Land and build

Underwriting Land and What You Build On It

CREMODEL · underwriting notes

Buy the land, put buildings on it, lease them, sell. The only number that matters is what the finished project yields on everything it cost you to get there.

A development deal is not an acquisition with extra steps. There is no in-place income to apply a cap rate to, no rent roll to inherit, and no stabilized year until the buildings open. What there is instead is a total project cost and a stabilized income you are underwriting toward, and the gap between the yield on that cost and the cap rate you will exit at is the entire deal.

Construction belongs in the basis

This is the single most common way a ground-up model flatters itself. If the build cost is treated as capital expenditure in the year it is spent rather than as basis, then yield on cost gets measured against the land price alone. A project that cost $4.8 million and stabilizes at $381,000 of net operating income reads as an 8% yield when the construction is in the basis, and as something absurd when it is not. The loan sizes off the same figure, so the error compounds: too much leverage against too little basis, and a development spread several hundred basis points better than the deal actually is.

A pad and a shop building are different risks

A build-to-suit for a credit tenant on a fifteen-year corporate lease is close to a bond once it opens. You know the rent, the term, the escalations and the allowance before you break ground, and the covenant is investment grade. Cost per foot is high. A small pad with a drive-through can run past $550 a foot. But so is the rent, and there is no leasing risk.

A speculative shop building is the opposite. It goes up at $250 to $300 a foot, and then you have to lease it: four suites, second-generation allowances that do not exist because the space is new, full commissions on every deal, and months of carry between certificate of occupancy and the first rent check. Model the two on separate lines with their own delivery dates, because they deliver on different schedules and they carry different risk.

Nothing earns until it opens

Square footage should join the building on the day it is delivered, not on day one. That matters for more than the rent: the recoverable pool, the management fee, the reserve and every per-foot operating cost should apply to the floor area that exists in that year. A model that charges the full stabilized expense load from year one on a building that does not open until month twenty will understate the return, and one that credits the full income from year one will overstate it by considerably more.

Expenses do not compound quietly through a build

The assessor is the obvious one. Raw land is assessed as raw land, and the year after the buildings open the tax bill is a different number entirely. Not the land figure grown at 3%. Set the year and the new figure rather than letting the growth rate carry it, or the model will understate the single largest recoverable expense for the whole hold.

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