Land Acquisition and Development Finance

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In this article, we will discuss organization business structures and selecting a lender. Business Structures After determining the goals of the project and the approximate amount of financing needed, you must decide on the legal structure of your business. You should make your decision based on the impact of the legal structure on your liability, initial cost, government control, impact on inc...

December 01, 2005

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Earn Credit—CGB
Land Acquisition and Development Finance Test

In this article, we will discuss organization business structures and selecting a lender.

Business Structures

After determining the goals of the project and the approximate amount of financing needed, you must decide on the legal structure of your business. You should make your decision based on the impact of the legal structure on your liability, initial cost, government control, impact on income taxes, and the management process desired.

There are several types of business structures, each with unique legal liabilities, risks, tax liabilities and benefits. Each business structure will be discussed in the following pages.

Sole Proprietorship

A sole proprietorship is a business owned and operated by one person.

While there are some minor costs of doing business, they are typically less than under other legal structures. The owner files a single, personal tax return and is allowed to deduct losses from personal income. The owner of a sole proprietorship has personal liability for any legal or financial problems in the business. For example, if the business earns taxable income, tax may have to be paid with the owner's tax return even if no cash is drawn out of the business.

Partnerships

A partnership is a business formed by two or more people joining as co-owners. It involves both shared risk and reward as all co-owners are liable for company debts to the full extent of their personal assets. Advantages to a general partnership structure include informality and flexibility. Business practices in the general partnership are usually simplified to include straightforward rules for organization and liquidation, arrangements for capitalization, profit and loss allocation, and voting rights. Tax benefits flow through to the individual partners, and the partnership itself is not taxed. Each partner is an agent and a principal, thereby making him or her liable for the acts of all other partners.

Within the classification of general partnership there are two common types of partnership formed:

  • Joint Ventures. A joint venture is a commercial understanding by two or more persons or entities organized to accomplish a single purpose. It differs from a partnership because its existence continues only as long as its specific purpose continues. It requires a common interest in that purpose, and the parties must have some right to direct and govern the conduct of each other in all aspects relating to the project. The expectation of a profit and the sharing of that profit are indispensable elements. If there is not any express agreement about sharing profits, an agreement for the equal sharing is implied.
  • Limited Partnerships. In a limited partnership, certain partners are designated general partners and some are designated limited partners. The potential liability for limited partners is limited if certain legal requirements are met. Some limited partners have no control over the business and only take a limited profit/loss. The limited partnership used to be the most common form of partnership for real estate development. Tax benefits pass through to all partners (including limited), and the partnership itself is not taxed. More recently, other structures, such as the Limited Liability Company (LLC), and S Corporation have gained in popularity over the limited partnership due to their advantageous features related to owner liability and taxation.
  • C Corporation. A corporation is a business treated as a single legal entity and is owned by its stockholders whose liability is generally limited to the extent of their investment. The ownership of a corporation is represented by shares of stock issued to people or to other companies in exchange for cash, physical assets, services, and goodwill. The stockholders elect a board of directors, which appoint officers that then direct the management of the corporation's affairs.
    A corporation offers stockholders insulation from personal liability, thus it allows the conduct of business free of risk while at the same time enjoying full participation in the rewards. Generally, stockholders can transfer their stock interest freely. However, the incorporators are subject to more state and local regulatory control than business owners organized using other business structures. The state in which the corporation is registered, and any other state in which they do business, has the right to levy initial and annual incorporation fees and franchise taxes. Additionally, the profit is taxed twice—first the corporation pays tax on it; second the shareholders pay tax on dividends they receive.
  • Subchapter S Corporation. A subchapter S Corporation is a corporation that elects to be treated as a partnership for income tax purposes. Income and losses are passed through to the stockholders up to the amount invested. Net income is then declared by and taxed to the stockholders. To be eligible for this election, a corporation must meet certain requirements as to the kind and number of shareholders, classes of stock, and sources of income. The S Corp structure is attractive for spouses or other small groups of investors involved in one project. It eliminates C corporation problem of double taxation (taxes on profits and dividend) and permits pass through of losses only to the extent of the investment.
  • Limited Liability Company. LLCs are business entities created under state statute and owned by investors, called members. The LLC allows other corporations to be owners (members) and does not limit the total number of owners. The ultimate legal control of an LLC rests with its members. They outline the powers delegated to others in an Operating Agreement.

The LLC is the relatively newer business structure. It has advantages because investors are attracted to the limited liability and member control characteristics. Along with the liability protection, it also offers members the tax advantages of a partnership or proprietorship. Additionally, unlike the S Corp, other corporations can be members, which open up additional revenue sources. One of the greatest advantages of an LLC is that profit and loss can be allocated among the members in a variety of ways.

Selecting A Lender

Your success in selecting lenders can increase if you look at the loan process from the lenders' point of view. Their restrictions include regulatory influences, expectations of income from certain types of loans and geographic diversificatio requirements. Additionally, each lender establishes unique goals and criteria to drive its loan portfolio. Lenders in the same area may have different targets, criteria and loan type preferences. When looking for a loan it is important to remember the following steps presented in the next few pages.

Research the Lender

Research the lender to understand their business focus and strategies and apply first to lenders that have a preference for the type of loan you seek. It is common practice to check references before deciding.

Plan Your Approach

Your relationship with a lender takes a thoughtful approach, including good communication. Poor communication, stemming from misunderstandings or the lack of communication, can usually be blamed for the failure of the financing deal. An opportunity to improve communication comes with status reporting.

Whether you are actively seeking financing or not, supply the lenders you work with, or would like to do business with, status reports regarding your business on a monthly, quarterly and annual basis. These reports should provide details of all relevant projects, not only those the lender is financing.

By supplying first-hand details about your projects, you increase the lender's comfort level and reduce the possibility of rumors and misinformation about your performance as a developer. Be sure to supply the right kind of information, as well.

The margins banks make on loans are comparatively low compared to those of equity investors. Consequently, the banks cannot afford many losses. They are primarily concerned with loan repayment and interested in information that demonstrates repayment assurances.

Prepare the Loan Package

Loan application package requirements vary from lender to lender. As a first step, ask your lender what he or she wants to see in your loan proposal. The insight you gain can help you prepare a complete package and avoid spending unnecessary time and money on providing extraneous information. The key is to make it complete and to the point.

If you provide inadequate or inaccurate information, a banker or broker may be unable to rewrite the loan submission in the format the lender demands and jeopardize your chances of obtaining financing for an otherwise viable development. Remember that you must first gain the lender's confidence. Providing all of the required information is an important part of that task. Walk the lender through your development on paper, and back up your statements with facts, site plans, credit history, photographs, etc.

There is no magic format for a loan package, because each must be custom-designed for the borrower, the project, and the lender. A description of the elements of a typical submission package follows:

  • Cover Letter. The cover letter explains your purpose for submitting the package and summarizes its contents. It also summarizes your project and the financial need. Brevity and a positive tone are the keys to a good cover letter. If the cover letter does not provide a good impression and generate interest, the lender may never move beyond it to review the details of your request
  • Loan Summary. A loan summary describes the requested transaction in a concise manner. It enables the lender to decide quickly if your loan package fits within their business parameters. Include the loan amount needed; rate desired; terms (length time, collateral, etc.); and borrowing entity (individual, company).
  • Borrower's Resume. Regardless of how well you know the loan officer, provide your professional resume. The loan officer is often not the only person involved in the loan decision. The resume is your chance to convince the decision makers that you are capable of successfully completing this job.
  • Project Team Profile. Include a brief biography on each member of the development team—architects, land planners, engineers, general contractors, public relations agent, sales personnel, etc.
  • Market Data. Summarize your conclusions gathered through market research and analysis. Describe the scope and location of your project, the targeted customer, and market absorption projections. If the project is large and complex, then have a professional report prepared to include in the package.
  • Project Data. State the project goals and highlight development's features and benefits. Summarize information regarding the project and include actual documentation in an appendix, such as a map of the project, detailed plans and specifications for the units, a site plan, a project cost statement, a schedule of development activities, soil conditions report, zoning approval documentation, and written assurance of utility availability.

Financial Pro forma

A financial pro forma is an analysis of the expected cash requirements and profits of the project. It projects the disbursements and revenues based on anticipated sales rates and costs over the life of the project. It can be the key to the loan approval. If the numbers won't work, the lender may be reluctant to loan you the necessary funds. It is a good idea to prepare a realistic and conservative pro forma because it is a big factor in negotiations with the lender.

Loan Guarantees, Bonds and Appraisals

You may be asked to provide a personal guarantee. This is a written pledge to make good on a loan. Guarantees are usually required if you have set up a corporation specifically for the project — the lender may want your personal guarantee that you will pay the loan even if your corporation defaults. Additionally, if you are a first-time developer, you may have to obtain a performance bond and/or labor and materials bond. You purchase these as to insure the project completion in accordance with the plans and specifications. Following completion, you may have to produce a property appraisal to verify that the project complies with plans and specifications.

The lender uses the information you provide in the loan package to confirm your creditworthiness, assess the financial feasibility of your project, and evaluate your ability to perform in a competent manner. A professional look and presentation of the application package supports a positive perception on these matters. Make sure the package is well organized, clean, legible, and appealing to the eyes. When you meet in person with the lender, remember always make sure that your appearance and personality reinforces your image as a competent businessperson.

 

Earn Credit—CGB

The label says it all — Learn. In each issue we publish must-know material prepared specifically for Professional Builder by the best educators in the industry. This is the very information the NAHB has used in teaching Certified Graduate Builder and Graduate Master Builder classes.

Every builder who regularly reads this section will come away with the knowledge necessary to run his or her business more profitably. But the benefits don't stop there. Readers interested in the Certified Graduate Builder program can earn course credits through PB's Learn section. Each course is a series of six lessons.

  • To register for a CGB course, call the NAHB Education Group at 800/368-5242, extension 8153 for a course application. Complete the enrollment form and return it to the NAHB with a $50 course fee. Then read the Learn section each month, complete the monthly review quiz on PB's reader service card and send it in. Pass the test in this issue for that course series and earn one course credit toward the CGB designation or toward maintaining it.
  • For questions about the CGB program or about the author of this course article, contact the NAHB Education Group at 800/368-5242, extension 8153. Contact your state or local association for additional CGB courses offered throughout the year on site in your area.

This will be the last article of the Learn series.

Land Acquisition and Development Finance Test

For each question, select only ONE CORRECT ANSWER based on the information in the Land Acquisition and Development Finance course materials.

1. A builder asks you to explain the major steps of the land development process. Which of the following lists would you provide to answer the question:

List A List B List C
Market analysis Market analysis Market analysis
Finding Land Finding land Finding land
Preliminary investigation Preliminary Investigation Environmental study
Tying up land Tying up land Tying up land
Financial analysis Due diligence Due diligence
Land development Site planning Site planning
Government approval Government approval Community relations
Site improvements Site improvements Site improvements
Financing Financing Financing


a. a b. b c. c d. None of the above

2. Which one of the following purposes can be accomplished through market research and analysis?

a. Determine project feasibility and forecast sales rates (market absorption)

b. Identify the designs and features of product to be built

c. Provide the basis for a marketing plan and support for zoning or annexation permit request

d. All of the above

3. Which one of the following options lists all of the research areas of a market analysis?

a. Loan rates, geographic boundaries, home sales

b. Economic base, supply and demand, buyer profiles

c. Home prices, product features, lot sizes

d. None of the above

4. Which one of the following sources can help you locate land for your new development projects?

a. Advertised and vacant parcels or failed development projects

b. Real estate brokers and government officials

c. Your personal and professional network

d. All of the above

5. You meet with a landowner to discuss previous uses of a parcel of land. Together you walk the land as you share your plans for development and listen to the owner's hopes for the property. Back in your truck you make a note to contact engineers, land planners, municipal planning and zoning officials, grading, and utility contractors to get their thoughts about the parcel. You have specific questions about the land's status as a flood plain, the soil conditions, water, utilities and waste water disposal services availability. As you drive away you note the surrounding uses and consider their compatibility with your development plans. In sum, which one of the following tasks are you doing?

a. A preliminary investigation for due diligence

b. A formal due diligence study

c. A market analysis

d. A land acquisition

6. Which one of the following statements is true regarding due diligence?

a. Due diligence typically involves three phases: market analysis, preliminary investigation, formal due diligence.

b. Your initial contact with the landowner is the lease important element of due diligence.

c. The due diligence for a parcel should explore three major areas: physical, political and financial feasibility.

d. None of the above

7. Which of the following items should be factored into a financial feasibility analysis of a parcel?

a. Profit margin

b. Indirect soft costs

c. Infrastructure costs

d. All of the above

8. Which one of the following statements accurately defines a purchase contract used to tie up land?

a. It is a nonbonding agreement that describes a buyer's interest in a parcel of property and the terms and conditions under which he or she will purchase it from a seller.

b. It is a document that outlines the terms and condition under which you will purchase and a landowner will sell their property.

c. It is a secure agreement that clearly states the conditions of the sale and allows the buyer to remain unbound to satisfying the contract until all contingencies have been met.

d. It is an agreement that specifies the length of time a buyer has to purchase a given piece of land for a certain price and the amount the buyer will pay for tying up the land during that period.

9. Which one of the following types of option agreement do developers use to gain control of a large piece of property as it is needed for development?

a. Interest option

b. Letter of credit option

c. Rolling option

d. Straight option

10.Which one of the following types of considerations are not commonly addressed in purchase contracts?

a. Any terms and conditions, called contingencies, set forth by the buyer and/or seller that must be met prior to purchase as well as the outcome in the event the buyer is unable to complete the purchase

b. Agreements on timeframes and automatic extension on the feasibility period of approvals that are pending when the agreement expires

c. Agreements on the profit margins and pricing of homes and developments that ensure a rate of return for the landowner and buyer

d. Provision to allow a buyer to assign closing rights on the property to another individual or entity without amending the original terms and conditions of the contract

11. Your business is structured in a way that protects each member from liability beyond the amount invested. In compliance with your Articles of Organization, company decisions are made according to majority vote. Also, should any member withdraw from the company, it continues as a viable business entity. It offers the members the tax advantages of a partnership or proprietorship. Which one of the following options presents the name of the business structure your company uses?

a. Sole proprietorship

b. Limited Liability Corporation

c. Corporation

d. General partnership

12. Which one of the following financing types is not a major source of land acquisition financing?

a. Construction financing

b. Personal equity/builder retained earnings

c. Lender financing

d. Private and public financing

13. Which one of the following financing types is a developer's first source of funds for land acquisition?

a. Construction financing

b. Personal equity/builder retained earnings

c. Lender financing

d. Private and public financing

14. Which one of the following statements is not characteristic of land development lenders?

a. They carefully scrutinize the credit worthiness and project potential.

b. They offer loans used to secure the purchase of raw land.

c. They package each parcel's development loan separately from the original construction loan.

d. They recapture the bulk of the loan before project close-out through a release price procedure.

15. Which one of the following loans is not classified as seller-financing?

a. Subordinated or Purchase Money mortgages

b. Installment contracts

c. Seller's mortgage

d. Syndications

16. A developer seeks a loan with no amortization from a lender and then asks the seller to agree to subordinate the first mortgage on the land to a subsequent construction financing lender. What type of loan is this?

a. 1031 exchange

b. Installment contract

c. Purchase money mortgage

d. Seller's mortgage

17. Which one of the following statements describes a seller's mortgage?

a. The seller retains title (and possibly possession and use) of the land until the purchase price is fully paid however possession of the property is given to the buyer.

b. The seller grants and mortgage to the buyer and retains a note due from the buyer as part of the sale.

c. The landowner contributes land to the project in return for a proportionate ownership interest in the project.

d. The purchaser makes periodic payments to the seller with interest on the unpaid portion of the purchase price until the purchase price is entirely paid and the deed is delivered to the buyer.

18. Which one of the following statements is not true regarding land installment contracts?

a. The owner retains title of the land until the purchase price is fully paid however possession of the property is given to the purchaser.

b. Some contracts arrange a phased release of land portions, with 20 percent of the land held by the seller until full payment of a three or four-year contract.

c. They often offer the seller security and enable the buyer to obtain release of at least a majority of the land.

d. The seller usually has the right to force the buyer to purchase the remainder of the land at any time during the contract.

19. Which one of the following options accurately completes this statement? Joint ventures, builders cooperative agreements, and syndications are forms of __________.

a. Seller financing

b. Equity financing

c. Public financing

d. All of the above

20. Which one of the following options accurately completes this statement? When a developer and one or more outside parties including a debt partner join forces to provide capital and/or expertise for a project, it is called a __________.

a. Builder's coop

b. Joint venture

c. Mezzanine loan

d. Syndication

21. Which one of the following options accurately completes this statement? When builders share the risk and combine their equity and borrowing power to acquire and develop a larger project than they could take on individually, it is called a __________.

a. Builder's coop

b. Joint venture

c. Mezzanine loan

d. Syndication

22. Which of the following options is not a form of public financing?

a. Syndications

b. Revenue bonds and housing finance agency programs

c. Tax increment and abatement financing

d. Special service district assessments

23. Which one of the following statements is not true regarding debt and equity financing?

a. Lender financing has the lowest cost, but the highest risk

b. Equity financing has a much higher cost, bur a lower risk

c. Replace lender financing with equity financing as quickly as possible to maximize your return

d. Use equity financing to cover the difference between what you can borrow and the total amount you require to do the project.

24. Select the option that lists the terms or phrases which best complete the following statements regarding finding a lender.

When looking for a loan always __________ the area lenders to understand their business focus and strategies. Once you have selected a list of potential lenders, request a sample __________ from each to determine if any have __________ with which you cannot or do not want to comply. When working with a lender, take care to __________ effectively to avoid misunderstandings. To allow the lender to accurately assess the success-rate of your venture, always provide a thorough __________.

a. Interview, loan, rules, communicate. project description

b. Research, loan application, procedures, communicate, loan application package

c. Consider, rate sheet, loan types, apply, proforma

d. Study, policy manual, regulations, budget, company overview

25. Which one of the following items is not typically included in a loan application package?

a. Borrower's resume and project team profile

b. Mortgage revenue bond application

c. Market and project data including a proforma

d. Cover letter and loan request summary

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