Managing Profitability in Land Development
Maximizing profitability in land development:
The first thing most land developers think about when profitability is mentioned is getting maximum lot yield. Lot yield is an important and necessary consideration for anyone designing a project, but there is a lot more to hitting bottom line profitability than gross revenue based on yield. We’ll take this in two parts: first, lot yield considerations, then a look at budgeting and cost control.
Lot yield:
Lot yield is the holy grail for most developers. When more lots can be produced and costs are amortized over a greater number of lots, the result is usually increased profits - at least that’s what a lot of land developers think. However, top line sales revenue does not always equate to bottom line profitability and this is where some guys fail to see the obvious.
I had a project where I could have done 327 small lots using my county Rural Cluster Subdivision Code, or I could do 124 five + acre lots using a conventional design. Here’s what it looked like:
Lot yield options:
327 small lots x $50,000 average sales price = $16,350,000.00 gross sales revenue
124 large lots x $149,000 average sales price = $18,476,000.00 gross sales revenue
The variance was $2,126,000 in favor of using the large lot option just looking at gross sales. Of course, I needed to consider as an added cost factor the increased cost of construction, additional infrastructure, and materials for the large lot option.
I was lucky to have existing logging roads throughout the project and the large lot design fit well within this rough road system, but a lot of work was needed prior to hard surfacing. The small lot option would have resulted in significant construction of a new road system and other cost factors. Here is how it worked out:
All in all, when factoring in everything, the large lot option would cost about $725,000 more in additional costs to bring to market. This made the large lot option more attractive in gross sales revenue by $1,401,000 and it was more profitable, even with the additional costs vs the small lot option. The moral of the story is that lot yield alone does not always equate to the most profitable choice. I chose the large lot option and it worked out well.
Budget forecasting:
I don’t think I am any worse than other land developers in budgeting, but I sure as heck ain’t much better. My biggest frustration is that I have never finished a project that hit my original budget estimates and I have continually had to update for variances along the way (and they always seem to be increases). Still, I can make the honest claim that I have never finished a project that was not profitable. Still, I tell myself “ if I could only forecast those pesky costs better…..”.
The biggest budget busters for me are design modifications and/or add-on costs as a part of entitlement and permitting, fluctuating material costs and time delays resulting in increased costs. Almost no one in land development will tell you anything at all about their budgeting accuracy, but I took a real estate law class one time from an attorney that also developed land. I talked with him during some of the breaks and bought him a sandwich one day at a lunch break. His viewpoint was “ that’s the nature of the budget beast that we try to tame in land development”. Since he was a smart and experienced guy who continually faced this same problem I’ve felt a little better about myself regarding budgeting, but not that much better!
So, I figure that I am either just like most others, or I am not that good at budgeting. Either way, my pragmatic solution to the problem is my little friend called the contingency cost center. From the start, which is the initial pro forma, I always add an additional 20% to the highly variable projected costs as a contingency factor. If the investors balk at it, they can go find someone else. I’ve been under 20% many times, close to 20% several times, but never over. If someone out there knows how to consistently tame the budget tiger in land development without a contingency cost factor, I am all ears.
Cost control:
Here, I am much better. I can put on my green celluloid accounting visor, put on the “old guy” 2.5 power readers, sharpen a #2 Ticonderoga pencil and flip the beads on the abacus calculator with the best of ‘em.
Having a good book keeper is a great relief and I finally hired one about 3 years into my land development business. She could produce crucial data quickly and accurately, but I knew that I had to actively manage it and that’s where guys can fall off the wagon.
As expenses roll in and are paid a guy has to reconcile it with the budget in real time to get the running total. There is great software available for this but I’ve always used my own system. No matter how it’s done there has to be an ongoing reconciliation.
Cascading effects:
It’s really easy for costs to spin out of control, especially if you don’t look at them quickly and track them to the budget. It gets super tedious because one cost overrun has a tendency to result in others. This cascading effect is how a budget cost center can spin out of control and here’s an example:
About 15 years ago, I had to do an unexpected traffic study on a large project. The key issue was whether or not the traffic count increase from my project would require the installation of a traffic signal at a key intersection in a small town about 2 miles from the west end of my project. I had not budgeted for a signal and until the project was under review it had not even been a topic of discussion, but there it was anyhow.
It didn’t work in my favor as you might guess, so way back in the town I had to put in a traffic signal. That one single signal was $150,000 and with the other modifications at the intersection I was up to about $220,000 total.
Here’s the bigger parts of the cost path on that one: traffic study > engineering > internal and external review > close intersection > re route traffic > construction > inspection > Bam! $220k budget variance. The cascading part is: that one traffic study resulted in six significant additional costs.
Annoying cost variances:
Certain non-budget conditions have caused repetitive pains for me. These are not budget line items, but they still affect the budget and profitability.
Example:
Seasonal construction delays. The Pacific Northwest in winter is not the easiest place to asphalt miles of road. Think 37” of average annual rainfall. If construction approval comes in April you’re good, if it comes in November, well …
Unanticipated considerations like the example above are just part of it all and the most annoying part of it for me is that they are difficult, if not impossible, to predict.
Review:
Profitability in land development can be closely related to the discussion topics above, plus others. I start thinking about it in the pre acquisition phases and continue to stay focused. The civil engineer will produce a conceptual design early on and a review of it from a cost standpoint, not just an aesthetic one, is essential. I have found that a key aspect of managing costs in a project is active management of the costs as they roll in and reconciling them with the budget. Variance impacts in either direction are adjusted to the budget with necessary adjustments going forward.
