Jeff Handlin

One of the biggest challenges facing production builders this year is the search for affordable, quality land. In the current environment of escalating land prices and a diminishing pipeline of entitled land it’s crucial not to take the profit out of land development, industry consultant Jeff Handlin tells BIG BUILDER. What is the No. 1 misconception builders have about land strategies?
The No. 1 mistake builders commit in creating and implementing land strategies is when they fail to demand a land development profit margin when self-developing lots. Often home builders pay materially more for undeveloped land than land developers who are competing alongside the home builders for the land. In doing so, the builder forgoes the normal land development margin intrinsic in all land development financial models. Instead, the builder essentially redirects all or a substantial amount of such normal land development margin to the raw land seller in the form of a higher raw land price. This happens more frequently in an upcycle because of the builders’ accelerating need for well-located lots.

This scenario can present big problems because of one four-letter word: risk. Land entitlement and development carries an immense amount of risk—arguably more financial risk than construction of houses. When home builders’ land endeavors do not produce enough incremental profit to counterweigh incremental land risk, then the home builder is effectively taking on substantial risk with no reward.

It’s important to remember that land development companies are very different than home building companies. Each requires a very different set of skills and human capital. A home builder’s land development department requires a culture that fosters the critical ingredients of a successful land development enterprise: proper risk management; and getting the big, costly land development decisions correct regardless of how those decisions might affect next quarter’s earnings.

What can builders do to better seize land-related opportunities?
I believe the most effective land entitlement/development strategy for home builders in the current environment is the following:
—Use internal land acquisition and entitlement professionals to option key land positions, making the land closing conditional upon procuring final entitlements.
—Expend the ‘soft costs’ necessary to plan, entitle, and engineer final approvals on the land.
—Assign the land purchase contracts to third-party land development companies prior to closing on the land. The assignments to the land development companies should dictate the terms by which the builder will purchase developed lots from the land development companies once the lots are finished.

How can home building companies give this area the critical importance it should have?
First, a builder should enact an internal policy demanding incremental profit margin from its land entitlement/development activities commensurate with the incremental risk inherent in self-developing lots. Second, the company must hire the best land development professionals in the industry. In the downturn, homebuilders cut headcount aggressively, often cutting deepest in their land development talent pool. Over the last one to two years, many home builders have hired back plenty of land development personnel; however, many of the best land development professionals in the industry did not return to the ranks of the home builders. One quick way for homebuilders to effectively manage land risk is to ensure they employ the best possible land team.

Jeff Handlin is the president of Denver-based Oread Capital & Development.