As land-light operating models become increasingly prevalent among home builders, land banking is playing a more significant role in the industry.
Many public home builders have signaled shifts in land strategy during earnings calls over the past several years, moving away from long land strategies in favor of a more asset-light model. The land-light approach helps builders balance risk, emphasizes optionality and capital efficiency to improve returns, and limits exposure to market risk.
One prominent strategy among builders is to utilize off balance sheet land banking arrangements to support land-light models. Land banking involves acquiring and holding land for future construction, providing builders with capital as well as an off balance sheet vehicle. Land bankers act as capital partners for builders, offering a debt-like instrument with the purposes of acquiring paper lots and funding land development and holding finished lots.
Under a typical structure, the builder sources land for future development, securing zoning and entitlement. Prior to or upon closing of the land parcel, the builder and land banking partner agree on a development budget, takedown schedule, and price per finished lot; the land banker then holds title to the land until all finished lots are purchased.
“Once this three-way agreement is being established [between land seller, land banker, and home builder], a very important variable for the builder is the velocity that they are going to commit to,” says Margaret Whelan, founder and CEO of Whelan Advisory.
“[The builder] needs to understand the depth of the housing market: Are they going to be selling one home per week or two per month or something else?” Whelan continues. “[The builder] needs to feel good that the market will hold up and that they are going to be getting a good return selling those houses, otherwise they could have the lot position build up as they take down finished lots that they are paying for and not selling homes or realizing cash flow on.”
By utilizing land banking, builders can realize greater advance rates compared to traditional acquisition and development loans, allowing them to control land positions with less capital. Additionally, it affords builders less risk in fluctuating market conditions. Land banking also allows for predefined schedules and pricing to ensure pricing transparency with lot takedowns matching planned starts. Whelan says the land-light models of home builders means that more M&A transactions are being consummated with a third-party land banker at the table.
For public builders, off balance sheet land banking has a direct positive impact on their return on capital and, in turn, their multiples and stock prices.
“Even though the cost of land banking capital is expensive [and] your profit is going to be lower, your asset turn is going to be so much higher that incrementally it’s accretive to your return on capital, and Wall Street will pay more for that,” Whelan says.
Private builders also realize the benefits of land banking because they need to allocate less capital than if they were to own the land outright. By putting down a co-investment deposit on land, they can expand into new locations, master plans, and communities and reduce the concentration of risk they have in one particular asset.
“[Land banking] levels the playing field, because if any builder of size can get access to the capital through a land banker, that’s capital and a growth opportunity they would not have otherwise had,” Whelan says. “That levels the playing field for all of those folks versus their bigger competitors.”
While becoming increasingly popular, Whelan stressed the importance for builders to find land bankers whose strategies align with their goals, evaluating factors such as geographic market, profitability, production velocity, and duration.
“It used to be that the land bankers were the ones concerned about the builders performing, but now when you have so many land bankers, the builders have to be concerned about the land bankers performing because there is a lot of nuance,” Whelan says. “Having said that, I feel like every pot has a lid. There are lots of big, sophisticated, well-financed land bankers [and] there are much smaller groups working with smaller builders. It’s all about fitting into place the right way.”
Long term, Whelan believes the shift toward land banking among home builders is a “secular shift versus a cyclical [shift].”
“The reason I think it is secular is because the home building market is so much more concentrated now,” Whelan says. “To be competitive, the private builders and the smaller public builders that are trying to grow quickly need to have more growth opportunities in front of them. The only way to do that is with access to more capital like land banking. I think it’s a permanent shift, it’s not just in vogue.”
