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Lots and Land Development: How do you know when the Market is Ready?

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Land development tends to be one of the riskiest roles in the housing industry, so for land developers it is important to know that the market is ready for a new project to avoid taking on excessive risk. What are the tools or metrics that land developers can use to analyze housing markets and help them evaluate whether the market is ready for developing land into lots for new home projects?

Risks of Land DevelopmentWhat is the measure of when the market is ready for lot and land development? Image of heavy equipment ready for site work for new lots

Land developers are at the front-end of new home construction. Land developers typically borrow and advance the funds that are needed for them to pay for the high costs of preparing raw land for new homes. On any project there is a risk that a land developer will invest large sums of money into a site and then find that the market has turned sour or just is not ready for the new home project. If a land developer is doing a “speculative” land development project (where a buyer is not contracting to buy lots from the developer) then the developer can be stuck with an enormous investment of their own funds, and no buyers. And land developers even can find that a homebuilder-buyer that is bound by a contract to purchase finished lots may back out of the deal and leave the land developer high and dry when the housing market looks bleak. This means the land developer takes on a very high level of risk in a project, and may be left holding partially or fully-developed building lots that they can’t sell.

Assessing the Housing Market’s Health

It was particularly difficult to assess market conditions for land development for new homes as the U.S. economy was recovering from the Great Recession. Unless a quality builder-buyer was involved with acceptable, safer terms, many land developers were not willing to take on new projects. And “speculative” land development projects have been extremely rare in recent years. Homebuilders also have taken on land development for themselves even though for some it may be beyond their core expertise.

Understanding macro-level market conditions is critical in real estate, and there are all sorts of numbers and metrics that can be used to take the temperature of the housing market and the economy:

  • The unemployment rate and other “jobs numbers”
  • Consumer confidence
  • Retail sales
  • Manufacturing inventory levels
  • Housing starts
  • Building permits

In the real estate and home construction industries, especially, there seems to be good, reliable data to gauge and assess the health of the marketplace, such as residential starts,  construction spending, new home sales, existing home sales and home value trends.

 

Where is the Development Industry’s Standard?

But to date, we’ve found no particular “industry standard” for gauging the state of the land development sector. Unfortunately, most of the existing construction and real estate indices noted above only indirectly measure the development market. These metrics tend to focus on actual home construction or sales, which are not always timely and useful for those working in the residential lot and land development field – as lagging indicators that reflect activity that occurs significantly later in the residential development pipeline, home construction and sales are not really predictors or current measures for development risks.

So what factors might be useful in determining the current health and direction of the residential lot and land development sector?  It certainly would be useful to have a trustworthy “lot demand” or “lot inventory” metric to help you guide your decisions, making a developer’s or builder’s choice of when to start – or stop – developing a little less risky.

But that is easier said than done. To provide an accurate assessment of national and regional lot inventories you must overcome one of the biggest variables – and potential areas for inaccuracy – which is trying to standardize what actually qualifies as a “lot” in such an index. For example, if you only measure finished lots for sale in planned developments you invariably exclude lots that are available but not actively marketed, plus a large number of lots in developments that stalled during the most recent downturn just needed the finishing touches to begin home construction. Because of this, reports of lot inventories must be reviewed carefully and often are not able to be compared reliably across different markets.

Using Existing Metrics

Without a specific set of metrics for the residential lot and land development field, developers tend to look at a combination of the existing data reports. You can keep an eye on housing inventories and the Case-Shiller reports, to track the direction of existing home values. In addition, consumer confidence measures the degree of optimism that consumers feel about the overall state of the economy and their personal financial situation. Plus, housing starts and building permits give insight into the minds and current activity levels for home builders.

This is not a comprehensive analysis, but if you can see increasing consumer confidence along with increasing home values you may have a decent indication that consumers will be willing to spend some of their money on new homes. And it helps to know if other builders have grown confident enough to start building new homes. Good signs for lot sales and land development.

Ultimately, of course, you rely on your own unique understanding of local market conditions and your own knowledge and experience in determining when the time is right to buy, sell and develop land for new homes. What advice can you offer others in our industry on what to look for when it comes to economic indicators? What factors would you use in creating a “development index” to evaluate broad market conditions or to provide a reliable comparison of different local markets? Or would such a measurement be useful in your business at all?

 

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