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The Third Wheel

Last week I posted on two of three critical players in real estate development: buyers and sellers.  The third wheel, if you will, are the banks.  Most developers and investors use leverage, loans, to acquire and then develop whatever it is they’re working on. Some use less than others, some do all cash deals, but at the end of the day development deals typically have some level of leverage involved.  For all the reasons that don’t need repeating here banks continue to be very reluctant to lend in general, and even more so on development deals.  

Generally speaking, when a developer acquires a piece of land or other development parcel and looks to finance it through a lender, the “deal” if it’s available, is/was something like this:

  • 25-30% of acquisition cost in equity (cash)
  • The bank finances the remaining 70-75% of the initial acquisition
  • The lender also offers construction financing of 100% of the construction cost, assuming that the expected finished value (as determined by an appraiser) is at least 20% more than the total costs.

There are other variables, and of course all banks have their own guidelines, but the structure laid out above was not uncommon.  In terms of real numbers, here is a rough example:

  • Buy a piece of land for $400,000 - put $120,000 down in cash, with the bank financing the remaining $280,000
  • Spend $250,000 on construction, with the bank financing it
  • Total debt upon completion is +/- $530,000 and total cash invested is $120,000 + soft costs (debt service, fees, etc.) of perhaps $30,000 - $150,000 total
  • Total investment is $150,000 debt + $530,000 debt = $680,000
  • To support this structure the value would need to be around $816,000 or more (20% more than total costs).
  • If this all happened as planned, and the property is sold, the seller makes $136,000 on a cash investment of $150,000 - a 90% return thanks to leverage (it would likely be less in actuality due to realtor fees and taxes, etc.)

That is how it used to work.  It is clear that this was probably too attractive and too easy.  Too much was built by too many people who were just trying to cash in on the boom - many investors bid up the prices of just about everything develop-able and the resulting end prices were too high - and the supply too large - to be sustainable.  

Yet now, with market prices down say 20% from highs (much more in some markets), the banks are generally unwilling to lend, and it doesn’t make sense to me for a few reasons.  First, banks don’t want to own property.  I get that. They don’t want to foreclose, selling property or finishing partially complete projects is not their business. Yet if you think back to the example above - and you change the numbers a bit to be less favorable for the developer, you can easily create a scenario where it is hard to imagine a bank losing in nearly any situation.  The bank could require more down and/or more of an equity cushion on the back end.  Let’s say their requirement changes so that you put 40% down and need 30% equity on the back end.  In the example given above that would mean putting $160,000 down and having to have total costs not exceed about $571,000 (on finished value of $816,000).  Would this eliminate many investors and developers from the market?  Sure it would.  Would it also almost eliminate all risk for the bank?  It really would.  

Assuming the lender were comfortable in the ability of the developer to complete the project so the bank wouldn’t get stuck with it, there is very little financial risk.  For the bank to get hurt the property would need to sell for $245,000 less than expected, and it would need to do so in markets that are already down 15-20%.   Could the developer lose money - you bet.  Could the bank? Nothing is impossible, but if you’re not comfortable with that little risk as a lender I’m not really convinced you’re a lender. 

Unfortunately many lenders won’t make these types of loans under any scenario.  That type of close-minded and formulaic approach to lending is exactly what got us in this mess in the first place (check this box, now that, ok, approved!).  I continue to believe that there are many deals that can and should be financed by lenders right now, and that their risk, because of market forces, would be far less than they used to be.  To be fair I know that many of their hands are tied by regulatory agencies, etc., but at the end of the day, lenders lend.  It’s what they do, or should.  

Here is a video on a passive house being built in New England from an article in the NY Times.  Passive houses are common in Europe, yet only a handful have been built in the US.  The ten-year payoff for the extra energy saving features may seem like a lot … but most people spend 30 years paying off the debt on their home.  Starts to seem more reasonable when you think about it like that, doesn’t it?

Beach Replenishment

For as long as I can remember beach replenishment has been an issue on Long Beach Island (and other barrier Islands). Every fall and winter storms batter the coast and take a bite out of the beaches, or worse. In recent years there has been quite a bit of debate on the Island, as oceanfront homeowners in some towns (Long Beach Township, Harvey Cedars, etc) have been approached by their towns and Army Corp of Engineers to not just expand the beaches but also add to the dunes that are in front of most of these homes. In theory this beach expansion both protects the Island and the homes (especially the oceanfront ones) from nasty storms while ensuring that the Islands greatest attraction - the beach - sticks around for the following summer. The issue isn’t as cut-and-dry as it may seem for a few reasons.

One, many oceanfront homeowners contend (correctly, it seems) that adding substantially to the dunes blocks their views from lower levels of their home and reduces the value of their home because of it. There are property rights, market value, views, and the belief held by many that these projects simply don’t work all in the mix. Some have been reluctant or unwilling to sign the easement to allow the Army Corp of Engineers onto their property to make the changes. This has gotten nasty, with some towns threatening to condemn the land and use eminent domain laws to capture the dunes. There have been multiple lawsuits. One was settled this week. Here is the link to the article in the Star Ledger.

I have to admit that I’ve always been in the highly skeptical camp when it come to Army Corp of Engineers projects on the Island. Certainly I am no expert, and if I were lucky enough to own an oceanfront I would consider this carefully. The irony, and challenge, is that both sides of the argument can site the same examples as evidence of why their right. Just last winter, after millions were spent on many local beaches in the fall to replenish them, vast chunks of beach were completely gone in Harvey Cedars and Long Beach Township. It was a serious problem and it does pose legitimate risks to Islanders. The beach and dunes are the only thing protecting homes and the people in them from the power of the ocean.

Are these storms evidence that more beach replenishment is needed or that no amount of it can stop mother nature? Both sides of the argument can point to the same erosion as evidence to bolster their argument.

What bothers me in these issues is the apparent lack of civility shown by the town and some of the homeowners. If you read the article I linked to, you know that Harvey Cedars initially offered homeowners $300 for the rights to their property to build larger dunes. Many people sued. This week one homeowner settled for $150,000, after initially being awarded nearly $500,000 in court (the town appealed). I don’t know the laws, precedent, etc., but a few things really jump out at me.

$300 to $480,000 (the initial court award) is quite a leap. How do two supposedly logical institutions, evaluating the same situation, come to such different conclusions about value and rights?

I suspect that, from the town’s perspective, the $300 was a token payment and that the homeowners should have relented for the better good (town’s perspective), as many did. I also get that, from a practical perspective, a town with an operating budget of $3m can’t go around paying very many $150,000 settlements before it has a substantial problem.

What bothers me is the zero sum game approach taken by all parties involved. The town acts as if there is no value at all in views of the ocean and little disruption in having workers in their resident’s front lawn for months at a time. They offer $300 and guilt people endlessly that don’t accept.

At the same time the homeowners act as if their suffering is far greater than it fairly is. I am staunchly in favor of property rights and I think the homeowners were unfairly being bullied - but I don’t think $480,000 is even close to appropriate, and $150,000 seems crazy to me too.

Both sides, rather than being fair and honest and civilized, act instead as if there is absolutely no merit to the other parties’ argument. It can only be one way or the other. It is either $300 or $480,000 worth of value. I suspect that lawyers would say this is how it “has” to be, and that you can’t concede anything in an argument such as this. Perhaps they are right legally. But this wrong.

The towns should have made a fair and reasonable offer from the start while stating that they realized the issues for the homeowners were fair. I am just making up a number - but my guess is that $20,000 per home would end up being far less than they will ultimately pay in legal fees and settlements. I am sure that some people may still have sued, but I bet a lot less. People don’t like to be treated like fools, and, to me, the town treated these people - their taxpayers - as fools. Moving forward are they ever likely to get someone to agree to $300 again? Would you? If you were one of the folks that thought the town was in the right and took the $300 how would you feel now? If your neighbor was just awarded $150,000 of taxpayer money how would that feel? Nobody wins in these situations because everyone is made to feel the fool. Why not just act reasonably from the start?

Plant Seeds

Yesterday I golfed in the Annual Pat Romano, Sr. golf tournament.  It is to benefit SCARC (Sussex County Association for Retarded Citizens).  Pat Romano Sr. was my dad.  He passed away 8 years ago, on the golf course. 

The tournament is named for him because he started it over 30 years ago to fill a need in the community.  His son, my brother, had downs syndrome.  At that time there was very little support for families coping with this challenge.  So he and his late first wife Gloria got SCARC going.  Later, once he’d married my Mom Susan, she and he continued this commitment through this tournament and many, many other events and time spent bettering the lives of the disabled and their families. Over the years he and my Mom helped raise millions of dollars for organization.  It now has learning centers, group homes, advocacy programs, and the list goes on.  Yesterday alone they raised over $170,000. 

It started with a seed and a hope to help.  Over the course of time that seed turned into a tree.  Its branches aid families all over the county.  He is gone and is missed daily, but his tree remains.  It is nourished by countless other people who never receive the credit they deserve, but care and give just as fully.

The tournament isn’t the only thing named for Pasquale Romano.  SquallCo is too. 

The Trouble With Sellers

Man, this is frustrating.  With the very positive exception of a likely client (more info to follow soon I hope), getting deals done right now is tough.  The trouble continues to be three-fold.  First are the sellers.  Second are lenders (still).  Third are buyers, including me.  This post is about the sellers, I’ll post on the other two this week.

Most sellers continue to have unrealistically high ideas of the value of their land / home. Recently I made an offer on a lot on the Island and inquired on another.  In both cases the property has been available off-and-on for several years. Both are very challenging properties that offer limited appeal to buyers.  Realistically both properties are very unlikely to be purchased by anyone but an investor / developer.  For similar dollars there are plenty of other options on the market that have greater appeal to your typical vacation home buyer.  Most sellers fail to recognize this reality and price their investment home / land as if it is likely to be purchased for move-in value.  If they discount it at all, it’s $50,000 or so.  They are missing the boat.  

For an investor or developer to want to do a project and take on the risk (especially in this market), there has to be upside.  Take a lot where you hope to sell a finished home, upon completion, for $850,000.  Less the cost of sales of 6% your net sale is instantly $800,000.  Subtract $300,000 for construction costs (these are humble) and you’re at $500,000.  To a developer or investor, paying more than $350,000 on the initial acquisition gets risky.  Paying close to or more than $400,000 just doesn’t make sense.  Is this greedy?  I don’t think it is.  

In the scenario I just laid out the developer (buying for say $375,000) would be all in for $675,000 or so - add soft costs and you’re realistically going to have an investment of $700,000 or so on a home you hope to sell for $850,000 and make $100,000 on (don’t forget about the $50k cost of sales mentioned above).  

In this scenario if everything goes well you’ve made about 15% on your investment ($100k / $700k).  The truth is, for the level of risk involved in real estate right now, that’s not great.  It is at the low end of what a developer is willing to consider, and it makes you think two or three times more than you’d like to.  Sure, $100k is no small amount of money, but is it possible you end up selling for $775,000 - you bet it is. Adios profit.  

I don’t expect any seller to care.   I really don’t.  If they can get $550,000 for their knock-down home or lot, good for them.  Really.  But the thing is, they can’t.  When a property has been on the market for years with $5,000 price reductions and it hasn’t sold, it is time to re-evaluate things.  If the seller actually wants to sell the property, they need to realize who the buyers are (in this case, investors / developers) and how they value things.  Without motivation there are no deals made.  Right now, with some limited exceptions, it seems that many sellers, and the Realtors that represent them, still aren’t seeing the actual value in their development-type properties. 

If you’re a seller of a development type property (undesirable house or vacant land) and you actually want to sell your property, you need to understand the way people like me evaluate these things.  If, after doing that, the real value of the land isn’t enough to motivate you to sell, then don’t. Take it off the market.  Wait it out.  If, on the other hand, the real value of the property is enough to motivate you, then market it at the price and get it done.  

The Third Wheel

Last week I posted on two of three critical players in real estate development: buyers and sellers.  The third wheel, if you will, are the banks.  Most developers and investors use leverage, loans, to acquire and then develop whatever it is they’re working on. Some use less than others, some do all cash deals, but at the end of the day development deals typically have some level of leverage involved.  For all the reasons that don’t need repeating here banks continue to be very reluctant to lend in general, and even more so on development deals.  

Generally speaking, when a developer acquires a piece of land or other development parcel and looks to finance it through a lender, the “deal” if it’s available, is/was something like this:

  • 25-30% of acquisition cost in equity (cash)
  • The bank finances the remaining 70-75% of the initial acquisition
  • The lender also offers construction financing of 100% of the construction cost, assuming that the expected finished value (as determined by an appraiser) is at least 20% more than the total costs.

There are other variables, and of course all banks have their own guidelines, but the structure laid out above was not uncommon.  In terms of real numbers, here is a rough example:

  • Buy a piece of land for $400,000 - put $120,000 down in cash, with the bank financing the remaining $280,000
  • Spend $250,000 on construction, with the bank financing it
  • Total debt upon completion is +/- $530,000 and total cash invested is $120,000 + soft costs (debt service, fees, etc.) of perhaps $30,000 - $150,000 total
  • Total investment is $150,000 debt + $530,000 debt = $680,000
  • To support this structure the value would need to be around $816,000 or more (20% more than total costs).
  • If this all happened as planned, and the property is sold, the seller makes $136,000 on a cash investment of $150,000 - a 90% return thanks to leverage (it would likely be less in actuality due to realtor fees and taxes, etc.)

That is how it used to work.  It is clear that this was probably too attractive and too easy.  Too much was built by too many people who were just trying to cash in on the boom - many investors bid up the prices of just about everything develop-able and the resulting end prices were too high - and the supply too large - to be sustainable.  

Yet now, with market prices down say 20% from highs (much more in some markets), the banks are generally unwilling to lend, and it doesn’t make sense to me for a few reasons.  First, banks don’t want to own property.  I get that. They don’t want to foreclose, selling property or finishing partially complete projects is not their business. Yet if you think back to the example above - and you change the numbers a bit to be less favorable for the developer, you can easily create a scenario where it is hard to imagine a bank losing in nearly any situation.  The bank could require more down and/or more of an equity cushion on the back end.  Let’s say their requirement changes so that you put 40% down and need 30% equity on the back end.  In the example given above that would mean putting $160,000 down and having to have total costs not exceed about $571,000 (on finished value of $816,000).  Would this eliminate many investors and developers from the market?  Sure it would.  Would it also almost eliminate all risk for the bank?  It really would.  

Assuming the lender were comfortable in the ability of the developer to complete the project so the bank wouldn’t get stuck with it, there is very little financial risk.  For the bank to get hurt the property would need to sell for $245,000 less than expected, and it would need to do so in markets that are already down 15-20%.   Could the developer lose money - you bet.  Could the bank? Nothing is impossible, but if you’re not comfortable with that little risk as a lender I’m not really convinced you’re a lender. 

Unfortunately many lenders won’t make these types of loans under any scenario.  That type of close-minded and formulaic approach to lending is exactly what got us in this mess in the first place (check this box, now that, ok, approved!).  I continue to believe that there are many deals that can and should be financed by lenders right now, and that their risk, because of market forces, would be far less than they used to be.  To be fair I know that many of their hands are tied by regulatory agencies, etc., but at the end of the day, lenders lend.  It’s what they do, or should.  

Here is a video on a passive house being built in New England from an article in the NY Times.  Passive houses are common in Europe, yet only a handful have been built in the US.  The ten-year payoff for the extra energy saving features may seem like a lot … but most people spend 30 years paying off the debt on their home.  Starts to seem more reasonable when you think about it like that, doesn’t it?

Beach Replenishment

For as long as I can remember beach replenishment has been an issue on Long Beach Island (and other barrier Islands). Every fall and winter storms batter the coast and take a bite out of the beaches, or worse. In recent years there has been quite a bit of debate on the Island, as oceanfront homeowners in some towns (Long Beach Township, Harvey Cedars, etc) have been approached by their towns and Army Corp of Engineers to not just expand the beaches but also add to the dunes that are in front of most of these homes. In theory this beach expansion both protects the Island and the homes (especially the oceanfront ones) from nasty storms while ensuring that the Islands greatest attraction - the beach - sticks around for the following summer. The issue isn’t as cut-and-dry as it may seem for a few reasons.

One, many oceanfront homeowners contend (correctly, it seems) that adding substantially to the dunes blocks their views from lower levels of their home and reduces the value of their home because of it. There are property rights, market value, views, and the belief held by many that these projects simply don’t work all in the mix. Some have been reluctant or unwilling to sign the easement to allow the Army Corp of Engineers onto their property to make the changes. This has gotten nasty, with some towns threatening to condemn the land and use eminent domain laws to capture the dunes. There have been multiple lawsuits. One was settled this week. Here is the link to the article in the Star Ledger.

I have to admit that I’ve always been in the highly skeptical camp when it come to Army Corp of Engineers projects on the Island. Certainly I am no expert, and if I were lucky enough to own an oceanfront I would consider this carefully. The irony, and challenge, is that both sides of the argument can site the same examples as evidence of why their right. Just last winter, after millions were spent on many local beaches in the fall to replenish them, vast chunks of beach were completely gone in Harvey Cedars and Long Beach Township. It was a serious problem and it does pose legitimate risks to Islanders. The beach and dunes are the only thing protecting homes and the people in them from the power of the ocean.

Are these storms evidence that more beach replenishment is needed or that no amount of it can stop mother nature? Both sides of the argument can point to the same erosion as evidence to bolster their argument.

What bothers me in these issues is the apparent lack of civility shown by the town and some of the homeowners. If you read the article I linked to, you know that Harvey Cedars initially offered homeowners $300 for the rights to their property to build larger dunes. Many people sued. This week one homeowner settled for $150,000, after initially being awarded nearly $500,000 in court (the town appealed). I don’t know the laws, precedent, etc., but a few things really jump out at me.

$300 to $480,000 (the initial court award) is quite a leap. How do two supposedly logical institutions, evaluating the same situation, come to such different conclusions about value and rights?

I suspect that, from the town’s perspective, the $300 was a token payment and that the homeowners should have relented for the better good (town’s perspective), as many did. I also get that, from a practical perspective, a town with an operating budget of $3m can’t go around paying very many $150,000 settlements before it has a substantial problem.

What bothers me is the zero sum game approach taken by all parties involved. The town acts as if there is no value at all in views of the ocean and little disruption in having workers in their resident’s front lawn for months at a time. They offer $300 and guilt people endlessly that don’t accept.

At the same time the homeowners act as if their suffering is far greater than it fairly is. I am staunchly in favor of property rights and I think the homeowners were unfairly being bullied - but I don’t think $480,000 is even close to appropriate, and $150,000 seems crazy to me too.

Both sides, rather than being fair and honest and civilized, act instead as if there is absolutely no merit to the other parties’ argument. It can only be one way or the other. It is either $300 or $480,000 worth of value. I suspect that lawyers would say this is how it “has” to be, and that you can’t concede anything in an argument such as this. Perhaps they are right legally. But this wrong.

The towns should have made a fair and reasonable offer from the start while stating that they realized the issues for the homeowners were fair. I am just making up a number - but my guess is that $20,000 per home would end up being far less than they will ultimately pay in legal fees and settlements. I am sure that some people may still have sued, but I bet a lot less. People don’t like to be treated like fools, and, to me, the town treated these people - their taxpayers - as fools. Moving forward are they ever likely to get someone to agree to $300 again? Would you? If you were one of the folks that thought the town was in the right and took the $300 how would you feel now? If your neighbor was just awarded $150,000 of taxpayer money how would that feel? Nobody wins in these situations because everyone is made to feel the fool. Why not just act reasonably from the start?

Sunrise this morning.

Sunrise this morning.

Plant Seeds

Yesterday I golfed in the Annual Pat Romano, Sr. golf tournament.  It is to benefit SCARC (Sussex County Association for Retarded Citizens).  Pat Romano Sr. was my dad.  He passed away 8 years ago, on the golf course. 

The tournament is named for him because he started it over 30 years ago to fill a need in the community.  His son, my brother, had downs syndrome.  At that time there was very little support for families coping with this challenge.  So he and his late first wife Gloria got SCARC going.  Later, once he’d married my Mom Susan, she and he continued this commitment through this tournament and many, many other events and time spent bettering the lives of the disabled and their families. Over the years he and my Mom helped raise millions of dollars for organization.  It now has learning centers, group homes, advocacy programs, and the list goes on.  Yesterday alone they raised over $170,000. 

It started with a seed and a hope to help.  Over the course of time that seed turned into a tree.  Its branches aid families all over the county.  He is gone and is missed daily, but his tree remains.  It is nourished by countless other people who never receive the credit they deserve, but care and give just as fully.

The tournament isn’t the only thing named for Pasquale Romano.  SquallCo is too. 

The Trouble With Sellers

Man, this is frustrating.  With the very positive exception of a likely client (more info to follow soon I hope), getting deals done right now is tough.  The trouble continues to be three-fold.  First are the sellers.  Second are lenders (still).  Third are buyers, including me.  This post is about the sellers, I’ll post on the other two this week.

Most sellers continue to have unrealistically high ideas of the value of their land / home. Recently I made an offer on a lot on the Island and inquired on another.  In both cases the property has been available off-and-on for several years. Both are very challenging properties that offer limited appeal to buyers.  Realistically both properties are very unlikely to be purchased by anyone but an investor / developer.  For similar dollars there are plenty of other options on the market that have greater appeal to your typical vacation home buyer.  Most sellers fail to recognize this reality and price their investment home / land as if it is likely to be purchased for move-in value.  If they discount it at all, it’s $50,000 or so.  They are missing the boat.  

For an investor or developer to want to do a project and take on the risk (especially in this market), there has to be upside.  Take a lot where you hope to sell a finished home, upon completion, for $850,000.  Less the cost of sales of 6% your net sale is instantly $800,000.  Subtract $300,000 for construction costs (these are humble) and you’re at $500,000.  To a developer or investor, paying more than $350,000 on the initial acquisition gets risky.  Paying close to or more than $400,000 just doesn’t make sense.  Is this greedy?  I don’t think it is.  

In the scenario I just laid out the developer (buying for say $375,000) would be all in for $675,000 or so - add soft costs and you’re realistically going to have an investment of $700,000 or so on a home you hope to sell for $850,000 and make $100,000 on (don’t forget about the $50k cost of sales mentioned above).  

In this scenario if everything goes well you’ve made about 15% on your investment ($100k / $700k).  The truth is, for the level of risk involved in real estate right now, that’s not great.  It is at the low end of what a developer is willing to consider, and it makes you think two or three times more than you’d like to.  Sure, $100k is no small amount of money, but is it possible you end up selling for $775,000 - you bet it is. Adios profit.  

I don’t expect any seller to care.   I really don’t.  If they can get $550,000 for their knock-down home or lot, good for them.  Really.  But the thing is, they can’t.  When a property has been on the market for years with $5,000 price reductions and it hasn’t sold, it is time to re-evaluate things.  If the seller actually wants to sell the property, they need to realize who the buyers are (in this case, investors / developers) and how they value things.  Without motivation there are no deals made.  Right now, with some limited exceptions, it seems that many sellers, and the Realtors that represent them, still aren’t seeing the actual value in their development-type properties. 

If you’re a seller of a development type property (undesirable house or vacant land) and you actually want to sell your property, you need to understand the way people like me evaluate these things.  If, after doing that, the real value of the land isn’t enough to motivate you to sell, then don’t. Take it off the market.  Wait it out.  If, on the other hand, the real value of the property is enough to motivate you, then market it at the price and get it done.  

The Third Wheel
Beach Replenishment
Plant Seeds
The Trouble With Sellers

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