October 23, 2020
By Dan Spiegel, Coldwell Banker Commercial
What is driving these anomalistic land sales for residential development?
Since February, the U.S. economy has been in a recession. And while commercial real estate development typically slows during a recession, this recession is anything but typical. Land sales for office and retail development have slowed as expected, but land sales for residential development have accelerated due to high demand for housing. Housing is not driving the current economic downturn and is in fact one bright spot in the economy.
With high demand for housing, builders are acquiring land quickly. Most states are seeing a higher percentage of their total land sales earmarked for residential development compared to the prior year.
The country’s largest homebuilders pulled back on land purchases and laid-off workers in March and April due to the risk of holding large land parcels for hundreds of homes. But private developers who build on a smaller scale quickly went back to buying land and looking for projects after momentary nervousness in March. Many regional builders also regained confidence in April and were back to closing deals to satisfy the unexpected demand for housing, as interest rates hit record lows and many urbanites moved to the suburbs as remote work made commute time less of a consideration.
Low Inventory + High Demand
2020 has created the perfect set of conditions for land development. Going into the coronavirus pandemic, inventory was already very low. Builders were finding it difficult to meet demand due to regulations on where, how and what they could build. On top of that, they were facing a labor shortage. When mortgage rates continued to drop, buyer traffic remained high despite high unemployment, and new construction began to convert to sales at record rates. In some markets, supply is just at a month or two (compared to 5-6 months in a balanced market) – in fact, the supply of new homes for sale in the United States is currently down 33% year-over-year while existing home supply is down 26% from the prior year.
Sellers remain reluctant to return to the market, often out of concern that they will not be able to find a new home. As a result, home prices are experiencing upticks across the country, despite the recession, with 96% of U.S. metros seeing year-over-year gains.
These conditions have created an environment with strong competition for land among builders, who are attempting to ramp production up quickly. There has been a marked increase in building permits and starts, and homebuilder sentiment jumped 14 points in July to 72, returning to pre-pandemic levels despite a recession.
Less Debt Financing – More Financing with Cash
For several years following the Great Recession of 2008, banks were hesitant to finance land development. When banks began to relax their reins in 2013, demand for development land went up. But by 2020 banks had tightened their lending standards for construction and development land once again, reducing loan-to-value ratio by 20% in some cases and turning developers down in other cases. Because banks are uncertain about the post-stimulus environment, developable land that is not yet entitled is unlikely to get bank approval.
Most private builders prefer to buy land in phases, typically after they secure a buyer for their last project. They are usually able to use their own cash to finance the next land deal. In a few cases, private builders can secure financing with an established banking relationship.
Some secondary and tertiary markets are experiencing private investors loaning money to local builders for residential projects, in lieu of investing in the stock market. In these cases, the land or property is used as collateral.
Because private builders are less reliant on banks, they are in a better position to make land purchases for residential development.
We expect that demand for land with residential development potential will continue to rise, as buyer demand remains strong. While the coronavirus has caused preference shifts to the suburbs, demand remains high in all categories. Developers are willing to build a variety of residential products, including single-family homes, multi-family apartments and townhomes.
In summary, after a pause in residential development activity in March and April, commercial land sales for residential development accelerated to satisfy a new spike in housing demand. This anomalistic trend is just one of the many reasons why this recession looks different from ones prior.
Dan Spiegel is managing director with Coldwell Banker Commercial, based in Chicago.
For comments, questions or concerns, please contact Paul Bubny