Scotsman Guide - September 2011 Commercial Edition

For holders of large amounts of land and lots, implementing sales strategies that maximize value may be difficult. This is especially true for developers of housing developments and multifamily buildings.

Property and asset managers are not equipped to deal with the complex title and legal issues that commonly arise from distressed properties, nor are these companies willing to make all the decisions that may be involved in the construction of, and accompanying lending for, models on distressed lots.

Brokers should know the basic disposal alternatives available for these clients — particularly those who hold large amounts of housing development tracts or actual developments — and be prepared to help them clear these assets or secure new financing.

“Unlike bulk and one-off sales, which have low risk, the takedown sale creates risk for the seller.”

BULK SALES

A bulk sale occurs when a large number of lots are sold through auction or as a package. Its prime value is that it disposes of lots quickly, and it eliminates holding costs.

Bulk sales can occur by packaging a group of properties and selling through an agent. Real estate auctions offer another vehicle for selling properties quickly. Traditional real estate auctions have given way to online auctions today. Competitive bidding for online auctions usually lasts seven to 21 days. Online auction sites also ordinarily allow for direct bids to the owner. A seller can set terms of sale — including the right to reject a bid, even if the reserve price is met — or set time limits for a financed buyer to close. The auction company charges a transaction fee, typically around 2.5 percent.

ONE-OFF SALES

The opposite extreme from a bulk-sales strategy is a one-off sales strategy. In it, the holder sells lots, and the builder/buyer gets its own financing after the lot is sold free and clear. This approach is useful when significant value can be realized and there is demand for the lots. It also may be applicable if an area could rebound in value and the holder does not want to adopt a low-price alternative strategy. This approach is slower but will typically yield the highest price for a lot.

TAKEDOWN SALES

A takedown sales strategy involves selling lots at pre-agreed prices per a schedule. Ordinarily, there are performance standards as to which lots are purchased and when.

If performance standards are not met, the contract is terminated and the deposit is forfeited. It is a best practice to agree to a contract for deed as to the lots to be purchased and when.

This approach can yield good prices for lots, and the speed of disposal, although slower than bulk sales, is faster than one-off sales. Unlike bulk and one-off sales, which have low risk, the takedown sale creates risk for the seller. With a takedown schedule, the seller is responsible for holding costs, taxes, insurance, etc., until the lots are sold. If the buyer terminates, a deposit must cover all losses, but it is often difficult to negotiate a deposit large enough to cover the potential out-of-pocket losses, let alone lost opportunity costs.

SUBOR DINATION

For difficult-to-sell lots, one of the best, albeit risky, alternatives is subordinating the lot to a construction loan. With this approach, the owner is paid for the lot at closing of the completed structure. It is best to set a maximum loan amount on the first-position construction loan and also to get a guarantee from the buyer (who is a de facto borrower with the lot as collateral). If the building doesn’t close in a timely manner, the owner can pay off the construction loan to get in first position (i.e., the owner can pay subcontractors to get a deed in lieu of foreclosure). If foreclosure is necessary, it may be possible to leverage relinquishment of guarantee enforcement to get a deed in lieu or a voluntary foreclosure.

Although subordinating the lot may make it possible for a builder to get financing, the owner may be right back in foreclosure if the closing does not occur. Certain areas may require these extreme measures to get any kind of movement in lot sales, however.

FINANCE LOT AND STRUCTURE

Seller financing has been a common technique for moving inventory in this economic downturn, and real estate sales can benefit from this approach, particularly given limited credit availability. Providing financing for the lot purchase and construction on it can speed up disposal of the holdings and yield an optimal price.

There is the risk that the structure will not be salable and foreclosure will be necessary. In addition, unlike the subordination strategy, the seller must front the money to sell the lot, which creates more risk. Even if the structure and lot sell quickly, there is always the lost opportunity cost of that money. If the structure and lot do not sell quickly, then foreclosure may be necessary and the seller will incur additional delays before a sale is possible.

To reduce the risk of a foreclosure, the lot holder may wish to provide a loan to a builder to erect a structure while maintaining ownership of the lot. The holder can require the builder to sell the lot within a fixed time period or lose its right to a predetermined builder fee. Having a disciplined budget and paying subcontractors directly can help avoid inflated liens. This method allows for fast movement and high prices but at reduced risk and cost than traditional financing. Foreclosure becomes unnecessary because subcontractors can be paid off to get ownership, giving the holder the ability to immediately sell the structure and lot.

In implementing this option, financing a model/spec building or a separate model and spec structure is recommended. In this way, the buyer pool increases because the risk of building delays after an existing home is sold is eliminated. The value of a model is that it creates a base in a subdivision for sales, and buyers get a feel for the work of the builder. The model also creates a stimulus for sales and momentum in a subdivision.

COST-SAVING STR ATEGIES

Building a model or spec building is expensive. It is necessary to keep out-of-pocket building costs as low as possible and leverage marketing of that structure as much as possible to justify the expenditures on construction.

To reduce expenses, find builders whose owners want to benefit as much from the day-to-day labor as the potential profit in the sale of the structure. A small builder may achieve the lowest price for the structure, and a real estate agent, rather than the builder, can then be used as the primary sales driver.