Due Diligence
What Can Go Wrong?
In most land transactions, the land developer or homebuilder will have a due diligence period to vet out assumptions and issues with a proposed project. I also like to think of this DD period as an opportunity to ask “what can go wrong”. Throughout my career, I have seen, heard, or experienced project issues that you would not have expected to arise.
Entitlements. I was on a project team for a very controversial master planned community in a coastal location. After many years, the project finally won the support of a very active community group that had been opposing the project, which resulted in a project approval by the County. Finally, the project could move forward. But wait. A small faction of the community group still did not agree and splintered off into forming a new community group. And with the support of the State Coastal Commission, a lawsuit was filed against the project and delayed the project for another 10 years. So much for the County approval.
Finished Lots. You would assume with finished lots that you would have no risk with respect to entitlements, grading, or improvements. It would be just a matter of building the homes and hopefully achieving the home prices assumed in your pro forma. In an infill project in LA, a builder had such a situation. But as it turned out, some neighbors still did not like the small project and even sat in trees to delay the project. For some reason, the city that had approved the project and site improvement permits did not help in moving the project forward with building permits. So the builder had purchased the land and the interest rate clock was ticking against project profits.
Environmental Agencies. Some projects may fall into the jurisdiction of an environmental agency such as the Army Corps of Engineers. As a general rule, you should be able to obtain these environmental permits within 6 months after the local jurisdiction has approved your project. Some builders brace for the bureaucracy and maybe assume 12 months. But I have seen two projects recently where the Army Corps process delayed the grading permit by more than 4 years. In one case, the Army Corps reversed their original decision to issue a nationwide permit and a long permit process ensued. It is really difficult to plan for a 4-year Army Corps process.
Offsite Improvements. I tend to think that intract improvements are a bit more straight forward because after the site is graded, installing utilities and streets are pretty much on a clean slate. But when you go offsite, due to imposed project conditions, you might be dealing with major underground facilities that already exist in the street, traffic control, or the need for permissions from other property owners. I have seen some major water transmission lines play havoc with the condition to impose a new water line in an existing offsite street, which typically means more costs.
Of course, you also can have potential “what can go wrong” issues that are related to the market, grading, and a host of other topics. My experience is that the builders today, particularly the large publics, go into excruciating detail during the due diligence period to vet out all that they can.
If you have experiences, comments, or questions, please share with us below.
