Expected Return of Entitling Project
Suppose you buy a property, develop plans for a project, and obtain all variances, entitlements and approvals necessary to start construction on the building.
How much might you be able to sell such a property for? What would the expected return be for entitling the project and selling it to another developer to build?
And how would the buyer value the project? Say they normally target a 20% IRR when they start a project from scratch. You’ve reduced risk and holding period significantly, so would their required return on this be closer to 10%, 12%, 15%?
There isn't a single number. The question is basically how much holding the entitlements reduces risk, and that depends on the project's location and scope. There are some places where the municipal officials will all but throw you a party if you want to develop something...getting permits there will be easier, but won't reduce your risk much. In some other places the opposite is true.
One thing to keep in mind is that entitlements are based on trust to some extent. There's only so much detail that can be packed into a permit, and the members of the planning board/board of appeals/historic commission/mayor's office/etc ultimately need to believe that you'll execute in a way that's consistent with what you promised them. You need them to give you some rope, and they'll be more likely to do it if you're credible. If you sell an entitled project and the new developer then tries to ram through a bunch of changes, that's not going to do you any favors when you try to get your next project permitted. The authorities you need signoffs from won't know whether they can believe anything you say, since you might not be there to execute.
The basic formula is generally cost of plans and associated entitlement expenditures + carry costs on that capital + what is described above, which is basically a subjective "risk premium" of what someone will pay to get a shovel ready deal in a particular jurisdiction.
In a market like Dallas, where entitlements are basically by-right, that risk premium is marginal or non-existent. In a market like Los Angeles, where entitlement is a high-risk endeavor given NIMBY activism and environmental-based challenges, the premium can be huge. There is not a technical formula to calculate it...it's like a cap rate, and really just a reflection of what the market will bear.
I’d lean on this personally a lot in my market. If I am developing to a 5 YOC and my spread to fully stabilized exit is a 4 then I’d maybe value a long political tough entitlement 25-50 bps. Entitlements in tough markets are most of the work and most of the risk.
I mean, this can be very straight forward. Value as entitled/ready to build minus value/cost as-is + cost of entitlements, that is how this would be appraised (i.e. if you needed or wanted to contribute this as "imputed equity" into a deal and the investors/lenders agree to the values). Now clearly, those two "market" values can be difficult to find good comps for, so may take some guessing, but the procedure is very straight forward.
Like others have said, if there is little risk in getting entitlements in place, expect small difference in values. If very risky/time consuming (time is a huge factor), then the difference could be large.
In raw land/agricultural to subdivision/commercial development deals I've seen in places like Florida, the difference in values could literally be 3x to 10x (then subtract cost of process to find profit)... as in land bought for $25k per acre raw/ag becoming worth $75-250k per acre for subdivision development (this is where a change in Future Land Use and/or Development of Regional Impact approval was required, these are far more intense than a rezoning). You can see similar increases in urban land in cities like NYC where the upzone requires city council approval (and myriad of steps additional at various levels) that is often denied or made nearly impossible to obtain.
Depends on your cost basis and upside, I've seen a 1.5 equity multiple to 20x, a lot of factors
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