Now this means there aren’t too many deals being done in the land business right now. The main exception has been with several notable funds who have picked up a  number of developed lots over the past 2 years from some of the larger Georgia and national banks willing and capable of selling their foreclosed land and lots at whatever price the market will bring.

The rest of the market activity in vacant land and lots amounts to a lot of talk.  That brings me back to the conversation I had with an equity fund out of Michigan last week.  They were considering buying a loan on a 150 lot subdivision in Fairburn.  All improvements are complete including the top coat of asphalt.  The note is non-performing and would need to be foreclosed upon and any back taxes brought current.  The cost to foreclose and clear any tax liens together with what the investors pay the bank would be their total initial investment.

Since developed lots don’t produce a revenue stream, the key to determining the investor’s ROI is to accurately predict two things:  holding time and exit price.  That’s what the fund analysts want to know when they call me.  I usually throw out some recent transactions to show worst case exit pricing and then give them a “your guess is as good as mine” on the time required to hold the property.  Most are budgeting 4-6 years right now.

The problem I’ve had recently is that I cannot even give a good exit pricing estimate because deal activity is almost non-existent and listings that I have at under $10,000 a developed lot are not getting any offers in less desirable markets.  In the better markets along the northern suburban corridors, deals are still happening albeit at a snail’s pace — but on the south, east and west sides of Atlanta, activity is at a dead stop.

So the $64,000 question is, “What are these lots worth in less desirable markets.”  I heard one pundit on cable news say that a good portion of the developed lots in the current inventory never should have been developed and will never be built on.  I wouldn’t go that far — I expect almost all of the developed lots to be built on at some point.  For some lots, the hold may be much longer than most investors are willing to wait.

Let’s assume a market will exist for lots in less desirable markets in 5-6 years.  Let’s assume the taxes are $400 per lot annually and the cost to mow the grass and maintain the detention pond is another $200 per lot annually.  Without factoring in the cost of money, inflation, etc. — the lots would cost $3,600 to hold.  Add to that the cost to foreclose and pay off back taxes and we can reasonably assume our investment in each lot would be around $5,000.  Most of the investors I speak with are looking for pro forma returns of 25% annually. 

 A six year simple return would require the lots to sell voer $12,500 each in 6 years.  In my opinion that’s a best case scenario — what if the market doesn’t return for 12 years — at that time the lots would need to sell for $20,000 to accomplish the same 25% annual simple return on investment.  When demand returns for lots in these less desirable markets, I strongly believe the lots could go for $15,000 – $20,000 each. 

There’s one major flaw with my analysis.  I’m assuming today’s investors pick up the lots for free.  Is that the only price that will get these lots moving?

In Q3, overall sales in Atlanta decreased 82% compared to the prior year. Over the last 12 months, the price per square foot for office property is down 52%, multifamily is down 9%, industrial is down 24% and retail is down 15%.

You can order full reports on Atlanta or other markets by property type at Loopnet’s website.

Residential Lot Values in Metro Atlanta

The Lincoln Land Policy data takes a different approach to surveying residential lot values than the other two major research providers in the Atlanta market.  Since lots rarely change hands in built-up areas, it is difficult to ascertain lot values from direct sales.  Instead Lincoln takes home resale prices and backs out the construction cost to arrive at the value of the underlying lot.

Metrostudy and Smartnumbers rely on actual residential lot sales to reveal lot values.  The problem with this market based approach is that it only reflects the sales of vacant lots in new subdivisions that are most frequently located in outlying areas of the Atlanta metropolitan area.

The Lincoln Land Policy data is not intended to establish market comparables for actual residential lot sales.  Instead it can be used as a gauge of the market feasibility for new housing starts at any given time.  For most of the history of the study, the residential lot “share” fluctuated within a quarter to a third of the value of the house sale price (house plus lot) as shown in the graph below.

Lot Value as a Percentage of total House Value (Lot plus House)

Even during the housing boom of the last decade, we did not see the lot share deviate from the established range.  I remember when shopping for developed lots, most tract builders would try to purchase lots at 20-25% of the finished home selling price.  We saw lots for move-up and high end homes in the 25-50% range.

The current lot share value is 5% of the home selling price.  So if the average lot is worth $8,000 and the lot share is 5%, then the average home selling price would be roughly $160,000.   It’s fairly easy to see that if the average home price declines an additional $8,000, the value of the lot will go to zero.

What does this mean for home builders?

• It becomes very difficult to compete with resale homes when the average home price is roughly equal to the new home construction cost.  The builder needs to basically get the lot for free in order to compete.
• Construction costs will need to decline by decreasing square footage and finish levels in new homes to bring the lot share back in line with historical trends.
• Builders will pass along the cheaper lot prices to the buyers through lower new home selling prices in order to stay competitive with resale homes.
• Since it is not possible to deliver new lots at $8,000 each or less, new homes can only compete with resales if the builders purchase distressed lots at depressed prices.  Most new homes in the next couple of years will be built on foreclosed lots.
• Builders must be extremely selective in determining the price to pay for lots and the location to build.

Reference:  Davis, Morris A. and Michael G. Palumbo, 2007, “The Price of Residential Land in Large US Cities,” Journal of Urban Economics, vol. 63 (1), p. 352-384; data located at Land and Property Values in the U.S., Lincoln Institute of Land Policy http://www.lincolninst.edu/resources/

Now I suspect the recent uptick in appraisal activity has to do with the 4th quarter and for that matter the year coming to an end.  The problem is that the land market has been at a standstill for so long, the sales transactions of record are now too old to use in appraisals.  Most appraisers don’t want to use sales that occured more than 12 or 18 months ago.  Some counties don’t have a single transaction in this timeline and about half of the transactions that I’ve reviewed are not arms length sales — they are deed in lieu transactions or transactions between related parties.

Unfortunately, those ordering these appraisals — the banks who have foreclosed on land and subdivisions — are quickly finding out that the only way to truly know the value of their property is to sell it.  Appriasers use three approaches in valuing real estate: replacement cost, income approach and market comparables.  The first approach does not apply to land since land cannot be “replaced.”  The second approach very rarely applies to land since most land in northern Georgia produces no income in its undeveloped state.

When no comparable transactions exist, the only way to know the value of land is to make the market by accepting offers for properties that have received reasonable market exposure.  Once this starts to happen, we may start to see land trade hands again after over a year of almost no activity.

CoStar and Loopnet have been in a heated contest for market share. CoStar is the established commercial real estate data provider with products that track sale and lease transactions, market research data, as well as provide leads on tenants that may have a lease up for renewal. Loopnet entered the market in the late 90’s almost 2 decades after CoStar. Loopnet has only recently added products that track comparable sales and provide market research data. From the beginning, Loopnet was a listing service and it has grown quickly by providing web visitors what they want most: property listings.

Until this Spring, CoStar only allowed paid members to search their database of listings, comps, and leases. Loopnet has always allowed free searches of premium property listing ads. CoStar’s argument for the longest time was that Loopnet would one day cut out brokers by allowing principals to have direct access to the holy grail of commercial real estate — the listings. Whether or not CoStar is correct is a topic for another post.

CoStar finally relented and opened their for lease and for sale listings to the public to search for free.  Only the premium listings and some random sampling of the non-premium listings are displayed.  CoStar is in the process of up-selling premium listings to their existing broker subscriber base and currently don’t appear to have enough premium listings for most searches to provide useful results.  This is whey they include a random sampling of basic listings in the free search.  Paid searchers see all properies premium and basic.

Earlier this year, Loopnet issued a press release claiming it’s traffic was 9.9 times greater than that of costar.com.  Compete.com is showing Loopnet has a strong lead by not quite the 10 fold lead of earlier this year.  I expect, CoStar will gain on Loopnet in the coming months by virtue of the fact they have opened their data up to public search.  The surprise in the Compete comparison is Catylist.com.  This site is working closely with the national realtors trade group and may become the commercial equivalent of REALOR.com on the residential side of the business.

Banking profits declined 300% quarter over quarter while assets declined by 7%. It’s fairly easy to see how a small variation in a banks assets translates into a large impact on their bottom line. The troubling part is that a net decline in asset value of 7% does not reflect what is actually happening in the real estate market. During the same period the Case-Shiller home price index declined 9.3% in Atlanta. While the Moody’s/REAL Commercial Price index for repeat sales of the same properties is down an amazing 37% 3rd quarter 2009 over 3rd quarter 2008 nationwide.  Even these numbers don’t reflect the true state of the market because they don’t account for the decline in transaction volume that is result of decreased demand, lack of financing and the gulf between bid and ask on real estate listings.  When you look at total commercial investment activity, a recent Loopnet report showed dollar sales volumes down 90% year over year.

Why are banks assets not showing losses as great as the other real estate indices.  A major reason is that these assets or loans are made on many different types of real estate.  While rents are down across the board, many borrowers on apartment, office, industrial and retail loans are still making payments.  The lion’s share of bad loans and foreclosed assets reside in the land category.  Development loans are the real culprit in this banking crises.

As a broker working on land transactions in Metro Atlanta, I have a great deal of anecdotal evidence that suggests that banks are not willing to sell their land.  With the exception of the larger regional banks, national banks and the FDIC, bank land is simply not selling.

But what motivation do these community banks have to take the loss when most of the toxic assets are in vacant land and subdivision lots. Unlike improved assets, land does not have a high carrying cost and virtually no management is required when compared to revenue producing assets like offices, warehouses, and apartment complexes. Unless regulators force their hands, the banks are content holding the bad loans and foreclosed land on their books. If these assets were sold in today’s market, the sale price would invariably be much less than the value the bank assigns to them on paper. Realizing the the actual loss would further erode the capital reserves and draw even more pressure from bank regulators to increase reserves or shut down.

Put simply, the borrowers on subdivision development and other land loans were the first to stop paying when the real estate market turned south. Without a steady stream of lot and home sales, the developers had no means to pay the debt service. Unlike improved commercial property, the income stream on land development is pretty much all or nothing. Now the banks are left holding notes or title to land that is worth far less than the original loan. They mark down the value incrementally based on appraisals and wait for the market to improve so they don’t have to realize the actual losses that result from selling the land in this terrible market. The whole situation serves to prolong the pain and extend the time required for the land market to reset itself.

Even if the banks wanted to sell their foreclosed land and lots, many could not because they do not have adequate reserves to absorb the loss. The all to familiar news of a bank closing on a Friday afternoon have most bankers thinking about their jobs when faced with selling an asset that would reduce their reserves. I can’t say that I blame them, but my job as a broker isn’t made any easier when banks don’t  sell the assets they have nor lend money to buyers who want to purchase real estate.

Alternately, the graph below shows traffic on the largest residential real estate website, REALTOR.com. Traffic peaks at the end of the summer and bottoms out around the 1st of the year.