In today's new environment, investor plans to buy land, build homes, and sell them for huge profits doesn't add up quite as easily as it had for the past five years. Uncertainty in scores of slowing markets has flushed many a flipper out of the residential real estate game, and is leaving the field wide open to pros who know, and like, a good risk when they see one.
As faint-hearted individual investors trip over one another to blast out of the new home real estate market, institutional players with boatloads of cash continue to stalk a chance to produce even bigger boatloads of cash in the very arena that makes many individuals nervous. Some of those institutional investors are backing organizations that are buying up land—lots of land—even as the rest of the market gets queasy about it. After all, any savvy investor will tell you: the higher the risk, the higher the possible reward.
Thing is, if your investor's front pension funds looking for their customary mid-20s percentage point yield levels over time, few places in real estate can generate the internal rate of return necessary to keep these funds going. Hearthstone's Path of Growth fund [BIG BUILDER, Feb. 15, 2006], and separately, Atlanta-based Chadwick, Saylor & Co.'s CS Capital unit, have emerged recently as alternatives to conventional land bank companies as a source to big builders for lots.
For financial players, the strategy entails higher risk upfront. Although the initial price for unapproved parcels is lower than entitled ones, the catch occurs when impediments and politics snag entitlements in an interminable nightmare of municipal board meetings. Protracted entitlement processes mean carrying costs and no inventory turns—the enemy of builders. But when big money people team up with smart real estate land development people, approvals proceed on a palatable schedule. CS Capital's alliance with Terrestris exemplifies how pairing institutional capital with knowledge on the ground can work to at least several parties' advantage.
The Residential Land Fund's parcels, in heavily labor union member-populated Kane, Lake, and McHenry counties, get extra traction in approvals among municipal decision makers for two reasons. First, the fund's investor base includes big participation from union pension funds, and secondly, a requirement of the fund is that union builders be involved in construction of all the homes, providing union jobs. Terrestris chairman Dennis Cortesi has the union and political ties in the greater Chicago area, and approvals in some pretty challenging, land constrained areas have been averaging a modest six to 24 months.
“We work with experts on the ground,who can navigate entitlement and get the dirt moving,” says Paul Saylor, managing director at Chadwick, Saylor & Co. “It's our institutional capital access at the table, and Cortesi's local knowledge and ties make this work as a benefit to the unions on a number of levels, including the returns on their pensions' investments. Getting through entitlements with this kind of edge in the market alleviates some of the risk to our investors.”
The Residential Land Fund's returns are higher than land bank investments and the group is not bound to a single buyer or product line, says Cortesi, adding that returns are substantially higher than traditional pension fund investments. “We believe the fact that the homes will be built with quality union labor does expedite the entitlement process.”
At the same time, as the national marketplace gets softer, the era of big builders plowing 40 percent of home sales dollars back into land purchases to glom any available tracts, parcels, and lots on to their pipeline is over. At least until land prices drop a notch or two from their peak, big players are likely to hold fewer land committee meetings. They'll scrutinize every purchase much more carefully, buy tactically where the market opportunities emerge, and keep this non-productive asset off their books however they can.
In this case, builders ante up amounts ranging from $80,000 to $170,000 per lot, in $10 million to $15 million increments, to secure parcels for projects in the five properties. This yields double the money to CS Capital, providing a partner like Terrestris is around to secure entitlements in timely fashion.