What is Preliminary Underwriting?
When making an offer for land, the format I have typically seen in the industry is a 2 – 3 page “Letter of Intent”, which lays out the essential terms and conditions you wish to propose in your offer. The terms will include a proposed price, feasibility period, deposits, close of escrow, and other key terms. Most of these “LOI’s” are non-binding and are really intended to find a meeting of the minds between Seller and Buyer. Once these terms and conditions are agreed upon, the next step is a binding contract between the parties.
Over the years, I have seen land buyers who do little to no analysis yet throw together this LOI and submit their offer for a parcel. One of the pitfalls to this approach is that if your offer is accepted, you will start to face some expensive due diligence costs, starting off with expensive attorney fees for the contract. If you eventually find that your price and terms are not feasible, you can waste money as you may have to drop out of the escrow. And the next pitfall is that you get a reputation in the marketplace for putting out unfounded offers and falling out of escrow repeatedly.
More commonplace is that I see land acquisition managers who conduct some “preliminary underwriting”, which involves some market analysis, cost estimating, and the generation of a project pro forma. While these topics are vetted out more thoroughly during the due diligence period, this preliminary underwriting will help confirm that the proposed price and terms within the LOI are feasible and that your offer has some solid standing.
As a Seller, and if I have received multiple offers, I will want to review and qualify the better offers. This process includes knowing the reputation of the Buyer, and also asking questions as to what level of analysis has been put into their assumptions and their offer. Particularly in competitive land situations, a Buyer should be well prepared to back up their assumptions and convince the Seller that your offer is the strongest. Without good preliminary underwriting, it can be a difficult sell.
One other point on the expensive due diligence costs. I am fairly sure the company owners and division presidents will tire quickly of spending $20,000 to $100,000 on these due diligence costs only to have to drop out of escrow. Thus, most companies seem to do their preliminary underwriting and submit a defensible offer.
As always, please share thoughts, comments, and questions below.