Developing Land – A Look At The Professional
The acquisition and improvement of land is a large-scale operation and requires large amounts of capital. This has created methods of land acquisition that gives the developer access to and control over a large enough tract to make development economical without requiring an initial outlay of all of the capital necessary to acquire such a tract. From the point of view of the landowner, the disposal of a large tract at a good price may require a formula that will encourage the developer to commit improvement and development money for part of the tract that will build future value into the entire tract.
This may be accomplished by the following:
• The developer sets up a master plan that sets forth the general scheme of development and submits it for the approval of the owner.
• The developer and owner enter into an agreement setting forth the acreage prices for the entire property.
• Owner and developer agree on the number of years over which the full development is to be completed.
• To protect the owner against freezing of his property, the developer firmly commits to buy a predetermined number of acres each year.
• If the developer fails to meet this schedule, the owner is released from his commitment.
A Development Agreement
Another way of handling the problem is for the developer to share the net profits from the land development with the landowner. This can be done by a “land development agreement” in which the developer agrees to perform the platting, the laying out, the installation of lot improvements, and the promotion of the subdivision. The landowner agrees to accept a percentage of the sales price of each lot, with a fixed minimum guaranteed. For example, the developer agrees to pay net to the landowner 25% of the sales price of each lot sold, with a minimum of $50,000 per lot.
With this kind of arrangement, it is important to protect the landowner from finding his land cluttered up with liens left by a subdivider who went broke. The landowner should consider confining the developer or subdivider to a small tract of land at a time and give him “rolling options” to acquire additional parcels at intervals over a period of time. Failure to keep up with this purchase program results in loss of future options. The land that has been optioned but not purchased is not subject to liens against the developer.
Benefits Of Developing On Leased Land
The bundle of benefits for the lessee and lessor in a development on leased land are remarkable. The separate owners, land owner and building owner, come together in one investment at the same location. The land owner has a good lease to the owner of the improvement. The owner of the building puts up less money since the ownership of land is not part of the expenses in the development.
What The Lessor Wants
An example could be the developer of upscale homes who wants to keep the ownership of the land as an investment. The use of the land lease can widen his market by reducing the purchase price of the
house. In certain parts of the country, the value of the land equals the value of the house. Leasing the land can cut the purchase price nearly in half. With this type of land lease, there is usually a provision for a rent increase halfway through the lease term in accordance with the results of a reappraisal of the land. The
Benefits To The Builder
The land lease results in the following benefits for a builder or developer:
• He/she can acquire a valuable parcel of land with very little cash investment.
• This leasehold that is acquired is an asset that can increase in value, and then could be used as security for a loan, or could be sold for a profit.
• The rental payments are fully deductible by the lessee.
• With a subordinated land lease, the lessee-developer gets the equivalent of a 100% loan on the land.
The Best Lease For Both
Usually, a developer-lessee will attempt to get the longest possible term in the lease because the shorter term land lease would have a smaller market for resale. A long-term land lease is generally a net lease under which the lessee pays the carrying costs, including real estate taxes.
When the land rental is a fixed amount, it is a percentage of the fair market value of the land when the lease is executed. This lease will often include a provision for reappraisal of the land at fixed intervals, with new adjustments in the rent. In some cases, for instance with a shopping center, the landowner might demand a share of the percentage rentals over and above the fixed land rent. (Much of the income in the shopping center will come from percentage overages from the sub-lessees.
Subordination Of The Lease
If the owner of the land will not subordinate the lease to a leasehold mortgage, the developer should get a reduction in rent because the unsubordination will cause his financing to be more expensive. Subordination could be the most important item in the terms of the lease. Even a short subordinated lease might be better than a longer unsubordinated lease, even though the longer lease is more salable.
The landowner may or may not allow his interest as owner-lessor to be subordinated to the interest of a leasehold mortgagee. When there is a subordination to the mortgage, the lender, in effect, gets a fee mortgage on the land rather than a leasehold mortgage.
When the lease is unsubordinated, the landowner-lessor has first rights over the lender in case the lessee-mortgagor should default. With these terms, the lessee could find that he cannot get a loan, or can get one only at a higher rate of interest. Without the subordination, the mortgage is, in effect, a second lien since the lessor’s claim on the rents takes precedence over payments on the mortgage.
The objections of an owner to subordination of the lease could be as follows:
• He could lose the property if the lessee defaults on the leasehold mortgage.
• Subordination reduces his possibility of mortgaging his fee interest in the land, which would be a logical move for the lessor. If the subordination is part of the terms, the landowner would record his right to receive any notice of default from the leasehold mortgagee and the right to cure the default. The expense would be reimbursed to the owner by adding the amount to the lessee’s rent obligation.
This article appeared in the September issue of The Commercial Real Estate Investment Newsletter. One of the newsletters we offer to our clients. You can subscribe to the newsletter by going to NAI Cravey Real Estate Services website.
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