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Hi Guys,
In a land development scenario, how does one go about modeling a deal where the landowner contributes the land as equity and only gets paid once the development pre-sales are complete or at target level which the bank would require.
Here we are starting to see developers looking at more creative ways to enter in deals and not take land risk.
Do I just enter the LP contribution equal to land purchase price and adjust hurdles to 1x pref, and then add a promote?
I have come across across mechanisms that seem to have been used in Australia called land option agreements.
Have any of you come across this in your journey?
Hi JP,
This is a great question and also a somewhat common approach to land development that, as you said, reduces the dollars at risk to a developer. In these types of scenarios, the more common approaches would be (1) for a developer and land owner to enter into an option agreement whereby the developer locks up the exclusive right to purchase the property upon reaching a certain milestone (in your case, completion of pre-sales) or (2) the developer and land owner reach an agreement on land value and the land owner contributes the land to the partnership with an account credit equal to that price and rides along for the development process to get a return at exit based upon the agreed upon partnership structure. The second scenario, like any development JV, is subject to endless scenarios that can be negotiated about how this would actually work between the partnership.
For your specific example, unless I’m misunderstanding, it sounds more like scenario 1 above because there is a set purchase price paid to the landowner upon reaching a milestone and they are not participating in any further upside. In that case, I would most likely not consider the land owner an LP and would treat the land purchase as just that. So my thought would be to put the land purchase price in the budget section of the model and in the Land line item in your cash flow projections create a formula that triggers the purchase price to hit upon reaching the milestone. In this case, it would refer to completion of pre-sales, so the formula logic would be something like ‘if condo pre-sales equal 100% in this period then give me the land purchase price, if not, then give me zero’.
Hope that answers the question and let me know if you have follow ups.
MB
To follow up a little bit more about options and address your thinking about land as equity in this scenario; with option agreements, the landowner is not actually contributing the land as equity to the venture, but is really agreeing to sell the land at an agreed upon price at a certain date in the future, while giving the potential buyer the exclusive right to lock up the property for that period of time so that no one else can come along and buy it. This allows the potential buyer to go through any number of processes that will both remove risk and also justify the purchase price. In many cases, the process might be getting entitlements or reaching a certain amount of pre-sales or securing a tenant, for example. If the potential buyer fails, then he or she can simply walk away and not purchase. Options are always negotiated, so there can be costs associated with them where the buyer will have to pay the seller fees for the option regardless of the outcome. Free options are also common that have no costs associated with them.
Hope that adds further clarity.
Hi Michael,
Thank you very much for your feedback. This did help me guide my discussion a lot.
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