage Association (FNMA or “Fannie Mae”), the Government National Mortgage Association (GNMA or “Ginnie Mae”), and the Federal Home Loan Mortgage Corporation (FHLMC or “Freddie Mac”).

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Fannie Mae was established by Congress in 1938 as a secondary market specifically for residential loans. It became a privately owned corporation in 1968. It buys and sells conventional, FHA, and VA loans. Today Fannie Mae buys about one in every eight mortgages issued in the United States. Fannie Mae guarantees that timely principal and interest payments will be made to the holder of its securities. Ginnie Mae is a federal agency under the Department of Housing and Urban Development (HUD) that was created in 1968 after Fannie Mae became a privately owned company. Unlike Fannie Mae, Ginnie Mae does not issue its own mortgage-backed securities but rather guarantees mortgagebacked securities backed only by FHA-insured and VA guaranteed mortgages. Ginnie Mae securities are issued by some 1,200 approved issuers nationwide, most of whom are mortgage banking firms, savings institutions, or commercial banks. Because Ginnie Mae guarantees timely principal and interest payments, its securities offer a relatively safe investment with good yields. Freddie Mac was created in 1970, primarily as a secondary market for the savings and loan industry. It is a part of the Federal Home Loan Bank System. It operates similar to Fannie Mae but deals mostly in the conventional mortgage market, providing two basic services: buying mortgages from lenders and then repackaging pools of these mortgages to sell to investors. The securities are backed by Freddie Mac’s guarantee. The secondary market has become an essential part of the home mortgage financing business because it enables investors to sell loans for cash, which they then use to make new loans. The pattern looks like this: 1. A lender sells its loan to a secondary market, which may include private groups, the agencies discussed above, security dealers, or mortgagebroker dealers. 2. In return, the lender receives cash (or, sometimes, securities). 3. The secondary market participant may sell the loan for cash, or may repackage the loan as a security and sell the security to an investor. 4. With the money received from sale of the loan, the secondary market participant can then buy more loans from the original lender. To insure the quality of the loans, both Fannie Mae and Freddie Mac require that certain conditions be met before issuing a commitment to buy the loan. For example, Fannie Mae has an upper limit to the amount of a mortgage, currently $168,700 for a single family house, and requires a down payment of at

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least five percent. Fannie Mae also recommends that lenders restrict principal and interest payments for the loan to no more than 28 percent of the borrower’s monthly income and for all debt to no more than 36 percent of income. Freddie Mac has similar requirements. These Fannie Mae and Freddie Mac requirements have become a standard part of any application to borrow money to purchase a house in the United States. The guarantees and relatively good yields of the securities offered by the secondary market has created a lively market for these instruments, especially among institutional investors such as insurance companies and pension funds. These securities have brought new money into the mortgage market, made it easier to buy and sell mortgages, and reduced exposure to interest rate risk by allowing lenders to sell off old loans rapidly while adjusting interest rates for new ones. This means it is easier for developers’ customers to get money to buy their products. Financing Land Acquisition As discussed in Chapter One, there are four main players in real estate development: speculators, subdividers, land developers, and builders. Land speculators buy raw land and hope it appreciates in value. Land subdividers obtain zoning and subdivision approvals and sell the improved land to land developers or builders. Land developers buy raw land and install infrastructure such as utilities and streets and sell the land to a builder. Builders take the project to its final conclusion. The greatest profit is realized when you take the project through all four phases. At what point should you begin to look for financing to acquire land? Most lenders of land acquisition and construction loans will not discuss a loan until you can produce evidence that you control the land in the form of an option agreement, a signed agreement of sale, or a deed naming you as the owner. Without one of these instruments, both you and the bank may be devoting a great deal of time only to discover that the seller was not serious, the purchase was made by someone else, or some unforeseen problem denied you use of the land. There are eight main methods of land financing: cash, conventional mortgage, construction loan, purchase money mortgage, installment contract, lease-option, joint venture, and assumption of an existing mortgage. Cash Paying cash is clean and simple, but it is the least desirable method of acquiring land because usually it is more profitable to borrow money than take your own cash out of circulation.

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Conventional mortgage Land speculators and subdividers frequently apply for a conventional mortgage and seek to sell the appreciated land in a short period of time to a land developer or builder. There are many who make a very handsome living doing this. The risk in providing a land acquisition loan to a speculator who has no intention of improving the land will be immediately apparent in the terms: the ratio of the amount of the loan to the value of the developed property (known as the “loan-to-value ratio”) is usually limited to 50 percent for a land acquisition loan, requiring that you put up the other half with your own money. Construction loan It is common to extend land acquisition, land development, and construction loans as a single, short-term loan. Land acquisition and land development are the riskiest part of any development effort because the road to final settlement can be long and difficult if the purchase is contingent upon obtaining financing and the necessary approval to build the project. During that period, no income comes in and the developer has large carrying costs in the form of engineering surveys, architectural and legal fees, etc. In addition, many townships now require that the developer enter into a three-way agreement between the township, the developer, and the lender to insure that the site improvement work will be done properly. By integrating the land acquisition, land development, and construction loan into one package, the lender can insure that at least it will own the land if you default. With the infrastructure installed, the land will have an increased value. Purchase money mortgage Real estate development has long been recognized as the business which gave meaning to the phrase, “other people’s money” (OPM). In a purchase money mortgage transaction (also known as “installment sale”) the seller finances the acquisition of the property. This is ideal for a buyer, since it often involves little immediate cash investment. Under this agreement, a small cash down payment is made once certain conditions are fulfilled, and the buyer receives a deed from the seller and agrees to make periodic payments with interest until the balance is paid off. The seller “takes back” the unpaid balance in the form of a note secured by a mortgage. Why would anyone enter into an agreement like this? The advantage to the buyer is that more favorable terms might be available from a private seller than from a bank. This can be very important in times of tight money. For the seller, the main advantage is to spread out payments, which may result in tax advantages. It also allows a seller greater bargaining leverage.

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The disadvantages to the seller are twofold. First, the title to the property goes to the buyer. If a default occurs the seller must go through court foreclosure to regain the title. The second disadvantage is the 1986 Tax Reform Act, which imposed conditions that may create onerous tax consequences for sellers using the installment sale method. Land installment contract A land contract is similar to a purchase money mortgage with one important difference: the seller retains title to the land. The buyer receives only possession and an equitable interest in the property. Usually the contract will provide that the buyer must pay all real estate taxes, maintain insurance, and provide upkeep on the property. Title transfers when the terms of the contract are completed. The contract requires the buyer to make regular payments to the seller, with interest on the unpaid portion. In practice, most buyers eventually are able to obtain a mortgage loan and pay off the balance of the contract or sell the contract to a new buyer. This method of financing land acquisition is used when mortgage financing is unavailable or when the buyer does not have sufficient funds for a minimum down payment on a conventional loan. However, a land contract usually is weighted heavily in favor of the seller. Because the seller retains title to the property, care must be taken to ensure that the seller does not create any new encumbrances on the title. Often a third party escrow agent holds the title and collects payments acting on behalf of both parties. Most land contracts contain a default clause which permits the seller upon default by the buyer to return all payments, evict the buyer, and declare the contract null and void. Also, many land contracts fail to contain a grace period during which the buyer may cure a default, called a redemption period. In view of these harsh terms, when do developers use land contracts? They don’t, if they can be avoided. But if mortgage financing can not be arranged a land contract may be the only way available. Lease-option In a lease-option, the buyer receives a long-term lease with an option to purchase. The option may run for the entire lease, or may end during the term of the lease. The advantage is on the developer’s side, since the rent paid is a deductible expense. Joint venture Though rare until recently, joint ventures with landowners are becoming more common. Under this type of agreement, the seller would become a partner (general or limited) in the development venture. The developer can

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defer payments until the project has a cash flow. In return, the landowner insists on an equity share which would result in larger profits than an outright sale. Assumption of an existing mortgage This is straight-forward: the buyer takes over the seller’s old mortgage and pays cash for the difference between the balance remaining on the old mortgage note and the purchase price. This is a great deal when interest rates are high and the old mortgage note has a lower interest rate, but in practice most mortgage agreements contain due-on-sale clauses that forbid mortgage transfers without the approval of the lender. Usually the lender is a bank and makes approval of the transfer contingent on a higher interest rate. An Example Now that you are familiar with the major instruments used in negotiation and financing land acquisition, we will examine an actual example of seller financing provided to one of the authors for a 101 condominium-townhouse development located in Bethlehem Township, Pennsylvania. In March of 1984 the seller approached the buyer to purchase a 22 1/2 half acre site zoned for 101 condominium townhouses. Water and sewer were available at the site with municipal approvals in hand. “Construction could start in one day,” the seller stated. The site was visited and subsequently a land acquisition survey as described in the previous chapter was conducted. In favor of the site was a reasonable asking price ($5,000 per unit), available infrastructure, and the ability to start immediately. Working against the purchase was the mountain of rock on which the site was located, creating the risk of substantial costs, the fact that condominiums had never been built in Bethlehem Township and could meet with buyer resistance, and the close proximity of a major highway with the accompanying noise. While the property had possibilities, it also had potential problems. Judging from the length of time the parcel had been on the market, the seller realized this. After some negotiation, an option agreement was entered into. The purchase price would be $5,000 per unit, or $505,000 for the total project. The project would be phased in over ten sections, each consisting of seven to 13 units. At the start of each section payment of 50 percent of the sale price, or $2,500 for each unit in that section, was required. Title would transfer upon payment. The first section consisted of seven units, for a payment to the seller of $17,500. The balance of $2,500 per unit was paid at the settlement of each unit. The second payment of

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$2,500 was secured by liens against the property which were subordinated to a construction loan. The developer was under no obligation to complete the project if sales were not successful. If the project was not completed in four years, the buyer had the option of paying an additional $50,000 for the land or walking away. The seller was obligated to pay all real estate taxes, insurance costs, and maintenance expenses for all portions of the land not under construction. The seller was a site work contractor, and as part of the agreement was given the site improvement contract (for roads, sewers, etc.) at a fixed cost of $2,000 per unit, about the fair market price. An innovative real estate deal was thus concluded that satisfied the needs of both the buyer and seller. The seller was satisfied because it took a hardto-sell property off the market. The developer was satisfied because the property represented good profit potential with low cash investment and low risk. The project was completed in less than three years with no insurmountable problems and was very successful. There are three important points to note about this deal. First, it was an example of an option agreement with an option exercised at each phase of the project. Second, it was an example of seller-financed land acquisition in the form of a purchase money mortgage. Third, while opportunities such as this are unusual, they do exist and can be found if you are persistent. Fourteen different properties were evaluated before this one was selected by the developer. FINANCING CONSTRUCTION A construction loan is the most important loan for developers. FHA, VA, and conventional loans are applied for by buyers of improved residential property, but the developer is concerned with where to obtain financing to build the project. The construction loan is usually obtained from a commercial bank, a savings and loan association, or a savings bank, although large residential projects (as well as commercial and industrial projects), can be financed by other sources such as insurance companies. Construction loans run for a specific period of time, usually nine to 12 months for residential and 18 to 36 months for commercial, or until the construction is completed. The developer receives periodic payments from the lender, known as “draws,” at each stage of construction. The lender inspects the site and if it passes inspection permits the developer to make a draw for the next stage of construction. A construction loan is only a temporary form of financing; at the end of construction a permanent form must be arranged.

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Sources of Construction Financing Commercial banks The 14,000 commercial banks in the United States supply more than half of all construction loans in the United States. Some of these commercial banks are large, regional banks that deal primarily with businesses, while others are local banks that cater to individuals. All federally chartered commercial banks are subject to limitations on the amount they can lend and the percentage of their assets that they can invest in real estate loans. Construction loans are ideal for commercial banks. They prefer to maintain a high degree of liquidity, since much of their assets are in the form of short-term checking rather than long-term savings accounts. Short-term construction loans enable them to get their money back reasonably fast and thus maintain a high degree of liquidity. Savings and loan associations Savings and loan associations are the largest source of residential mortgages and the second-largest source of construction loans. The first building association was formed in Philadelphia in 1831. They offer their members liquidity, safety, and a source of funds to other members seeking financing for homes. Their financial security was often shaky, however, until the creation of the Federal Home Loan Bank (FHLB) in 1932. The purpose of the FHLB was to federally charter savings and loan associations, set mandatory reserve requirements for all members, and provide a continuing source of funds to member associations in the event of an emergency or to make additional loans. As an additional measure of security for depositors, the Federal Savings and Loan Insurance Corporation (FSLIC) was established in 1934 as a branch of the FHLB to provide limited insurance on all accounts deposited in federally chartered savings and loan associations. The FSLIC acts for federally chartered savings and loans in the same capacity as the Federal Deposit Insurance Corporation (FDIC) acts for federally chartered commercial banks—to insure all accounts up to $100,000. Deregulation in the early 1980s led to the collapse of many savings and loan associations because of over expansion; however, they are still an important part of the construction industry. About half of the 4,000 savings and loan associations in the United States are federally chartered; the other half are chartered and insured by their respective states. Most state-chartered associations are also members of the FHLB system. Originally, most savings and loan associations were owned mutually by their investors; in recent years, however, many have shifted to stock ownership.

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The role of a savings and loan association in construction depends on the size of the association, the geographic area served, and the size of the project. Some savings and loan associations directly invest in construction through subsidiaries designed to invest in development activities. They offer developers financing in return for equity participation in the project. Savings banks Savings banks are the oldest savings institution in the United States. They began in 1816 simultaneously in Boston and Philadelphia. Savings banks differ from savings and loan associations in that they can invest in ventures other than real estate. In recent years, however, the distinctions between the two institutions have lessened. Savings banks are state chartered and most are mutually owned by their depositors. In recent years, however, a number have switched to stock ownership. They operate principally in Massachusets, New York, and Connecticut. They are a very active source of residential and construction loans. Mortgage banking companies Mortgage banking companies act as middlemen in the real estate financing market by bringing together borrowers and investors. They began in the 1800s when a credit surplus developed in cities in the eastern United States. Organizations with a credit surplus (principally insurance companies and savings banks) began making investments in real estate in the western United States, where there was a large demand for credit to buy land and start new businesses. Their lenders, located in the east and without a knowledge of the real estate market in the west, needed someone to know local market conditions, originate the loan, and forward payments to the original lender. Out of this need the mortgage banker was born. They were local people who obtained a commitment from an eastern lender to purchase a certain block of loans under agreed upon conditions. They then borrowed money from a local bank to give the loans. Once the deals were made, they sold the loans to the eastern lenders, paid off their bank loans, and collected a commission. Today, there are 800 to 1,000 mortgage banks operating throughout the United States, though they are still strongest in the western and southern United States. They seek out large investors (principally insurance companies and pension funds) and they may also seek investors for specific real estate ventures. They make their profit by charging origination fees (usually in the one to three percent range), which cover the expenses of evaluating and documenting the loan for the lender, and by charging service fees (usually 0.25 to 0.5 percent) for collecting the payments and handling other administrative matters related to the loan. Mortgage banks generally invest their funds only

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on a temporary basis, usually 90-120 days, and then sell off the loan to acquire new capital. Mortgage brokers Mortgage brokers act in a manner similar to mortgage banks, however there are important differences. Mortgage brokers are strictly middlemen; they bring borrowers and lenders together but do not lend money. The broker’s involvement in the deal ends when the deal is made, whereas mortgage bankers may be involved for many years servicing the loan. Life insurance companies Life insurance companies are always seeking profitable investments for premium income. Since claims have been high for insurance companies in the past several years, premium income has declined, making investment income of even greater importance for them. Life insurance companies fund many of the major commercial real estate projects in the United States. Often, they loan directly to developers with some form of equity participation in the project as a condition of granting the loan. They also lend money through mortgage banking companies which act as intermediaries in originating and servicing the loan for a fee. Finally, they purchase large blocks of loans as an investment in the secondary mortgage market. Real estate investment trusts (REITs) REITs are to real estate what mutual funds are to stocks and bonds. They are organizations that buy real estate for individual investors. REITS are usually owned by a bank, insurance company, or other large investor. When you buy a part ownership in a REIT, you do not actually buy real estate, but ownership in the trust itself. REITs can be organized as partnerships, corporations, or business trusts. There are three main types of REITs: 1. Equity REITs buy equity in developed property (shopping centers, apartment houses, etc.), and then manage it on behalf of the owners of the trust. 2. Mortgage REITs lend money for real estate ventures. One form of the mortgage REIT is the construction REIT, which lends money specifically for construction ventures. 3. Hybrid REITs combine the features of both equity REITs and mortgage REITs. They are designed to be very flexible and to allow the managers of the trust to buy and lend as the needs of the market dictate.

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REITs, particularly construction REITs, were very popular in the 1960s and early 1970s. In addition to good returns on investment, REITs had high liquidity. Unfortunately, when the economy slowed in 1974 many developers defaulted on REIT construction loans and many REITs went under. The popularity of REITs plummeted and they have only recently made a comeback. Because of the bad experiences with construction REITs, the majority of REITs today are equity or hybrid REITs. Few REITs lend money for construction. However, REITs are an attractive alternative for those seeking to add some form of real estate investment to their portfolio. Pension funds Pension funds have only recently gone into real estate development financing. Most pension funds will only consider working with very large, wellknown developers on big projects, so they are not a source of money for small developers. However, because they have so much money at their disposal, even a small percentage of their total assets can amount to billions of additional dollars in capital for the development business. As pension funds acquire more experience in real estate development financing, they may utilize a wider group of developers. Credit unions The first credit union was formed in 1909; there are now over 20,000 in existence. They are owned by their members. Most require that you meet certain standards to become a member, the most important of which is occupation. Most of the assets of credit unions are in consumer loans to members. They do not have a great impact in the real estate market. Credit companies Credit companies are owned by major corporations that use their credit corporation to diversify their assets. Like pension funds, credit companies are almost invariably involved in large projects. Equity participation Traditionally, most development was financed by means of “debt financing.” In debt financing, you borrow money, and pay it back with interest. Many lenders now seek equity participation, where your lender shares profits with you. Insurance companies, for example, frequently finance development ventures and in return receive equity participation. There are several ways of raising equity capital. Two examples are the joint venture and syndication. A joint venture is a group of people or companies who join for the purpose of building one particular project. It’s purpose is to

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allow all the parties to share the risk and profit of the venture. It is not an ongoing enterprise; once the project is completed, the joint venture ends. A joint venture can take several forms, including a general or limited partnership, corporation, real estate investment trust, or tenancy in common. The most common arrangement is for each partner to form a new corporation to act as a general partner in the joint venture. The rules for making decisions are spelled out in the Joint Venture Agreement, which describes the form of the venture, how it is managed, how the project is to be constructed, how money is to be raised and spent, and other issues. In a syndicate, investors pool their capital to invest in real estate ventures. Each member has a share in the project. With the aid of an experienced attorney, you can arrange your own syndication deal, although most developers use professional syndicators. Professional syndication deals can work in one of two ways: the syndicator can buy shares in the syndicate directly from you and then sell them to investors, or the syndication can act as a middleman on a fee basis. The method you choose will depend on how you want to relate to your project. Obtaining a Construction Loan Where to start Typically, you will approach a lending institution for a combination land acquisition, land development, and construction loan some time after an option or agreement of sale is signed but before all the necessary government approvals have been obtained. Most of the components of the land acquisition study discussed in the previous chapter should be completed before approaching a lender, since you must know the project is worth pursuing before asking for a loan. It is the business of banks, mortgage companies, brokers, savings and loan associations, insurance companies, and private lenders to lend money. In other words, you are in demand as a borrower. However, the lender must be convinced you are capable of repaying the loan with interest, by assuring that you have sufficient collateral in the form of real estate and other personal and business assets to repay the loan if something goes wrong. The first rule of good borrowing is know where to ask for a proper loan. More than 75 percent of all construction loans are made by savings and loan associations and commercial banks (see Table 5.1). Savings and loan associations are particularly active in the single-family market, where they often provide combination construction loans and permanent financing loans. Commercial banks are usually the source of larger residential construction loans. Savings banks and mortgage bankers are also involved in the construction loan business, though to a lesser extent. Insurance companies are involved in large

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commerical projects. You will probably be applying to a commercial bank, savings and loan association, savings bank, or mortgage banker. The second rule of good borrowing is start where you are known. Your local source of banking, whether a savings and loan association or commercial bank, will have a thorough look at your personal and business checking accounts, money market savings accounts, auto loans, mortgage loans, personal loans, and other financial activities. It is helpful if they have this information from earlier dealings with you. In some cases, earlier dealings may be a prerequisite to obtaining a loan at all, since many lending institutions give preference to those who bank at the institution. A good banking record and relationship will not guarantee a real estate loan, but it will get you past first base. Table 5.1 Sources of Construction Loans in 1986 (Percent of Respondents)

The construction loan presentation The third rule of good borrowing is make sure you have all the facts the lender will need to evaluate your proposal, and that your request is arranged in a professional fashion. Your lender is interested in two things: that you (and any partners) have the character, ability and financial support to finish the project, and that your project will make money. Figure 5.1 is a checklist of information required for a construction loan presentation.

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Most lending institutions will begin with a personal interview to get your name, address, educational background, professional and business background, experience, other projects you have done, your prior relationship with the lending institution, and the type and amount of loan that you require. The loan officer will discuss the bank’s lending policy and give you a general idea whether the lender is interested in your proposal. After the interview, you will be required to file a detailed financial statement which will list your assets, liabilities, sources of income, and other personal information. You may also be required to make available tax returns and financial statements prepared by an accountant, often for the previous three years. The lender is seeking to establish your net worth to see that you have sufficient liquid assets for the project. Of course, that is why you are going for a loan in the first place, but very few lending institutions will make a 100 percent loan commitment—most require some of your cash in the project to keep your interest in the project as high as possible. In fact, for most construction loans the loan-to-value ratio is about 75 percent. Many lending institutions require you to make that 25 percent cash investment up front by paying for all or part of the land acquisition and approval process, which is the riskiest part of the project. Another reason lending institutions want to know your net worth is to identify assets that can be encumbered in the event something goes wrong. The bank will do everything it can to make sure that it will be able to recover the cost of the loan, with interest, in the event of a default. You can also be sure that the lender will check your credit rating. Even in large cities the real estate lending community is relatively small, so your credit rating is not difficult to check if you have taken out other loans. If you or any of your partners have been involved in previous development ventures, you can be sure that the lender will seek permission to speak with subcontractors you have used and make sure they were paid. The lender may also utilize private credit agencies. The bottom line is that the lender will be seeking to establish whether you have a good reputation with other lenders, suppliers, subcontractors, lawyers, accountants, and others whom you have done business with. Any partners or investors will also be required to disclose information concerning their role in the project, the amount and nature of any contributions they make, and personal financial information. The lending institution will also be taking a close look at the caliber of professional advisors you will be using for the project, including your attorney, accountant, architect, general contractor, and subcontractors. Finally, they will want to know exactly how much you want to borrow, when you will need it, and when you will pay it back. Do not be surprised if

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Figure 5.1 Checklist of information required for a loan presentation

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the lending institution seeks some form of equity participation in the project, a common practice these days. For example, your lender may offer you an attractive package consisting of 100 percent financing and a low interest rate in return for some form of equity in the project. Next, your lender will want details about your project. They will look for a general description, including the type, location, preliminary plans, zoning information, municipal requirements, utilities, etc. Much of the information will have been gathered in your land acquisition survey. Your lender will also want to know about the buildings, including the materials that will be used in the construction, information on the type of financing to be used to sell the houses (conventional, FHA/VA, etc.), and the form of ownership. Finally, they will be looking for detailed financial information on your project. They will be looking carefully at factors that will affect the ability of the project to be completed on time and to make money once it is completed. This information falls into two principle parts: cash flow projection and cost analysis. Cash flow projections show the bank where you are getting your money (principally, it will be your own, your lender’s, and the money from sale of the units) and what you will be doing with that money. The lender’s main concern is that you will have sufficient liquidity to meet your obligations through the life of the project. Figure 5.2 is a typical cash flow form for development. Cost analysis will break down the component costs for each unit—construction, land, financing, sales, and profit by unit. Figure 5.3 shows a cost analysis. Financial information is usually requested by project phase. Phasing is a construction and financing method whereby your job is built in sections or phases. For example, if you are putting up a 120-unit job, you may do the project in three phases of 40-units each. Phasing allows you to regulate the pace of construction based on sales, because you can complete and sell portion of the project quicker than you can finish the whole project. Your lender to see money paid back earlier. Also, it will allow you and your lender to see the real (as opposed to project) sales potential of your project. If no one buys the first phase of housing, you can either stop construction or fire-tune the unbuilt units to appeal to a different market. To increase your chances of having your application approved, follow the fourth law of good borrowing—do your homework. Have a plan that is buildable and costs that are correct. Know the market you are building in and the type of building that it can support. Put yourself in place of the consumer who is going to buy the house. One of the biggest mistakes developers make is to build designs and styles they do not believe in. “Personally, I don’t like the design or the location, but I am certain there’s a market for it,” is a line that

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Figure 5.2 Projected cash flow form

Figure 5.2 Projected cash flow form (continued)

Figure 5.3 Cost Analysis

Figure 5.3 Cost Analysis (continued)

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Figure 5.3 Cost Analysis (continued) will give any lender pause. Doing your homework also means having a competent professional team of subcontractors, lawyers, engineers, etc. The fifth rule of good borrowing is be conservative. This is especially important when you make estimates on matters such as construction time, financing, and income from your project. Remember that construction financing is considered a risky endeavor, so most lending institutions will base their estimates on previous loans and will add their own “fudge factor” to the equation. The more conservative your figures, the more likely you will obtain financing. A conservative approval will increase the bank’s respect for your figures and will greatly reduce the chance that you will have to go back to the lender for more money. Many builders, especially those involved in large projects, will opt to produce financing models depicting pessimistic, realistic, and optimistic scenarios based on the most variable and volatile factors: interest rates and sell-

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ing period. Builders in business during the 1972-1975 period when the prime interest rate varied from seven to 12 percent, or 19801981, when the rate soared from ten to 21 percent, recognize the need for producing variable financial models. Higher interest rates produce a double whammy for developers: increased costs and decreased sales. If the selling period is extended, from one year to two years for example, overhead and carrying costs increase expenses and decrease profit. Producing variable analysis, at least for yourself, will enhance your chances for success by anticipating and planning for economic downturns. When it comes time to sit down with your lender, stick closely to the sixth rule of good lending—do not underestimate your lender. One vice-president at a commercial bank confided to us that one of the biggest mistakes borrowers make is to try to bull their way through a deal with the bank and assume that everyone in the room is a dummy. The same banker also told us that borrowers often have a misperception of the market place and their own ability to handle a project. Do not walk into a lender’s office expecting 100 percent financing, special deals, or any enthusiasm about lending to a project that creates a new level of housing in a market that will not support it. Surety agreement Although a construction loan is secured by real estate, most lenders will require that you sign a surety agreement as additional protection, especially if you are relatively new to the development business. This is the lender’s polite way of telling you that if things do not go as planned, the bank will look beyond the value of the real estate to guarantee the loan. If you do not fulfill your contract, the surety agreement will act as a personal guarantee for the lender, using practically every unencumbered asset you own as collateral for the loan. The settlement A lender accepts a loan by issuing a loan commitment, which outlines the obligations of the borrower and the lender. Figure 5.4 is a loan commitment to build a two story house. At the settlement, you receive title or an equitable interest in the property, the financing papers are signed, and an agreement is usually executed with the township or local community that will require you to complete all infrastructure in comformity with existing regulations. Assuming that all necessary approvals have been received, you can then begin the infrastructure development. Most lenders advance money in a construction loan transaction in stages, known as “draws,” as work on the project progresses. To make sure that the stages are properly completed, an officer of the lending institution inspects the job at least every month and often

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every two weeks. The municipality’s engineer will also be by to ensure that the work conforms to code. Any changes in plans must be approved by the construction lender. LONG-TERM FINANCING Construction loans are a form of temporary financing. Once the job is completed, the lender will want to be repaid the loan with interest. Most lenders require that some form of long-term financing be arranged as a condition of granting a construction loan. In residential sales, you will sell homes to a buyer as they are completed, and your lender will be paid out of the revenues from the sale of the homes. To ensure that a bank is paid, it often seeks accelerated payback on the loan. Under an accelerated payback, you are required to repay more than 100 percent of the cost of the loan for each unit in the early phases of the project.

Figure 5.4 A typical loan commitment letter

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Figure 5.4 A typical loan commitment letter (continued)

Figure 5.4 A typical loan commitment letter (continued)

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By forcing you to pay, say, 115 percent of the cost early on, the lender ensures that it gets all its money early and that you don’t start making a profit until the project is near completion. Lenders argue that this protects their position and ensures that you build equity in the project, thus increasing the chances that you will complete the job. If your project involves leasing instead of selling (as is the case with apartment houses, shopping centers, etc.) then you must obtain a long-term lender that will “take out” the shortterm construction loan. You can then pay off the long-term loan from the cash flow from the project. Where you obtain long-term financing will depend on a number of factors. Local community banks and thrift institutions may be able to finance both construction and long-term financing if the size of your development is not large. For larger projects, you many have to approach a large commercial bank for construction financing and a savings institution or insurance company for long-term financing. It is not uncommon to have difficulty arranging long-term financing. Often interest rate fluctuations make it undesirable to obtain long-term financing. In situations like these, developers often arrange for interim financing, which are loans of about five years, serving as a middle-ground between construction financing and long-term financing. REAL ESTATE DEVELOPMENT PARTNERSHIPS What if you or a group of partners want to go into development but have never been in the business before? Will a lending institution finance a thoughtful development venture from people who have never been in the business before? Most lending institutions require that at least one of the partners in the project have experience in development before they will grant a loan. Lending is still a people business and the lender will want to do business with people whom they feel will be able to start and finish the project. Here experience is the best guide the lender has. However, “experience in development” does not mean that you have to be a developer. Often, a newcomer in development is a construction superintendent who has gathered a group of investors together and approached a lending institution. Providing the partners have sufficient assets and sureties to cover the loan and the plan is feasible, the chances are good that the lender will approve such a plan and make the loan. What if no one has had any prior experience in development? The chance that a lender would approve a loan under those conditions is not great. However, if you were known to the bank, could offer ironclad guarantees that you (and any of your partners) had sufficient liquid assets to cover the loan in

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the event that something went wrong, and were able to obtain a surety to that effect, you have a chance at the loan. You can be sure, however, that the lender will look carefully to make sure your general contractor has the experience and reputation to do the job. They may also require that the general contractor be bonded. A bond will guarantee that if the general contractor defaults, the bonding company will complete the terms of the contract between the developer and the contractor. Behind every successful developer lies a willing lender. Cultivating these relationships and conducting your business in a manner that will inspire lender confidence will ensure available funds for future projects.

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6

Retaining the Professional Team

O

ne of the least understood and most overlooked parts of the development process is the method used to retain the professionals required to successfully start and complete a project. This chapter will deal with the contractual and interpersonal relationships with the members of the professional team. In the course of even a small project you may deal with more than a dozen professional consultants, including lawyers, accountants, insurance brokers, title examiners, appraisers, surveyors, land planners, architects, and a host of different engineers. You must be aware of the functions and responsibilities of each professional. Learning to communicate with professionals is easy once you master the basics. The first step is to hire people that you have faith in. You can then be reasonably sure they will perform their jobs properly and be responsive to your input. FINDING PROFESSIONALS Most developers find the professionals they need in one of four ways: 1) recommendations from a friend or family member; 2) recommendations from

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professionals in related fields; 3) advertisements in public directories, 4) referrals from trade associations and professional societies such as the American Institute of Architects (AIA). The word recommendation should be emphasized. There is a big difference between obtaining a name from a friend and getting a recommendation. A name means your friend knows a professional you can use for your project; a recommendation means your friend knows the product of the professional and respects it enough to make a recommendation. The emphasis is on familiarity with the product, not on friendship. Trade associations and professional societies are good sources for professionals. Most professionals are members of at least one society or trade association. While no professional society will recommend one professional over another in the same region, most will provide lists of their members in your area. This list will provide you with a source for contacts, and will let you know how wide your choice of professionals is. You might be surprised how many architects live and work in the area in which you plan to build. Once you have checked your sources, you will have developed a short list of potential professionals in each of the fields you require. THE INITIAL INTERVIEW When you make your initial call, explain that you are buying property in the area for development and would like to discuss the possibility of retaining them for the project. Ask for a resume and any information on the firm that is available, especially regarding previous projects. Specialization is the norm today, and there are consultants whose knowledge of development may be limited. Once you are in the professional’s office, be specific about what you want. Explain your vision for the project and where the professional fits into the scheme of things. Tell them what you expect (such as weekly reports) and anything that is especially important for them to know. You are evaluating each other to decide if there is going to be a professional relationship, and it is a good idea to lay your cards on the table so the professional knows what to expect. You are looking for three things: competence, experience in the type of project you are developing, and whether or not you are comfortable with the individual. Be direct about fees. While you should be concerned with costs, placing too much emphasis upon obtaining the lowest possible price can often produce the least desired results. Most professionals will understand that cost

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containment is a major concern and that you will probably be obtaining proposals from other professionals in the same field. NEGOTIATING THE CONTRACT Once you decide who you would like on your team, you can get down to contractual details. It is always to your advantage to have a written contract which will outline what you and the professional will do for, to, and with one another. Before signing any contracts you should consult with your lawyer to determine if the contract clearly outlines what you expect to achieve. A contract should specifically state what you expect the professional to do for you and how much it will cost. You should describe your financial obligations in terms that are as specific as possible. For example, you may ask a civil engineer how much it will cost for all the plan and subdivision work necessary to receive preliminary and final approvals. The proposal is a statement of what they are going to do and is known as a “scope-of-work” proposal. It should break down into sketch, preliminary, and final plans, and include the cost for each phase. Usually an hourly rate schedule for each staff member in the office is attached. At some point you should explore the minimum and maximum fees that could be incurred on the project. Most professionals are willing to provide minimum and maximum costs, in spite of the fact that time and expenses can vary from project to project. You should avoid contracts that do not have a clear beginning, middle, and end. Next, you should know when you have to pay. You should release the money in stages as the work is done, or at the end of the project. Seek some understanding about the time it will take to complete the work. Explore what, if any, assurances your consultant will give about quality, results, or means of addressing any grievances. You may receive proposals from a number of people purporting to provide the same service but written in language which is so difficult to understand that you will be unable to compare one with another. For this reason, many developers have their own scope-of-work contracts. Figure 6.1 contains a sample scope-of-work letter from an engineer. When the amount of money spent on a consultant exceeds the amount you might normally expect to pay as a salary, it might be advantageous to hire the consultant as an employee. Many larger developers have in-house accountants, lawyers, appraisers, architects, and engineers. Now let us look at the role of each member of your professional team. Later, we will come back to general principles when we discuss professional team management.

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Figure 6.1 Sample scope-of-work letter from a civil engineer

Figure 6.1 Sample scope-of-work letter from a civil engineer (continued)

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THE BUILDING PROFESSIONALS Lawyers Years ago you could knock on the door of almost any lawyer with confidence that he or she would be able to represent you in a land use application. Today, with specialization in the legal profession and the increasing complexity of development deals, choosing a lawyer at random is tantamount to inadvertently choosing a general practitioner to perform open heart surgery. Of the professionals you will be working with, your attorney is the most important. Your attorney will be involved with the other professionals in contractual issues and also will work with you on zoning matters, subdivision of the property, preparing the agreement of sale, reviewing financial documents, and preparation for settlement, including examination of title report, deed, and settlement sheet. You will therefore want to be especially careful in your choice of attorney. During the initial interview, ask how many development applications the attorney has handled. Obtain the names of the clients and call them. While the identity of a few clients may be confidential, most attorneys will be able and willing to provide names of most former clients. You also may want to call the township solicitor and ask if the town has had experience with this particular lawyer. Ask the lawyer to submit a written proposal outlining the scope of services to be provided, the hourly charge for services including a suggested minimum and maximum, and a statement specifying the desired result that you as a client can expect the lawyer to achieve. Most importantly, remember to clearly communicate what you want. The attorney’s ability to adequately assist you will be contingent upon your ability to identify and communicate your goals. Appraisers The purpose of an appraiser is to tell you the value of yours and adjoining land. Value is determined by a number of factors including demand, location, size, design, tax rates, quality of life, zoning, traffic patterns, environmental conditions, income level, and level of services. It is the job of the appraiser to evaluate all of these variables. Fortunately, there are two very good professional societies for appraisers—the Society of Real Estate Appraisers (SREA) and the American Institute of Real Estate Appraisers (AIREA), both based in Chicago. They both provide continuing education for their members and publish annual directories. They also offer their members different designations (the SREA has three, the AIREA has two) to indicate levels of attained expertise. A Senior Real Estate Analyst designation from the SREA, for example, means that the individual has at least eight years of experience appraising income producing properties,

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has passed exams promoted by the society, and is an expert in all types of real estate appraisal. A Senior Real Property Appraiser (SRPA) is similar to a Senior Analyst but has less experience with commercial and industrial property. A Senior Residential Appraiser (SRA) does only residential appraisals. Your scope-of-work agreement with an appraiser should include comparable sales figures, special conditions that the property might have, an estimated value of the proposed project, and the appraiser’s certificate of value. You should also agree on appraisal cost and a delivery date for the written report. Do not be afraid to ask for samples of previous work. Accountants Your accountant is your financial advisor. In the broadest sense, the accountant’s job is to keep and examine your business accounts, advise you on business, tax, and other financial matters, and prepare statements. Your accountant will assist you in determining if the project is financially feasible, preparing statements for presentation to your lender, monitoring the cash flow of the project as it is being built, preparing tax returns, and determining future financial goals such as depreciation and the long-term value of your project. All accountants are licensed by the state in which they do business. Accountants Who pass specific educational and state testing qualifications can be licensed to use the title Certified Public Accountant (CPA). Most CPA’s are members of the American Institute of Certified Public Accountants, which is headquartered in New York City. Insurance Brokers You need insurance to avoid being wiped out in the event of a disaster, such as a fire, flood, earthquake, theft, explosion, windstorm, or injury. All of these and more have happened to developers. Although you require insurance, you do not necessarily require an insurance broker. You can simply obtain a quote from an insurance company containing the coverage you want, and if you are especially adventurous you can even compare quotes from a number of companies. At this point, however, you will be introduced to the world of insurance contracts, where it is almost impossible to compare one bid from another and there is a big risk of choosing the wrong company or obtaining too little coverage. The insurance broker obtains competitive bids and explains the differences in coverage. Insurance brokers generally pay their way. It will be your responsibility to advise the broker of the amount of liability and property insurance you require. Liability insurance covers suits for damages brought against you by individuals who are injured while on your

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property; property insurance covers damage that is done to your property. The difference between one insurance broker and another is the quality of service they provide. Aside from obtaining competitive bids, the ultimate test of an insurance broker is the degree of attention you receive when a claim arises. It is a good idea to ask the broker what percentage of claims made are paid, when they are paid, and what percentage of claimed amount is paid by the recommended insurance company. The sale of insurance is a highly regulated business. All sellers of insurance must be registered with the state in which they do business. Many insurance brokers are members of the National Association of Insurance Brokers, based in Washington, D.C. Architects Find an architect that has a sound knowledge of design and building materials for the type of project you want to build. The American Institute of Architects, based in New York City, has over 50,000 members with nearly 300 local chapters. In the initial interview, you should describe your vision for the project. The size and style of your project (single or multi-family, apartments, etc.) will be largely determined by the results of your marketing study. Within those confines there are many styles and designs to choose from. Topography will also play a part in the final design of the buildings. In addition to giving physical shape to your building, an architect can also review the differences between grades of building material and provide an estimate of cost for each material. They also may assist you (and your attorney) in drafting a contract for your general contractor, supervising the job, and making direct reports to you. The extent of their involvement will be outlined in the scope-of-work agreement. An architect’s final plans will usually consist of three parts: 1) general conditions, which describe the plan in writing and outline the responsibilities of the parties; 2) the working drawings, which are the blueprints for the plan, consisting typically of a plot plan showing the boundaries and prominent features of the property, floor plans, and section views showing cross-sections of the construction at various parts of the building; and 3) the specifications, which provide technical details such as the type of materials that are to be used in construction. In addition to an architect for construction, you may also need to retain a landscape architect, who deals with the design of outdoor spaces, particularly the planting of trees, shrubs, and lawns. The American Society of Landscape Architects is based in Washington, D.C., and publishes an annual National Directory of Landscape Architecture Firms.

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Title Insurance Companies You need title insurance, period. You need to know that there is clear title to the parcel of ground you are buying. There are dozens of ways a title can become defective in a manner that will not be apparent by just examining the chain of title, such as mistakes in recording legal documents, forged or falsified records or wills, claims by missing heirs, and liens for unpaid taxes. Title insurance will not necessarily uncover any and all defects, but it will insure you against those defects if they arise. You do not get insurance when you or your lawyer conduct a do-it yourself title search. Unfortunately, most title companies seek to minimize their own risks by excluding as many claims as possible. Typical exclusions include unrecorded easements, last-minute liens, verbal leases, and eminent domain proceedings. You and your attorney should check which events are covered or excluded in the title insurance. Some companies will be amenable to including events that they originally excluded; others will not negotiate, as a matter of policy. You have the right to compare policies. The ultimate test of any insurance is the extent to which the company will stand behind you when you make a claim, so make sure that you choose a company that is reliable. A list of local title insurance companies is available from the American Land Title Association, which is based in Washington, D.C. The bank where you are borrowing money may recommend a title insurance company. While you should investigate these also, you are under no obligation to take the bank’s recommendation. Land Planners Architects design buildings. Engineers make them work. Landscape architects deal with the aesthetics around the buildings. So what do land planners do? They help plan the best use of your land. In most states, land planners are not required to be licensed by the state. Consequently civil engineers, architects, and landscape architects may claim to be land planners. The land planner should be able to: • Review all the data about a site and, from such a site analysis, advise you of the important opportunities and constraints of your site • Help enunciate your goals and priorities and thereby clearly establish a development program • Combine the site analysis and the development program to present you with one or more strong design concepts for the land uses and evaluate their relationships • Take the design concept and develop a submission strategy, coordinate the submission package, and present the design to those agencies and individuals from which approvals are needed.

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Surveyors The principal job of the surveyor is to accurately determine the boundaries of your property. While the seller’s legal description may suffice, you would be foolish to invest so much time and money only to find out that the boundary of your property was not where you thought it was. The cost of the land survey is usually borne by the buyer, however it may be possible to make the sale contingent on a physical survey provided by the seller. Surveyors are generally licensed by the state. Their functions often overlap those of the general civil engineer discussed below, but a surveyor is not required to have a civil engineering degree. Engineers There are at least seven major branches of engineering—civil, chemical, mining, aeronautical, electrical, mechanical, and industrial—but the average developer primarily needs the services of a civil engineer. Civil engineering can be broadly defined as the building of things that do not move, such as roads and bridges. Within the broad category of civil engineering, there are four main branches—general civil engineers, structural engineers, traffic engineers, and sanitation engineers. Developers employ general civil engineers during the land acquisition study and design phase, and land development and construction phase of the project. In the initial stage, the civil engineer draws up a boundary and topographical survey and develops alternative layouts for the project. A boundary and topographical survey determines the boundaries of the property and identifies important physical features—elevations, trees, surface water, etc. The engineer can also develop alternative layouts for the site, including the location of buildings and roads, and water, sewer, and storm water facilities. The purpose is to determine if development is feasible. Several designs are usually suggested, with a cost comparison. Once you decide development is feasible and settle on a design for the project, the engineer draws up sketch plans that you can take to the township for initial feedback. If the feedback is favorable, a preliminary plan can be developed. The procedure for developing plans for municipal approval is discussed in Chapter 7. The structural engineer is concerned with the physical integrity of the building. This professional studies all the forces that will act on your proposed building, such as weight of the structure, wind, temperature, etc., and designs beams, girders, and columns to resist those forces. The structural engineer is required to be intimately familiar with the materials used in building and their comparative strength. Structural engineers will work closely with your architect to determine the overall appearance of the building.

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Sanitary engineering applies engineering and biological principles to the air, water, food, and shelter around us to protect and promote public health. Air and water pollution, food contamination, and proper living conditions are concerns of the sanitation engineer. The sanitation engineer is used primarily to insure that there is an adequate supply of water and to determine how that water will be treated as waste water. The engineer investigates the availability of public water storage and treatment (sewer) plants, as well as on-site facilities such as artesian wells and septic systems. The latter might include elevated sand mounds if soil conditions do not support a conventional septic system. These services are often performed by a civil engineer. Traffic engineers are concerned with providing the optimum conditions for the flow of traffic, on site and in the immediate off-site vicinity. They are involved in road design, providing proper access, studying traffic conditions, and designing parking facilities, guard fences, and directional signs. Developers occasionally require geotechnical engineers, who are concerned with soil analysis, subsurface water, and other factors that may affect the structure and the design of buildings. Most residential development projects will only require the services of a general civil engineer, though this will depend on the size of the project. For example, if there is adequate water supplies and a sewer treatment plant available, the conveyance of water and sewage can be handled by the general contractor. If you need to build a sewage treatment plant, then you need a sanitation engineer. Similarly, traffic is rarely so complicated that a general civil engineer cannot lay out the roads. Nevertheless many municipalities require a traffic study as part of the approval process. Structural engineers might be needed to build a bridge, but normally the general civil engineer, in conjunction with your architect, can handle building structural integrity. The elected and appointed officials for your local municipality will require that a state-licensed civil engineer prepare the plans, reports, road profiles, and all other related documents and place a professional seal and signature on the plans to certify that the information is accurate. The municipality will have its engineer review the plans prior to approval. Usually, you will be required to pay for the services of both your engineer and the township engineer. As you might expect, the engineering profession is well organized. The American Society of Civil Engineers, which is based in New York City, has more than 100,000 members and 139 local chapters. They maintain a data base on membership and publish an annual Official Register. General Contractors and Construction Managers Someone has to build your project, and in most situations you will hire a general contractor who will retain the services of electricians, plumbers,

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carpenters, and other subcontractors. Alternatively you may act as your own general contractor and retain the services of a construction superintendent to supervise the construction. Construction management is discussed in Chapter 9. Environmental Consultants It is not unusual for the developer to encounter environmental issues on the federal, state, and municipal level that affect a project. In addition to antipollution laws governing air and water supplies, there are laws governing hazardous waste sites, wetlands, coastal zones, endangered species, and flood plains. In recent years, a new class of consultants—environmental consultants—have come into existence to steer the developer through the maze of federal, state, and municipal regulations. More on these consultants in Chapter 8. Real Estate Agents When it comes time to sell your project, you can either hire your own sales team or retain professional real estate agents. Because real estate agents work on a commission basis, it is normally to your advantage to hire professional agents. Retaining real estate professionals is discussed in Chapter 10. PROFESSIONAL TEAM MANAGEMENT It is essential to establish a working relationship with your entire professional team. You should feel comfortable with each member, feel that each understands you, and have a contract that each understands and can live up to. It is important to instill a sense of teamwork among your professional team. A certain amount of tension is unavoidable, for example between the architect and the general contractor; if outright hostility erupts it will be up to you to quell the dissent and remind everyone why they are there. The best way to deal with these problems is to address them from the beginning. If everyone clearly understands their role and responsibility, the chances of misplaced competition and foul-ups will be greatly reduced. By maintaining regular communication, you will develop a more personal relationship and will be able to closely monitor the progress of the professionals’ work. By “monitor” we do not mean to tell the professionals how to do their jobs; but you should make sure that you understand what is being done and that everything is being done on time and on budget. In other words, you must become an informed consumer. Becoming an informed consumer helps bring down some of the walls between you and the professionals. This is not a way of demeaning the profes-

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sionals, but there is too much at stake for you to act otherwise. You must be able to treat professionals in the same manner as vendors of other products. You must apply the same standards of competence and professionalism as you would, say, to a master craftsman. By becoming a hard-nosed consumer of professional services you will receive more respect, better service, and maybe a lower fee. Becoming a consumer of professional services is not as difficult as it sounds. The professional knows you have much at stake, and will be sensitive to your concerns. By becoming an informed and discriminating client, you will be demanding that the professional provide responsive service. Each of the professionals should add value to the project. Many of them will be required on your project by law, but that does not mean that you cannot evaluate their performance. Is your engineer coming up with a creative, cost-effective solution to your engineering problem? Is your accountant actively looking for ways to reduce your taxes? Is your architect keeping in close contact with the general contractor to ensure the job is built to specification? The object is not to tell the professional what to do, but to ask the right questions so you are fully informed and satisfied that you are receiving the work you contracted for. It is possible that your questions may act as a catalyst for a new approach to some aspect of the job. Be prepared to act if differences between you appear to be irreconcilable. Knowing when to fire a professional is not always easy. You must be convinced that your requests have been reasonable and that there is a pattern of not responding to your requests, or that a major mistake has been made that is directly attributable to a professional. If you are convinced that one of these has occurred, then act decisively. WHEN SERIOUS PROBLEMS DEVELOP Consultants are not messiahs and anyone who expects instant wisdom 100 percent of the time will end up sorely disappointed. Occasionally, problems with professionals will develop that need to be addressed. The best method for dealing with grievances toward professionals is communication. Call or visit and explain your grievance. Be specific. Cite the terms of the contract and where you feel the professional has failed to live up to those terms. Reason and compromise should prevail. Regardless, more serious problems will occasionally arise. In one project an architect designed a laundry room with a 24-inch door leading into the kitchen. After 100 of the 260 units were completed it was discovered that the 24-inch door would not accommodate the 30-inch washer and dryer that the architect had designed for each unit. It was necessary to go back and rip out drywall and door framing for 100 units to accommodate the

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Ralph and Robert Pisani—How to Be a Successful Developer

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dryer, all at considerable expense. Fortunately, an amicable arrangement was reached with the architect without involving his insurance company. A second case proved to be less amicable and more onerous. Located within a project for a 150 detached single family homes was a high-pressure underground oil line. The engineering firm retained had located the oil line on the property based upon a survey that had been provided for them. The firm had the opportunity, at no cost, to ask the oil company to provide stakes showing the exact vertical and horizontal location of the pipeline, but failed to do so. You can guess the rest. When building started the oil line was discovered 30 feet east of the point shown on the plan produced by the engineering firm, and within five feet of completed houses. Instead of stopping the project and litigating who was at fault the developer paid the cost of moving the oil line to its proper location, a cost in excess of $100,000. A lawsuit was eventually brought against the engineering firm. The heart of sound professional management is communication—communicating your ideas, concerns, and hopes in a clear and articulate manner. You are the helmsman. In return, you should expect responsive and professional service and a willingness to work together as a team.

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Ralph and Robert Pisani—How to Be a Successful Developer

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7

Zoning and Subdivision

T

he purpose of a zoning ordinance is to enable a municipality t