HOW TO MODEL LAND VALUE VS COST IN A RE PRO FORMA
Can someone help me understand the following:
Lets say I buy a piece of property for $2.5mm and after the entitlement process, its value increases to $5mm. Now I want to raise debt and LP equity and I will be contributing the land valued at $5mm as GP equity. How do I model this on a project level Pro Forma and on the Capital stack?
because if I increase the land cost to $5mm:
1. Value doe not equal cost / cash outflow, so modeling this as a $5mm cash outflow would be false
1. Therefore it skews the returns of the project so negatively that it becomes unattractive
Basically, the total development cost of the project would need to be $2.5mm and the capital stack / partnership would need to show the actual value $5mm.
I mean the LP and lender will be buying into the venture based on a $5MM land value. So that will match the actual cash outlay.
You'd do two separate models. One model for you (and any partners) who are buying the land at $2.5mm and doing the entitlement work, and one for the future partners/debt providers who are getting the land at a $5mm value for the project. You're solving to two separate returns for two separate risk profiles. I would start backward from the 2nd model - with construction costs and forecasted NOI of whatever I am planning to build, at whatever return a developer would require on a new development (150-200bps+ north of spot cap rates), solve to an entitled land cost. Then take that value ($5mm in your example) and solve backward to what you can pay for it today given the entitlement process/costs/risks. As you move into 2nd phase of project, you're going to have a separate return waterfall for the two groups of investors, so you will run model #2 to get the cash flow to all investors in the development and drop the portion that gets paid to you as GP into model #1 to get returns/splits to the investors in the original dirt.
Simple example: you want to build a multifamily project on a site that is zoned for something else today. Coastal submarket, need +/-6% stabilized return on cost for your multifamily development - $45mm of project costs (excluding land) and anticipated NOI of $3mm means that your entitled land is worth $5mm. Assume it's a discretionary entitlement process with a little bit of hair, so you'd want opportunistic returns on that part (20%+). Assume you're going to spend $100k in entitlements and it's going to take you 3 years, a 25% annual return would result in a value you can pay for the dirt today of $2.5mm.
Project level model will have the land at the new value - if it's worth that you should be looking at it as the opportunity cost vs. selling (i.e. if you wouldn't do the deal at market value of land, you may be better off selling it).
Then above project level for the GP you're going to show their cash flow starting from time of original acquisition at the cost they paid rather than the new land cost new investors are coming in at, but the GP will also receive an outsized share of distributions than that cash outflow would suggest because they're getting a lift in their equity value from contributing the land (i.e. if total equity is $20M and land is worth $5M, the party contributing land will get a 25% ownership share rather than the 12.5% their $2.5M cash injection would suggest).
Alternatively as said by another poster you can run two separate models.
If you're contributing the land to the jv valued at $5million then you would be showing a $5mm cash outflow. If $5 million dollar land makes the project unattractive then something needs to change.
I really hope you're not a RE Director as your title implies
Wat
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