By Barry Gross
We all read about the current robust new home market. Although this years’ home sales have been strong, California land developers are facing a difficult environment to produce new lots in sufficient quantity to replace lots that are sold. The result will be a future shortage of approved lots and since replacement of new home inventory is not fast enough to satisfy existing home demand, it will inevitably drive up the future homes prices.
We have had recent discussions with leaders of homebuilders, and they acknowledge that they are not motivated to invest capital and time in processing Tentative Tract Maps (“TTM”) through the approval process. This is the result of previous experiences where they suffered significant increased expenditures and time delays and were not able to fulfill their business plans.
We were recently asked by a private client what it would cost to process a TTM in Riverside County, Ca. Their target property is about 22 acres and is currently zoned for up to six units per acre yielding a maximum of 132 units. We estimated the total investment risk required prior to TTM approval to be $751,000 or $5,700 per unit.
Investment Risk Required Prior to TTM Approval
Of a 22-Acre Parcel Zoned for 132 Units in Riverside County
Description Estimate
Due Diligence $50,000
Entitlements $125,000
Civil Engineering $163,000
Consulting Services $161,000
Soils Engineering $32,500
Landscape Architect $25,000
Environmental Processing $81,500
Planning Fees, Deposits, Permits $45,000
Land Development Soft Costs Contingency $68,000
Total Land Development Soft Costs $751,000
Investment per unit $5,700
Source: Land-Strat
The next question our client asked was how much time is required to process an Approved TTM. To answer this question, we met with local government planning officials and determined it would require about 18 months to obtain an approved TTM in their jurisdiction. However, these same officials would not comment about delays caused the by proposed state mandates or other unique development issues that may impact this parcel during the entitlement process which could reduce lot count or increase development costs.
Environmental Compliance
A major element in processing land in California is satisfying the California Environmental Quality Act (CEQA). In general, CEQA requires a jurisdiction to make “Findings” to support a land use decision. To make appropriate Findings, the developer must study the environmental impacts a project creates. To determine the required studies for environmental compliance, a jurisdiction often has a public scoping meeting to identify the studies required to identify project impacts and their mitigations. To satisfy CEQA, a project will follow one of three processes: an Environmental Impact Report (EIR), a Mitigated Negative Declaration (MND) or a No Further Action (NFA) determination. For most smaller projects, a project applicant can “tier” off an existing certified EIR where the jurisdiction can make Findings based on an existing certified EIR, usually an EIR prepared to support a General Plan Amendment or Specific Plan.
We have been involved with projects requiring EIR certification that requires up to 30 independent third party studies that require up to 3 years to prepare. In a typical smaller project, an EIR may not be required, and the developers will prepare a Mitigated Negative Declaration (“MND”). If the scoping meeting identifies no unmitigated development issues, the jurisdiction may issue an NFA.
Prior to project approval, there are still other issues to be addressed. For example, if a local Not in My Backyard (“NIMBY”) group opposes a project, their input could not only delay a project, but it may also doom a project to failure.
State and Federal Agency Compliance
Another item discussed with the officials was that the jurisdiction had not yet developed a long-term program to address the state mandated Regional Housing Needs Allocation (“RHNA”). The RHNA program addresses affordable housing and in the extreme case a jurisdiction could require that up to 15% of the units must be affordable. If the developer did not want to include affordable lots in their program, an alternative was to consider paying an Affordable In-Lieu fee. In some jurisdictions this fee is as high as $15.00 per home SF or for a 2,000 SF house, the fee would be $30,000 per unit.
Although a developer may process a project TTM for approval, this is not the final approval required prior to construction. There may also be Federal or state agency approvals to consider. Often these agencies will not accept an application for their permits until a TTM is approved. For example, the California Coastal Commission will not accept an application for a Coastal Commission permit until a TTM is approved. This could add a year or more to a final determination of approval.
In the extreme case, we were involved in a project that initially applied for a Coastal Commission permit in the early 1990s and still has not received final approval. Other projects subject to the commission have been delayed up to five years only to be burdened by additional Coastal Commission mitigation conditions that impact the duration of an approval and lead to increased costs.
Another issue that land developers face is obtaining biological clearance. Certain biological issues are seasonal and require completion of a field survey during the “active” cycle of the affected species, that often is as short as 3 months. If the survey is not completed within the proper timeframe, a developer will be required to wait 9 months for the next cycle to complete its survey. Since a TTM may not be approved without mitigating biological issues, the project will be delayed.
We can cite various other obstacles that land developers encounter, but we only discuss these three to illustrate typical hurdles that impact the development process.
Additional Costs After TTM Approval
As illustrated above, a significant amount of capital must be placed at risk before a land developer can obtain an approved TTM. Although for many projects TTM approval is not the final approval, development risk may drop significantly and many homebuilders will close escrow with an approved TTM, despite the necessity to obtain additional governmental approvals. But since each parcel is individual, close of escrow conditions are established on a project-by-project basis.
After approval of a TTM, the civil engineer must prepare improvement plans that usually require 3 to 4 months. Once preparation of these plans is completed and submitted, the government agency will require an additional 3 to 4 months to review them before issuing a building permit.
If the TTM requires 18 months for approval, the project may still require 26 months from conception until a homebuilder can commence house construction. In some jurisdictions, the developer may “go at risk” by simultaneously processing improvement plans while the TTM process is ongoing. However, if during the entailment process the jurisdiction adds or modifies a condition, the plans will have to be modified at an additional cost.
In addition to the $750,000 in entitlement costs shown above, the cost to produce the improvement drawings and obtain City approval is generally between $5,000 to $10,000 per unit. So, for a project of 132 units, the additional investment is between $660,000 to $1,320,000 before construction starts.
Why Homebuilders and Investors Want Approved Lots
Government officials and the public are often not sympathetic to these developer issues. These officials have various government mandates to implement and enforce. However, the homebuilding and development community is sensitive to these and other issues that affect the subdivision process. The result is that many homebuilders have established strategies to avoid lot creation and development risk.
Many homebuilders and investors are sensitive to achieving predetermined financial metrics such as profit, internal rates of return, maximum capital investment and project duration. They focus on investment that generates rapid capital turnover with minimal risk. These financial metrics are difficult to achieve during the development phase since many projects have difficulty determining durations from conception to construction and expose the developer to substantial known and unknown risks.
For the reasons cited above, homebuilders plan to purchase approved lots from existing developers, landowners, single purpose developers or individuals that have the time, patience and financial resources to accept development risks. The reward for them is that upon completion, they may be able to earn a large multiple on their investment, often a return of 5 to 10 times their investment. And to increase the probability of increased expected return, some will speculate and process multiple projects simultaneously. If they believe the lot shortage will continue and prices will rise, they expect their returns will be substantial. However, we do not think this strategy will generate sufficient lots to fulfill existing and future demand.
So, now we know what has happened to the entitled lots. The more pertinent question is “Who will subdivide land into future developed lots for future homesites?” Who is willing to accept increasing risk with the intention of earning large speculative profits? Meanwhile, homebuilders need help to fill their pipelines, plan their projects and calculate how much to pay for entitled lots when they do materialize.
Land-Strat and Barry Gross will guide you through the process, assist with planning and help organize the many layers of data to assess the “Risks verses Rewards” of your project. After evaluating your property information related, we can help by preparing a land planning checklist in Microsoft Project that to can use as guide to achieve a successful entitlement. And since the guide will be in Microsoft Project, you will be able to make updates through project approval. Call Barry to set up a meeting at 949-637-2124.