What is development?
In general terms, the word “development” usually describes some kind of positive change. In the world of real estate, the term “development” refers to the process by which a piece of raw land is transformed or upgraded to provide increased value to the stakeholders in that land.
Why develop?
The motivation for developing land is typically a combination of two desired outcomes:
- Profit & wealth creation
- Community enhancement
The best development projects accomplish both of these things in significant measure. Any given geographic area can usually be enhanced by the addition of physical amenities that are currently lacking or insufficient to meet the demand for them. As such, a good development project will not only increase the value of the land that is being developed, it will also increase the value of the surrounding property. Examples might include:
- Parks and golf courses
- Residential dwellings, such as single-family homes and apartment complexes
- Restaurants, retail & entertainment
- Office and professional space
- Commercial and industrial buildings
- Hotels and resorts
Real Estate development can be lucrative for those with the vision to understand how value is created, and the expertise to efficiently bring that vision to fruition. Zoning regulations help determine the general category of development that can happen in a specific area (although land can sometimes be re-zoned). In most real estate development projects, there will be conflicting views about how the land should best be used. Knowing how to navigate these conflicting viewpoints with the various stakeholders is one of the key skills in successful real estate development.
Highest and best use
Developers have a responsibility to improve the land in a way that is the most beneficial to all stakeholders. The phrase highest and best use is commonly used to describe this ideal. Determining the highest and best use is not always an easy task because there are typically many stakeholders in a given project. Examples include:
- Investors
- Engineers
- Adjacent property owners
- Competitors
- Community organizations
- Environmental groups
- Local government
More often than not, each stakeholder group will have a slightly (or drastically) different values hierarchy. These differing values create a wide range of perspectives on what the highest and best use of the land should be. Ultimately, it is a big part of the developer’s job to make a compelling case for why the intended use of the land is the highest and best use, and to overcome whatever objections may be presented. This is an art form that requires a blend of persuasive ability, political acumen, legal understanding, persistence, and perhaps even some lobbying. It is also critical to have people that know how to “read the room” when representing the development at city meetings.
Diligence
In simple terms, diligence is about knowing as much relevant information as possible before committing too many resources to a project. Some examples include:
- Financial modeling to conservatively project the expected return on investment.
- Validation of projections for the potential developed value of the property. Local real estate agents can be a good asset here.
- Accurately forecast the project costs. Builder that have recently completed similar projects in the area may be able to assist.
- Anticipate any potential hidden costs associated with making the land buildable. An engineering firm with local knowledge can help with this.
- Evaluate political and legal obstacles that could hamper the development progress.
Developing for short-term rentals
A common challenge with the short-term rental space is resistance from HOAs and municipalities. One of the great advantages of developing short-term rental properties (as opposed to buying existing properties) is that the developer gets to shape the community. Developers determine whether or not to set up an HOA and what the covenants, conditions, and restrictions associated with that HOA will be. Knowing what you can and cannot do based on zoning regulations and the city codes is critical.
Entitlement
People often think of entitlement as just the process of getting the necessary approvals to move forward with a project. While that is true, it is also important to understand that entitlement is a right of sorts. Entitlement says that if a development complies with certain conditions and parameters – such as would be described in the city code and zoning regulations – then the developer has the right (i.e. is entitled) to move forward with the project. Understanding entitlement from this perspective is important because it helps the developer know when it is time to take off their persuasive hat and put on their legal hat. Entitlement laws help to limit the degree to which the personal biases of city officials affect the approval processes, which also helps to prevent corruption. This understanding may become critical if a development plan is every contested by the city without valid grounds.
Conclusion
Real estate development almost always involves variables that are outside the immediate control of the developer. If you are considering your first development project, there will be many things you don’t know that you don’t know. It is wise to partner with individuals or entities that have experience in navigating these variables. Do your diligence. Make conservative realistic projections. Engage professionals with specific local knowledge to validate assumptions and avoid costly pitfalls. And – perhaps most importantly – choose the right individual(s) to be the face of the development with stakeholders and in city meetings.