Why Full-Scale Land Development is Not Solely Done by Homebuilders

The full range of developing raw land into residential construction is becoming too much a risk for companies that build homes. The task is now split, with good results.

Home builders in the UK have traditionally functioned as developers. This means they took on everything from buying land to developing streets and utility infrastructure to building the homes. If the homes are priced right for the market – and meet market expectations for what a home should be – they made a good profit.

But the housing crisis in the UK suggests that this formula is no longer working effectively as it once did. Despite a robust increase in the population (2011 Census found that, overall, the country grew by 7% in the previous decade) and a historically underbuilt environment, homebuilders were unable to undertake the traditional risks of building. While the population grew by about 4 million people between 2001 and 2011, only 1.4 million homes were built in the same time period. The average home has slightly more (by statistical averages) than two people, suggesting that this rising population is underserved. Consequently, the price of homes has risen even while lending standards have reduced the numbers of qualified buyers. About 270,000 new homes built per year would satisfy population growth, according to the (now defunct) National Housing and Planning Advice unit.

That said, growth and demand are not uniform across all regions of the country. London and the South East have high demand, while the Midlands and elsewhere (including Wales) have lower economic growth and therefore lesser demand and wherewithal for housing. And in surprising niches here and there, there is an absolute demand for new homes.

This is where the creativity has come into play. Instead of taking on the full sequence of development – buy, plan, build infrastructure, build homes, then sell – home builders increasingly rely on strategic land specialists and their investment partners to bear some of the risk, do part of the work and share the reward. The land specialists and investors therefore do the following:

1. Identify local housing needs – Land specialists study economic, business development and other data to learn where new housing is most critically needed.
2. Identify appropriate sites – Within an identified market, land investment groups search multiple locations to determine where the best opportunities lie for optimal return on investment.
3. Understand local planning authority preferences – Land is not acquired without knowing the local predisposition to make zoning changes that would allow residences to be built where another use, such as agriculture, is the status quo.
4. Negotiate a purchase – One or several landowners need to be approached with an offer. Needless to say, this needs to be done within clear financial parameters.
5. Work with local planning authorities to achieve use designation changes – Once the land is purchased, a strategic rezoning must be pursued. This is more possible under the new National Planning Policy Framework (NPPF), which grants local authorities more discretion than in the past. Local authorities are now encouraged to free up between 5% and 20% of land for housing.
6. Construct development site infrastructure – With that land-use change, the land investors will fund construction of streets and utilities that provide homebuilders with a ready-made place for residences.
7. Sell to homebuilders – This is where the homebuilders pick up the programme. They buy single or multiple lots, build the homes then sell them. Of course, their capital investment in structures is significant, but it’s less money carried over a shorter period of time than if the six previous steps had been their responsibility.

Individuals who are interested in the land investment phase – up to and including step 6 above – should do so in partnership with experienced land investment specialists. And at that, they should consult with a personal financial advisor to determine if such an investment fits their overall investment goals and objectives.

What is the Root of Home Shortages in the UK?

Speaking of ‘the UK housing shortage’ misses the point. Cities Outlook 2013 says thatlocalizing the problem might be the national solution.

It is conventional wisdom in the United Kingdom that there is a housing shortage. And while that in fact is quite true and is evident in the high cost of housing overall, it is wrong to think the shortage is emblematic of only the economic downturn since 2007. In fact, this shortage goes back at least 30 years and arguably is due to failures in government policy in combination with robust population growth.

Various economics and population studies suggest that approximately 232,000 houses or housing units need to be constructed per year, simply to keep up with population growth (about 7% over the past decade, according to Census 2011).  But since the mid-1980s, housing completions by the three main sectors – private enterprise, housing associations and local authorities – have exceeded that number only once. The shortfall has been cumulative and has rapidly gotten worse since the burst of the housing bubble that peaked in Q3 2007.

But the actual picture of housing shortages is mixed when examined city by city, according to a report titled Cities Outlook 2013, sponsored by The Centre for Cities and supported by the Local Government Association. According to their study, the problems in the housing sector vary considerably from city to city. London currently has the least affordable housing and highest demand found today, in 2013, greater than it was in 2007. This same situation of elevated prices and high demand is found in Cambridge and Bristol. In weaker economies (Hull, Hastings and Middlesbrough, for example) prices are lower, the existing housing stock is poor and jobs are lacking, illustrating how housing inventory is a vastly different picture and subject to, but not a driver of, local economic conditions (the quality of local jobs and connectivity to other markets are more influential to those economies).

This matters more than just how crowded and unaffordable housing has become. The Cities report also details how housing markets impact local economies in three key areas:

• Business and enterprise – A robust housing market, where buying and selling transactions occur, stimulates several industries: construction, estate agents and the mortgage industry, to name a few. When housing is expensive, it effectively puts a cost burden on business if companies need to pay more to attract essential workers to an under-built area.

• Labour markets – Workers are drawn to not just jobs but an area’s quality of life, therefore outsized housing prices tend to discourage labour mobility. And for those workers who move to expensive housing markets, consumption of other goods subsequently declines, negatively affecting the local economy.

• Infrastructure – Housing development is intrinsically related to transport infrastructure and consequently needs to be considered holistically: Build the roads and rails from public coffers as private investors and perhaps housing associations add to housing inventory.

According to Cities Outlook 2013, the crux of the problem is that housing policy and programmes are set on a national level. This then fails to address local challenges and opportunities (e.g., the Infrastructure point above). For example, some of the locales where housing is more plentiful (indeed, many properties are abandoned but could be rehabilitated) benefit little from new-construction incentives (which is how the “Help to Buy” scheme is largely focused).

Initiatives such as Get Britain Building, changes to the National Planning Policy Framework and the New Homes Bonus accomplish this inadequately, says the report. It acknowledges the Localism Act does this in part, but argues instead to jumpstart home building in 2013 by two means: focus government policy on development in the specific cities where housing demand is greatest, and incentivise retrofits and reconfigurations as well as new-build development. To this latter point, the government should look at cities where vacancy rates are highest then target funding and zoning powers to retrofit and build new, whichever makes the most sense (i.e., allow for local decision making).

Without question the role of the private developer is essential – centralised development that is too heavily focused on social housing does not lead to a balanced and thriving community. Increasingly, private development of housing involves groups of investors who work with professional strategic land buyers, who themselves develop raw land or brownfield properties where demand is greatest (and where public policy is amenable to such development).

Individuals who are unschooled in land development should consult with a qualified personal financial advisor to determine how and where their money can be wisely invested in housing development. As should be clear, it is a complex arena where special skills are extremely important.

Understanding Property Funds

A property fund allows investors to participate in real estate opportunities with the added benefit of diversification.

With greater awareness of the opportunities present in the current real estate market, many investors are looking carefully at property funds. The volatility of traditional investments, especially publicly traded stocks and bonds, drives interest and investment in various forms of real estate and property investment instruments.

A property fund allows the investor to diversify – and minimise risk – by buying multiple properties that are appropriately vetted (before acquisition) and managed (after acquisition) by skilled property fund managers. This differs from individual investors who are sole owners of single or multiple parcels of land. The lone investor may face headwinds from external factors, such as change-of-use resistance or an adverse change in local economics, whereas a property fund will strive to avoid such situations. While the nature of land will always be subject to externalities, the diversified nature of property funds leaves the investor with proportionately less exposure.

An alternative to a property fund is a REIT (real estate investment trust) fund; however, the two have key differences. A REIT is more liquid – an advantage to some investors and a disadvantage to others. But this also tends to subject the investor to market volatility, something avoided by a trust fund. REIT funds incur management fees that are generally greater than those found with property funds.

Understanding Joint Venture Investments

There are many advantages to joint venture investments, including how the partners can bring experts together with a pool of investors.

Joint venture investments are vitally important to many types of enterprises: For new or revitalising companies, in technological research, and to businesses that work across national borders (where the joint venture partners bring financing and local expertise together). Joint ventures in real estate are a special category because of the nature of land development.

To the individual investor, a joint venture investment in land provides several advantages. A lone investor would bear all the risks – and rewards – of real estate development. But this can be too large an exposure for many individual land investors. The advantage of a joint venture investment in land is that individual investors can participate in larger acquisitions with better knowledge, expert management and economies of scale.

The nature of land investing raises many questions. Is it ripe for development? Are there barriers to development, such as local zoning or economic uncertainty? What are the opportunities that are not readily apparent to investors who are geographically removed from a particular parcel? In a joint real estate venture, appropriate expertise and analytical tools can help to answer these questions.

In a recovering economy, land located in favourable regions, counties and countries offers promise for capital growth through development as well as from market forces. Joint venture investors have already begun to seize the opportunity.

The Role of Property Fund Managers

Good property fund management bolsters the strength of real estate investments.

The attraction of historically low land valuation is compelling investors to consider real property as an important complement or even lynchpin of their financial strategies. Because most people lack deep familiarity with real estate and land investing and how to discern a smart acquisition from a poor one, investors depend on property fund managers to guide them in their investment choices.

Managers of property funds will follow a strategy, such as a focus on warehouses, retail centres, hotels and resort properties or undeveloped land. Typically, fund managers expect most of the land it acquires to be sold to developers involved in house building.

These strategies adapt to evolving market conditions, of course. A good example of a fund management strategy is one that considers how residential homebuilders are decoupling their role of cost-effective housing delivery from that of land acquisition. That presents opportunities for property fund managers to prepare and deliver land that is ready for construction. The specialists who manage those funds are experts in the acquisition, design, master planning and promotion of sites.

In that same example, it is beholden on the property fund management firm to first identify – on behalf of investors – where the best opportunities lie in land acquisition. They are attentive to where population and economic conditions will drive housing or other needs for land development and to where local authorities are likely to allow rezoning or change-of-use plans to accommodate the kind of development that will ultimately be profitable to all stakeholders.

Property Fund Partners and their Role in Land Investment

The investor looking to take advantage of real estate opportunities is wise to find property fund partners to manage his or her risk.

The uncertainties and risks associated with all investments – publicly traded stocks and bonds as well as alternative investments such as hedge funds and real assets (real estate, for example) – require all investors to work with trusted and competent advisors. Nowhere is this more important than when investing in land. Variability between real estate choices compels the investor in most instances to work with property fund partners who know how to mitigate risk and maximise returns. These partners will work with its own in-house team of experts as well as strategic partners across the market.

The confident lone investor may be someone with an education and career experience in land and land development. But the vast majority of investors choose to work through a diversified portfolio fund, where the smart acquisition and management of multiple parcels of property limit their exposure. The fund or funds they select are only as strong as the expertise and skills of the land fund managers.

It is those skills that enable the property fund partners to succeed for their client-fund participants. They identify where the maximum asset returns can be found and what optimal external factors are present. Externalities include local development and planning schemes, trends within a local economy and competing properties in the district. Fund managers also assemble a portfolio of properties with a variety of characteristics that will take advantage of a variety of market conditions – again, to mitigate exposure.

Add to this the fact that investors have their own set of tax strategies that can be affected by land investing and it's clear that property fund partners play a vital role in creating a holistically profitable asset for the investor.

Joint Venture Land Opportunities in the UK

The joint venture land opportunity of today is to anticipate where post-recession growth will increase demand for housing and businesses.

Land investors – especially those interested in investing in strategic land – are currently focused on the UK, where a chronic shortage of housing means demand for land is high – and growing.

Global and local economic forces, in combination, are making joint venture land opportunity investing a particularly compelling scenario for investors.

Let us analyse how that works and its consequences. To the land investor, the depressed price of real estate caused by the worldwide economic downturn is a distinct factor – and opportunity. An economic recovery could well unleash demand for housing and commercial construction, which would consequently increase the price of land with relative speed. In some jurisdictions, the desire to attract residents and businesses creates a willingness to enact a change of use on key parcels of land.

Investors who are wary of the exposure from “going it alone” instead use joint ventures to purchase, manage and resell land. This enables the purchase of larger and perhaps more strategic tracts of property, often without borrowing money. A joint venture will also corral the talents of specialists in real estate acquisition, development and management who provide an important bridge between financiers and real property. That expertise can allow the partnership to focus on the most profitable part of the land development process: acquiring sites that have been identified to come forward for residential or mixed-use development but do not yet have detailed plans or permissions.

More investors see such JV arrangements as enabling them to achieve a balanced, diversified portfolio. Real estate has historically performed well and is in fact the source of wealth creation for a large proportion of individuals of high net worth. Current market conditions are thought to provide a rare opportunity for rapid valuation increase.

Can Investors in Property Funds Participate at Varying Levels?

Discover the different levels of participation in property fund investments.

The range across which investors can grow assets includes REITs, joint land investments and sole ownership of vast tracts. Each offers advantages and disadvantages.

Building wealth through buying, selling and holding land is a time-honoured tradition across the world and throughout history, in the U.K. as anywhere else. It is not fool proof, of course – everyone and anyone could get rich if it were – but at least the means by which one can invest in land are now more varied than ever before. It is possible to own shares in a real estate investment trust (REIT) for a few hundred pounds, just as the land barons of today own thousands of hectares in Britain and elsewhere.

REITs’ rules in the U.K. have been in effect since 2007, and are lauded for providing investors a means to access property value increases without having to buy the property itself.

However, REITs are traded publicly and tend to rise and fall with general market trends. The owner of REIT shares has no involvement in the actual properties, therefore value growth is entirely a function of the markets and the broader economy. Performance by REITs shares in the economic downturn since 2008 has been unkind to shareholders.

At the opposite end of the UK land investment spectrum, confident and experienced land developers look for raw, undeveloped land for asset growth. The savviest investor learns where market pressures for developed properties (e.g. housing) drive a need for zoning changes that will convert unused (sometimes agricultural) property to residential tracts. That investor will know how to buy at a price that will ultimately return a profit. The Duke of Westminster, one of the richest land investors in the UK, exemplifies this model.

In between REIT shareholders and His Grace are land development investors who work with property funds that hire professional land investment advisors. The price of entry into either type of fund ranges between £10,000 and £25,000 (US$15,000-$40,000) in most scenarios. Such an investment provides the investor greater opportunities than they might find in an REIT – for example, the prospectus will detail the specific features and risks associated with a particular land purchase. The investor will enter with some knowledge as to how long the investment will be held – typically between 18 months and five years – and what the benchmarks are for light development (infrastructure, less so buildings) before selling to housing or commercial structure developers.

Alternatives to land investing and property funds include stocks, bonds, commodities, hedge funds, precious metals (gold, silver), forestry products, energy (fossil fuels and renewables), and rarities such as art and antiques. For more information on choosing the right investments to match your individual asset growth needs, seek counsel from a qualified financial advisor.