How Do Entitlements Add Value?
You may have heard that the entitlements, or government approvals, for a project adds value to a property. In some cases, the entitlements may add more value to a project than all of the grading, streets, and utilities constructed on the property. How does some simple approval add such value?
First, some approvals are not exactly “simple” in some markets such as California. Anti-growth neighbors and communities can influence the politicians in what gets approved, if anything. With such uncertainty comes risk. And with that risk, the land value can fluctuate depending on the project that gets approved.
Maybe one of the key items in the entitlements is how many homes or units get approved. If you have a site plan that easily plots out 100 lots, getting only 90 homes approved can have a significant impact on the project revenue and therefore what you can afford to pay for the land. If the approvals only allow 50 lots, the numbers might get real ugly and the land value will plummet. And if no homes are approved, the value of the land is really that of a vacant parcel.
Another key item with the entitlements are the project conditions associated with the approvals. The city council might approve your project for 100 homes, but the approval might also come with some offsite conditions such as the requirement to build a bridge, install a traffic signal, widen arterial roads, or pay some special fees. If you have budgeted maybe a reasonable $500,000 for these offsite items but the city council places $3 million of total offsite conditions on the project, the difference most likely impacts the land dollar for dollar.
Entitlements add value by bringing more certainty to a project. If you know that you have an approval for 95 homes and the conditions cost out to $1.5 million, you might find that you can pay $10 million for a parcel. Without these approvals and more certainty, you might only want to pay $3 – $5 million for the parcel so that you can allow for the risk of less homes and more conditions. Many land transactions allow longer escrow periods for the developer to obtain the entitlements and pay a higher land price to the land seller.
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