Wednesday, April 9, 2014
Fin 180 Blog Post 2
Residential Development: The Precommitment Phase
By: John Gligich
With the recent and ongoing turnaround of the Fresno real estate market, residential land development is once again becoming a prosperous endeavor. Recently, there has been a lack of finished home lots on the market. This is leading local home builders to buy up large amounts of raw land with the goal of creating residential space. This, along with other positive statistics for the Fresno residential real estate market, are all contributing to a healthier environment for builders in the Central Valley (Harvey). Residential land development can be extremely lucrative, especially in current conditions, but extensive planning is crucial to the success of a residential development. The precommitment phase of real estate development in particular is especially important for developers when choosing whether or not to develop residential space.
The precommitment phase has three vital steps that must all be carried out to the fullest in order to ensure a successful development. These stages are also necessary to make a decision on if the project will even be feasible or not. The three stages are as follows: Stage 1, conceive a development project, stage 2, examine the feasibility of the project, and stage 3, refine the concept. These three stages must be performed exceptionally if the development is going to succeed. During the precommitment phase the developers risk is relatively low and no extreme commitment has been made. This allows the developer to examine their options in order to make the best investment decision possible (Diaz 203).
The first stage is to conceive a development project. This includes defining the type of project, determining a site, and gathering other valuable information regarding the investment and the proposed site. For residential construction, the “Use in Search of a Site” method is the best method for determining a site, because the developer already has the project defined as a residential development, so finding a site for that use is necessary (Diaz 203). In his article, Developing Real Estate: How to Price Land for Profit, Craig Grella discusses the proper methods to employ when choosing as viable site. Grella writes that finding the future value of a proposed site is the first step in evaluating a site. For residential development, using comps, not only in size and style, but also in age, is a good way to determine the potential value of the property you plan on developing (Grella). Once a site has been selected the developer should perform further research on the site. This research can be done inexpensively through planning and development departments and public records (cite book). Once preliminary research has been completed the developer can proceed to stage 2, examine the feasibility of the project.
Stage 2 brings the vast majority of the research in order for developers to make a sound decision on their potential investment. During this stage the developer must determine the market feasibility of the project, and perform final research on the site regarding suitability and potential legal issues. The developer can do this by performing a market analysis and feasibility study, and performing due diligence. It is good for developers to analyze the local demand for residential space, the relative supply of residential space in the area, and to survey the competitive space located in the area the proposed site is located. After completing a market analysis, the developer performs due diligence on the specific site proposed. By researching legal issues that may arise, zoning issues, physical issues, and environmental issues, developers can hope to weed out bad investments while there is still a relatively low amount of commitment. Ample information is readily available once again through public records and planning and development departments (Diaz 205). Once sufficient due diligence has been performed, the developer can further refine their development concept.
The final step in the precommitment phase of development requires the developer to further refine their idea and gain a more solid understanding of the commitment that will be required if the developer chooses to proceed with the project into the post-commitment phase. The final stage focuses on further refinement of the concept, including the type of residential space, the quality of the space, the price range, and the potential customers. By performing marketing studies on the local public, the developer can gain insight into the needs of the community. This will assist in determining the specifics of the proposed residential. Once the product is further refined the next step would be to create a pro forma. A good pro forma will further help the developer determine the financial feasibility of their investment (Diaz 208). Grella suggests determining the development costs, which include permits, fees, and construction costs. After the development cost are solidified, the developer now knows how much he or she must pay for land based on the future value they expect to obtain from the development. This is known as the residual land value. After determining the residual land value, expected profits are then figured into the equation (Grella).
Once the three stages listed above are carefully completed, the developer can determine whether or not to move on to the post commitment phase and proceed with the project. If the precommitment phase is done properly and thoroughly, the post commitment phase will be a success, limiting the developer’s risk, and increasing their chance of success.
Diaz, Julian, and J. Andrew. Hansz. "Project Precommitment." Real Estate Analysis:
Environments and Activities. Dubuque, IA: Kendall Hunt Pub., 2010. 202-10. Print.
Grella, Craig. "Developing Real Estate: How to Price Land for Profit." The BiggerPockets Blog
RSS. N.p., 2 Oct. 2009. Web. 09 Apr. 2014.
Harvey, Chuck. "Developers Scramble for Bare Land to Build Houses." The Business Journal.
N.p., 17 Mar. 2014. Web. 09 Apr. 2014.