When you participate in a Trust Deed investment at Ignite Funding, you are essentially acting as a private lender for real estate development. As a private lender, it is vital to have a greater understanding of the different phases of development and what they entail. Contrary to popular belief, there is more to real estate development than simply erecting a building on a piece of land.
Understanding the different phases is important for investors to be able to understand how the borrower intends to utilize their financing for the project. This knowledge is also important for investors to be able to recognize the value a borrower can add to a property in any phase, that there are inherent risks in each phase, and how the combination of added value and Ignite Funding prerequisite steps help to mitigate those risks.
The different phases of development at their fundamental level are referred to as acquisition, horizontal development, and vertical construction or rehabilitation. Let’s take a more in depth look at the acquisition phase.
The Acquisition Phase
There’s more to it than meets the eye.
Borrowers can purchase land at different stages of development, not just raw land. For example, the property could already be zoned for specific type of development, or it could be partially developed with basic street work and utilities in place, or it could have an existing home or multiple pre-existing commercial use buildings.
What the borrower intends to do with the property will be affected by the stage of development of the property. That is why the acquisition phase is often comprised of more than just the initial purchase of a property. Some big-ticket items this phase can include are general feasibility and engineering feasibility studies on the subject property, zoning & entitlement, tentative and final map approval from the city or county.
Debunking common misconceptions.
“There’s no other stage of development that can add the single most amount of value than on the acquisition,” states Pat Vassar, Ignite Funding’s Director of Underwriting. “You can put a ton of equity into a property primarily through the zoning and entitlement of the land and by buying right.”
For example, in Nevada, when the Bureau of Land management sells land to private individuals, it is sold as R-2 zoned land. R-2 zoned land is where two homes can be built per acre. 99% of the time that land is rezoned. Rezoning adds a tremendous amount of value for two main reasons. First, the buyer of the land will know exactly what they can develop/build. Second, it takes timing out of the whole process.
“Time is money in real estate. When you reduce the amount of time it takes for a developer to acquire the property all the way through to selling to an end-user, you have increased the lands value because a developer would pay more for a quicker turnaround,” says Mr. Vassar.
During the entitlement process, the property has already been zoned. For example, someone purchases a property originally zoned for commercial use that will allow for retail and office space. They then build a site plan for specific tenants and property design that will maximize the property’s value for its intended use.
“Entitling the land takes a lot of the guess work out for the next person in line, which is usually the developer that will turn the raw land into a finished lot,” affirms Mr. Vassar. “Again, this adds tremendous value by removing more of the unknowns and shrinking the timeframe for the next developer.”
There are even situations where value is added upon the acquisition of the property. For example, if a borrower purchases a retail center that is currently undervalued, value is increased even before the borrower begins physical improvements or simply leases up vacant space or inserts more reliable tenants.
As you can see during this phase, there is a lot of work done behind the scenes as well as resources invested into the project before a borrower can even move into the next phase or sell it to the next developer.
The risks and how to mitigate it.
When acquiring raw land, the biggest risk is the unknowns. Will the local government approve the proposed zoning and/or entitlement plan? Will the local government only approve a portion of the plan? How long will the approval process take? What will they find on the property once acquired?
Different governments have varying rules and regulations which will affect properties purchased in different locations within the same state. City planning committees also have varying amounts of times that they will meet to discuss zoning and entitlement proposals. For example, if you are waiting on revisions or requests for more reporting from a committee that only meets once a month, you will be subject to the meeting intervals; time is key in real estate transactions.
However, as we discussed above, when a borrower acquires a property that is already zoned and/or entitled, that dispels much of the unknowns associated with raw land. This puts the developer in a much better position to completing the project as planned.
Ignite Funding deploys a few strategies to help mitigate risk for investors. For example, if a borrower approaches Ignite Funding for financing the acquisition and the zoning and entitlement process, then Ignite Funding will go to the city planners beforehand to discern the likelihood of borrower’s plan being approved. If we know that it is part of the city’s master plan for growth of a certain area, then we have a better understanding of what is more likely to be approved. Ignite Funding will also make sure that some of the feasibility studies have been completed so that we know the borrower is purchasing the property with a plan in mind, not just because they like the property and the location.
If the borrower is financing a property with an existing commercial property, then Mr. Vassar will travel to walk the property in person. If there are improvements that need to be done for new or existing tenants, or to improve the site in general, then we make sure that we are comfortable with the rehab costs associated with it as well as the after-repair value. After repair value ensures that even if the borrower faces unexpected cost overruns, they will still be profitable.
In the same example, if there is a high vacancy, Ignite Funding also makes sure that the borrower has tenants in tow or a lease-up plan in place. We also make sure that the borrower has the ability to negotiating renewals with existing tenants that have contracts that are close to expiring, which adds additional value to the property.
As you can see, acquisition projects can provide investors with a vast number of opportunities for diversification within just this one phase. If you are a less seasoned investor, we hope that this knowledge will help you become more confident with investing in these types of projects. Of course, it is always important to evaluate your threshold for risk before engaging in any investment opportunity.