April 23, 2004

Building Your Family’s Portfolio with Real Estate & Land Investments

Worth Magazine -- June, 2004

Divest or Develop? … (the financial considerations and benefits) are not the result of mere chance. Rather, they are the rewards of a sometimes lengthy process, one that begins with us asking two important questions : What can I do to make the most of my property ? How involved do I want to be in its development ?

The first question goes to the heart of vision and intent, the second to execution.

The simplest solution for a landowner is to sell the property outright to a developer without contingencies and be done with it. This is a clean, quick, and relatively risk-free option and may well be the best one for those not interested in taking on a potentially long, expensive project, or entangling themselves with business partners.

Steve DiFrancesco, president of the Philadelphia-based real estate firm Hunter, Reed and Company Inc explains, “On average, the development approval process can take 12 to 36 months – it’s not something that happens quickly, and it’s not inexpensive. A landowner needs patience and financial staying power, and also needs to consider that there may be an opportunity cost to capital associated with having the market value of a property tied up for an extended period of time.”

While a simple non-contingent sale offers the most immediate payout for a landowner, it also leaves the most money on the table, since a developer buyer assumes all the risks of a project, and therefore also takes the lion’s share of the profits. Over and above the acquisition cost of the land, for example, the developer will allocate for hard costs (improvements such as roads, sewers, and utilities) and soft costs (time value of money, capital risk/reward ratios, projected absorption rate, debt service, etc).

“A developer will factor hard and soft costs and the risk/reward ratio – among other things — into his pro-forma, and, ultimately, this will determine what he’s willing to pay to acquire a particular tract of land “, DiFrancesco notes.

A straight sale bars a landowner from having any influence over a project’s direction. If we decide that we do, in fact, want to play some ongoing role, we may do best to partner with an experienced real estate advisor, like DiFrancesco, and/or an actual developer – whose expertise can save a landowner immeasurable delays, costs, and aggravation.

Once a landowner and developer define a project and form a legal partnership, the team must coordinate and consult with important constituencies – local political leaders, neighbors, environmental groups – to keep a project on track, both before and during the approval process and construction. Aggravating any one of these sensitive groups can cause significant delays, additional costs, and may even doom a project completely.

DiFrancesco tells of one development disaster that resulted from a landowner ignoring such considerations.

In the bucolic countryside just west of Philadelphia, an investor purchased a rather large tract of land in a wealthy enclave where fox hunting is a popular pastime and the ability to cross properties during the hunt is an unspoken cornerstone of the social contract. The investor wanted to subdivide and develop the property, a goal that, according to DiFrancesco, did not immediately doom the project, because it would have actually preserved considerable amounts of open space.

Unfortunately, the plan’s execution turned into a costly debacle for the investor. Instead of hiring local land planners and real estate attorneys with established political connections and the knowledge of what it takes to ensure a successful approval process, the investor opted for a hardball approach.

“The landowner brought in a lot of outside people with no knowledge of the local area – a team of high-priced lawyers and other powerful experts from Philadelphia – they never solicited the local township’s opinion, never consulted with the neighbors or the conservation community for input. They went in like a proverbial bull in a china shop”, DiFrancesco recalls.

When he became frustrated with the community opposition and lack of progress, the landowner retaliated and further antagonized the community by closing his land to horseback riders and foxhunters.

Though most community property use laws are designed to respect the rights of owners, in some instances, the citizenry may view private property as a quasi-public resource one in which they have a legitimate stake. As a result, concessions (or at least open lines of communication) to a local community can be critical to winning approvals for development. These concessions often include promising not to seek maximum density and preserving significant open space; occasionally, they even extend to providing trails and rights of way to foxhunters.

Though in this case, the landowner did ultimately reverse his decision to close his property to equestrians, the damage was done, and local politicians and residents responded in kind : the approval process, which should have taken only about a year, utimately required six years and cost over $300,000.

Ultimately, the landowner became so frustrated with this expensive, seemingly endless process that — after finally winning scaled-down development approvals — he called in DiFrancesco to assess the situation and find a buyer for the estate.

DiFrancesco reports that the new owners of the property (longstanding Hunter, Reed clients), by working closely with the local community and developing good relationships with the township, neighbors, and local foxhunters, have won two consecutive 5-year extensions to the original owners’ development approvals – an unprecedented accomodation by the township.

Even with local politicians and the community behind a deal, the long arm of state and federal environmental regulations can prove challenging. The most common issue is wetlands management. If, for example, an environmental engineer designates more of aproperty than expected as wetlands or watershed, the developer may have to return to square one in terms of land planning. The disovery of an endangered species of wildlife or other particularly sensitive environmental or historic features which may exist on a piece of land, can represent a significant obstacle, and can place a property on the radar of environmentalists. “A well-funded environmental or conservation group can really hamstring a project “, says DiFrancesco.

DiFrancesco observes ” For a landowner, partnering with an advisor or developer who has expertise in the development approval process is obviously essential for success. But as a landowner, you also need to be prepared for the unexpected — you need to be able to respond flexibly and effectively to unexpected issues and obstacles that can arise.

No matter how much due diligence is done ahead of time, unexpected things inevitably come up — development is a dynamic process, and, despite its complexity and degree of difficulty, it can yield huge financial rewards for a landowner who is patient, financially sound, and has a team of great advisors”.