Land Transactions
Why Are Site Costs Negotiated?
While a land transaction is in escrow, the buyer is typically conducting all of its due diligence investigations and trying to confirm development costs. A homebuilder will be wanting to confirm all of the house costs, both hard and soft, but it is the site development costs that often become a point of negotiation before the due diligence period expires, especially if the site has not been graded or improved.
The homebuilder should have a fairly good grasp of the house costs, since the same house or some version will be built again on the new property. But if the site has not been improved, the grading and improvements can often be very unique to the site and therefore maybe a point of contention. If the land transaction assumes the buyer will complete the site work, why would either party be concerned about these site costs?
When a parcel is brought to the market, the homebuilders do not typically have adequate time nor do they want to spend the effort on a site cost estimate until their offer has been accepted. A sophisticated land seller will usually provide the prospective buyers with a site cost estimate to use as a basis for their offers. As example, a seller’s site cost estimate of $2.0 million will be used by the buyers to determine how much to offer for the land. If all buyers are using the same cost estimate, the playing field should be level to all.
During the due diligence period, suppose that the buyer’s cost estimate comes in at $2.5 million. The buyer will contend that the seller’s estimate was too low and that the offered land price should be reduced by $500,000 to compensate for the higher cost estimate. And then the negotiation begins. The seller will want the buyer to accept the lower estimate and maintain the offered price while the buyer wants the opposite. A typical process will be each party sitting across the table from each other and dissecting each other’s assumptions.
As you can imagine, a buyer may want to pad their estimate to get to a lower land price. The seller needs to understand how much of the increase is legitimate, if any of it at all. The other prospective buyers may come in with the same higher cost estimate and the seller will be in the same situation with an alternate buyer. Strategies and tactics are very much a part of this negotiation, which sometimes can become quite contentious.
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