Huge Markup on Land Sale / Non Arms Length - How to Value?


Land purchased in 2019.  $3MM acquisition price, with an additional $1.6MM in entitlement costs.  Being "sold" into a JV whereby the seller is part of the new entity at 5% ownership stake/sponsor.  Contract price is $17MM.  No clue why the major spike in value (in less than 5 years and given how land values have been the past few years).  Guessing either retail investors/syndicated equity or the like.  Either way, I called bullshit.  

Development cap stack reflecting the land value as $17MM.  I want to underwrite land at cost and size debt based on that budget.  It would obviously kill the structure from developer's perspective, but isn't this how much lenders/construction lenders tend to look at land basis?

I could understand if the land had been held for a long time and through upzoning or major demographic shifts, it appreciated 4-5x.  But its been 5 years and I'd argue that net-net land values are way below where they were in 2019.

Anyone agree or think I'm missing something in my analysis?


Based on the WSO threads discussing real estate valuation and investment strategies, here's a detailed approach to your scenario:

  1. Valuation at Cost vs. Market Value: Typically, lenders and construction financiers prefer to underwrite land at cost, especially in a scenario where the markup seems unusually high without clear justification. This conservative approach helps in mitigating risk associated with inflated valuations.

  2. Assessing the Markup: A jump from $4.6MM (acquisition plus entitlement costs) to $17MM in less than five years is significant and warrants a thorough investigation. Key factors to consider include:

    • Zoning Changes: Any upzoning or changes in land use that could have significantly increased the value.
    • Development Approvals: Whether any new developments or infrastructure projects have been approved that directly benefit the land.
    • Market Dynamics: Examination of local real estate market trends to understand if there has been an exceptional rise in land values in the area.
  3. Non-Arms Length Transaction: The fact that the seller retains a 5% stake in the JV could potentially influence the sale price, suggesting a non-arms-length transaction. This should be carefully analyzed as it might affect the true economic value of the land.

  4. External Opinions: Engaging independent real estate appraisers or consultants could provide a neutral perspective on the land's value, helping to validate or challenge the $17MM valuation.

  5. Financial Modeling: Adjust your financial models to reflect both scenarios - valuation at historical cost and at the proposed $17MM. This will allow you to assess the impact on the project's financial feasibility and return metrics under different assumptions.

  6. Risk Assessment: Consider the risks associated with overvaluation, such as difficulty in securing financing, potential cash flow issues, and challenges in achieving expected returns.

  7. Stakeholder Communication: If discrepancies or concerns about the valuation persist, these should be transparently discussed with all stakeholders, including potential investors and financial partners, to ensure alignment and avoid future disputes.

By following these steps, you can form a more grounded opinion on the land's valuation and make informed decisions regarding the project's financial structuring.

Sources: Contrarian Thesis: Acquisitions is the Least Interesting Job In Real Estate, Life in Acquisitions (Analyst/Associate), Real Estate Development Modeling, Thinking Like an Investor, Thinking Like an Investor

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Has there been a major change to zoning recently? 

Or, is the land located in a highly restrictive environment? Ie - did they get favorable entitlements in the Town of Southampton which is a notoriously difficult process?

Those were some of the questions I was planning to ask.  Absent something along those lines, it's hard to justify land appreciation of 400% in 5 years.  I also am not debating that developer was able to convince equity to recap him at such a big multiple, but that doesn't mean a construction lender is going to simply nod and agree.  

My other thought was to request that cash profit from land recap be kept in the deal or a large portion be used as equity, although I am sure developer will not want to tie his "profit" up for another 3 years.

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We've done this as the GP with an institutional capital partner on many occasions. The sponsor should get a bump in value for taking the risk to acquire and entitle the parcel and then is "selling" a shovel ready site the the JV entity. We didn't cash out and left the equity in the new JV deal. That said, a 4-5x is aggressive. The simplest way to handle is a land residual on the approved plans or get an appraisal to determine the fair market value of the parcel and therefore the sponsor's bump in value.


Is the debt able to be supported on a permanent loan basis with projected NOI covering DSCR?

If so, it doesn’t matter what the land value was, if the land goes to auction and you believe in efficient markets hypothesis then theoretically the land will be bought at a price the developer can then back into building to a minimum yield which you would have a sense of what’s being seen in the market.

This is very common and not at all outlandish.


Yeah, I mean if you’ve vetted the other costs it would take to execute a property that yields the projected NOI, then you’re only left with the remaining input being land. Assuming everyone has access to the same contractors here, if this thing went to bid, you’re telling me nobody would be happy with the projected return down to a project level +/- what they’re showing in this deal? If so, land isn’t overvalued it would actually likely be supported at that price!


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