What Most Developers Get Wrong About Land

We’ve noticed that some developers struggle with land deal evaluation, often focusing too heavily on price per acre while missing the factors that actually determine whether a deal will be profitable.

This newsletter breaks down how to properly assess a complex land transaction, referring to our experience across several large land deals.

Before we begin, we should acknowledge that there are many different types of land deals.

For the purpose of this newsletter, we’re focusing on a specific scenario, in which you’re buying land from a master developer who has either acquired a large tract of land or owned it for many years via a family trust, negotiated entitlements with the jurisdiction (via a PUD or development agreement), and is now selling off individual parcels to other developers who will further subdivide or build.

Although this is the general example we will be referring to, many of the concepts we share still apply to smaller, less complex deals.

In a typical deal progression, the master developer strikes a deal with the original landowner (usually a family that held the property for a long time), pays for and negotiates the terms of a PUD or development agreement with the jurisdiction, then markets and sells the land to specialized developers. All transactions downstream from that initial entitlement must follow the terms of the PUD or development agreement, plus any additional terms established in the purchase agreements.

A purchase agreement with the master developer will reference these entitlements and typically includes additional obligations such as HOA fees for common area maintenance, design guidelines, performance metrics, development timelines, and any use restrictions or subdivision requirements specific to the parcel you are purchasing.

These contractual obligations exist alongside the entitlements established in the PUD or development agreement.

A typical development agreement might allow for a mix of uses like this one:

• 200 units of multi-family rentals

• 50 residential condominiums

• 100,000 square feet of retail

• 3 F&B outlets with hours not exceeding 11pm

• Hotel with 100 keys

These agreements also include a list of prohibited uses like bowling alleys, gun ranges, arcades, mini golf, and vape shops, to name a few we’ve seen.

Now that we understand the general structure of our example land deal, here are the three main factors that we review to determine how much a site is worth.

These are the deal and contract structure of the purchase, the details of the entitlements (how much of each use type can be built), and the site conditions that will impact the complexity and cost of building.

We’ll start with deal structure because it is often missed as a major factor in the value of the land. Getting the structure wrong can meaningfully decrease the land value, here are some of the ways that can happen.

On one end of the spectrum, you have outright purchases where the seller is no longer involved in any capacity. On the other end, you have Co-GP arrangements where the seller retains not just ownership but also operational control. In between, there are joint ventures where the seller retains some ownership but limited control, such as major decision rights.

This is one of the more obvious ways where the PSA structure can impact value. If the seller’s motivations are too onerous on the capital requirements, the cost of capital may be too high and negatively impact the overall returns.

Even without a Co-GP arrangement, a savvy land seller will often include performance metrics and milestones in the PSA that are intended to ensure the buyer is making sufficient progress on their parcel. These milestones may be written as “Buyer must spend $XX amount on hard construction costs by Y date or the seller can take back the land,” or they can denote specific construction or fundraising goals that must happen by a certain time. Frequently, land sellers will also include sale or transfer restrictions on the site. The reason for this is simple. They want you to build what you agreed to build, and not flip pads to other developers for a quick profit.

Be careful how these restrictions are written. Prohibiting an outright sale before project completion or before a future date is one thing, but prohibiting transfers that restrict your ability to bring in joint venture or other partners, recapitalize a deal, or otherwise operate with typical financial flexibility are an entirely different type of constraint that should be avoided. No one wants to have to go back to city council or the land seller to get their entity or capital structure approved every time there is a minor change.

Onerous restrictions regarding performance and sales can cost a lot to comply with. In some instances, more than they would’ve cost if those milestones had simply been completed during the course of a thoughtful development plan. This is another reason why understanding the business plan before finalizing the PSA is helpful since it allows for comparison to specific project metrics and decisions regarding feasibility can be made with tangible context.

Beyond required performance metrics, the actual payment structure for the site can vary widely.

Deals can be structured where the full payment is made early in the process, or they can be structured where payments are spread out over months or years. Consider a land lease with an option to purchase, or a land sale with installment payments triggered at certain development milestones to avoid a large initial capital outlay (and one that can possibly be at risk if no entitlement or permitting contingencies are established)

Regardless of payment timing, deals can be structured so the buyer benefits from the land lift or other economic uplift of the broader master-planned development (e.g., higher rents, higher ADRs), or so the seller retains most of the economic uplift to the surrounding parcels or pads.

Consider a deal where you, as the buyer, have the right to build retail, residential, hospitality, and office on a 50-acre parcel. If you get the hotel amenities right, you’ll be able to rent the multi-family for more. If you bring high-income earners to the multi-family, a retail tenant will pay you more to lease your ground floor space. If you attract the right mix of retail tenants, an office tenant will pay you more to lease your office space. All of these components eventually contribute to the value you create for the project and its investors.

Now consider the opposite scenario, where you own just one single-use parcel. While it can operate profitably, any economic uplift your parcel creates for adjacent uses is captured by someone else.

The purchase price you’re willing to pay differs significantly between these two scenarios.

The relationships here are straightforward:

• Deferred payments: The more purchase payments are deferred into the future, the more a buyer can pay, and not just due to time value of money. Because of the very real capital constraints that most projects face, the benefit of paying later likely far exceeds the time value of money, even at a healthy discount rate.

• Economic exposure: The more economic exposure a buyer retains to the land lift on adjacent pads, the more a buyer can pay.

• Performance requirements: The more lenient any performance requirements are, the more a buyer can pay.

These variables don’t operate in isolation. Evaluate them together, because the cumulative effect of unfavorable terms across all three (full payment at closing, onerous milestones, and no participation in adjacent uplift) can quickly result in land value that is zero or even negative. Understanding the business plan before finalizing the PSA isn’t just helpful; it’s what makes that evaluation possible.

Now let’s discuss how entitlement impacts land value. This aspect is the most straightforward and easiest to understand for anyone with even limited real estate experience.

If you can profitably build 100 rental units on a site, then building 200 rental units probably generates more profit. Hence, you can pay more for a 200-unit site than you could for a 100-unit site.

How much more? Likely about twice as much, or even more than twice as much, because of improved economies of scale.

(Note: this obviously isn’t true in every market or for every product type, but if you assume the same rent per foot and absorption, it’s generally true.)

In a master-planned development, there are usually a variety of uses entitled, for-rent residential, hotel, retail, and office. As unimproved land, each one of these has a different value, since the profitability of building each is different.

A straightforward way to determine land value is to underwrite the expected value of each pad based on its use and density entitlements, then discount those values back to an aggregate purchase price.

Here’s an example:

• Pad 1: Entitled for 15,000 square feet of retail. Retail sites in this market sell for $100 per buildable foot. Therefore, this retail pad can be sold for $1.5M to a retail developer.

• Pad 2: Entitled for 300 multi-family units. Multi-family land deals in this market sell for $50k per unit. Therefore, this multi-family pad can be sold for $15M.

• Pad 3: Entitled for a hotel with 150 keys, or approximately 60,000 rentable square feet. Hotel sites in this market sell for $75 per rentable foot. Therefore, this hotel pad can be sold for $4.5M.

In this example, Pads 1 through 3 can be sold for total proceeds of $21M. Now assume that total expenses to get the sites sold is $3M. This includes architect fees, engineering fees, legal fees, county fees, and any site work like clearing, grading, installing utilities or roads.

So now we have the total sale value of all the pads, plus the total cost to get them ready for sale. How much should we discount our sale proceeds in order to arrive at a purchase price?

A good rule of thumb is approximately 40% development margin for this type of large master-planned mixed-use site.

If we use a 40% development margin, we can pay $12M for the site. $12M land purchase plus $3M development costs equals $15M total basis. A 40% return on $15M equals $21M in net proceeds.

If instead of selling off each pad individually you plan on developing each pad yourself, can you pay a higher price for the land?

The answer is yes, probably, but not that much higher (unless there are some variables within the development equation you can meaningfully affect). Each subsequent step in the development process requires time, capital, effort, and risk.

In theory, you should be getting paid for each subsequent step: master planning and subdividing your parcel into separate pads, developing each pad yourself with a vertical structure, and stabilizing and operating each new building.

Each of those steps should have a required return and, therefore, a corresponding profit margin.

You don’t want to find yourself in a situation where you’re performing all three of these steps only to earn the same return as performing just one of them on a different deal.

Site conditions are arguably the trickiest of the three components to assess, because doing it well requires a broader base of experience than either deal structure or land value.

Adequately evaluating site conditions almost always requires third-party inspections and reports. More importantly, it requires someone on your team who has enough experience to know which inspections and reports are necessary in the first place.

Standard property condition reports and appraisals will cover the usual suspects, but can easily miss major items that only become visible to someone who has seen many deals. What complicates this further is that the list of relevant site conditions varies significantly from one property to the next.

Soil conditions are extremely important, and the two nonnegotiable reports we look to order once a deal becomes imminent are a geotechnical and a Phase 1 environmental (if one isn’t already provided).

If the site contains contaminated soil or soil that’s otherwise difficult to build on, remediation or fill import will be required before construction can begin.

Importing substantial fill can run into the multiple millions just to make a site buildable. The best way to measure this is through multiple site borings or test pits at adequate intervals, strategically located based on a general understanding of where certain types of structures will be built.

We typically don’t rely on an existing geotechnical report and prefer to order our own, since that allows us to select the test sites and coordinate them over areas we suspect are problematic or where we expect to build certain types of structures. If that level of detail isn’t possible within the established due diligence period, general borings can still provide enough data for geotechnical and structural engineers to make reasonable assessments on fill quality and craft PSA language that captures and mitigates the risk accordingly.

The same principle applies to environmental conditions. If remediation is required, establishing in advance who is responsible for both the cost and the work is critical.

Understanding soil conditions before agreeing on price or terms is not optional. Both fill and environmental remediation carry costs significant enough to materially affect whether a deal makes sense at all.

Topography is another factor that significantly impacts buildability and cost.

Is the site flat, sloped, or some combination?

If part of the site is sloped, what is the degree of that slope, and is it extreme enough to prohibit construction in that area?

Many sites, especially in the Mountain West, contain portions that are simply too steep to build on per jurisdictional requirements. So even if you had the budget to build on them (assuming grading is not feasible), the local jurisdiction won’t allow it.

In some cases, those sloped areas can still provide value by counting toward required green space or outdoor public space, or by serving as natural buffers between different uses on the site. But in general, sites with extreme or highly variable topography are substantially more complicated and expensive to build on.

This consideration requires a nuanced understanding of what will be built and where. If the topography prevents the site from physically accommodating the building footprints the business plan requires, it becomes the limiting factor for feasibility.

At that point, a different development strategy must be considered, one that may generate meaningfully different returns. If that alternate strategy doesn’t fit the market, the land is worth significantly less, or possibly nothing at all.

Before signing a PSA, you should be able to answer these questions:

• Is your site located next to a river or on a wetland?

• Is it downwind of a sewage treatment plant?

• Is it at the top of a mountain with limited access and 600 inches of annual snowfall?

• Is it in a wind tunnel or other area with frequent high winds?

• Does construction require access rights from a neighbor?

• Will you need a retention pond or other drainage infrastructure?

• Will your building plan require building below the water table?

• Do you have room to stage equipment and materials?

• Does your site contain any wetlands or protected species?

(This isn’t a comprehensive list, but it is directionally indicative of the types of things you should be looking out for when assessing land.)

All of these site features can significantly impact either the cost of construction or the value of finished buildings. While added costs or extended timelines may seem obvious, several of these issues carry second and third order effects that aren’t fully understood at the time of site purchase.

Take proximity to a major river as an example.

Let’s say your site is on a river and you’ve consulted the FEMA flood plain map, determining that you’re either not in the flood plain or have successfully petitioned FEMA to remove the site from it.

That doesn’t mean parts of the site won’t periodically flood, and it doesn’t mean there aren’t other government agencies or jurisdictional requirements governing the use and zoning of the site as it relates to water.

The Army Corps of Engineers permit requirement is a good example of something that is often missed. If you’re building close to the river, that approval is likely required, and that step alone could add many months to the timeline and significant costs.

And if you’re planning any sub-grade construction near the river, such as a parking garage, basement, utility rooms, or pool, the water table will typically be higher in that proximity, meaning those subterranean structures may require significant dewatering costs during construction and potentially on an ongoing basis.

Infrastructure is equally critical. Before signing, you need clear answers to these questions:

• Who’s going to be responsible for installing utilities, building roads and drainage, and ensuring there’s sufficient power and water for the new development?

• How and where will utilities be accessed?

• Will the sewer be city sewer, or will it be on site?

• Are utility will-serve letters available, or will they have to be obtained?

• Under what timelines are any improvements by the master developer expected to be made, and what happens if there are delays?

• Where are the utility easements going to be located, and how will they limit any vertical development in their vicinity?

• Is there existing site access available, and if not, how will it be created?

• Are there other existing easements on the property?

• Will new easements on neighboring land be required to service the site? Who is in charge of drafting up those easements and recording them?

All of these questions are important to not only consider, but many of them should be specifically addressed in the PSA. If there’s a delay in the master planner delivering required site work, your investors’ capital could be tied up materially longer than expected. This is why identifying the major risks that are outside of your control and protecting the downside in the PSA matters so much.

Construction costs could rise while interest, taxes, and other holding costs continue to accrue, all of which erode returns for both LPs and your own team. These potential delays and cost overruns need to be addressed before a deal is made, not after contracts have been signed and capital has been called.

As you can probably see, arriving at a price and negotiating a PSA in a complex land deal requires significant expertise and resources. These negotiations typically last several months and can cost hundreds of thousands in legal and other fees. When you factor in the human dimensions of competing personalities, communication styles, and schedule coordination, getting to a signed PSA can be a significant undertaking on its own.

And that’s before the real work of design and construction begins.

The difference between a profitable land deal and a value-destroying one often comes down to how thoroughly you evaluate deal structure, entitlement, and site conditions before you sign. Miss any one of them, and you may find yourself locked into a deal that looked attractive on a per-acre basis but turns out to be unprofitable once reality sets in.

Why Share This?

We are currently working through several land deals across the Mountain West and other markets. The frameworks in this newsletter aren’t theoretical. We’ve been writing versions of this material for our own clients and internal processes, walking through exactly these questions on active deals. At some point it became clear that a wider audience would benefit from seeing how we think about it.

Land deals are where a lot of projects go wrong before they ever really begin. Getting the structure, entitlements, and site conditions right at the outset is the work that protects capital and makes everything downstream possible. We’ve learned this across 35+ jurisdictions and over $1 billion in executed projects, and the more people who understand how this process actually works, the better the industry is for it.

Most importantly, we want to meet and begin building relationships with people who are interested in what we are doing and who believe in how we approach the work, regardless of interest in our current deals.

Send us a note if you’d like to chat!

In addition to our development work in NY, MADDPROJECT provides fee development and professional project management services across the US.

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