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.
Works
Cited
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.
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