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How every stage of a real estate development adds value

There are typically four distinct stages in a real estate development project. At each stage, a d...

There are typically four distinct stages in a real estate development project.

At each stage, a developer must decide whether to spend their time and money and take on the risks to increase the property’s value, or monetize their investment and sell to another group of investors.

If the developer chooses to see the project through to the fourth stage, a fully developed project like commercial property is often sold to an “income-producing” property operator, such as a REIT.

Let’s look at how each stage adds value to a development project.

Stage 1: Land banking

The land banker pursues and buys undeveloped land they believe will be attractive for developers. When the market conditions are right, the land banker sells to a land packager.

The land banking stage and the redevelopment stage are the same except that the land banker usually has “greenfields” (undeveloped land), and the redeveloper has “brownfields” (previously developed land that is not currently in use).

Stage 2: Land packaging

The land packager improves the land value through conceptual land planning, zoning changes, financing schemes, or other “paper enhancements” like title insurance, accurate surveys, or environmental studies.

Stage 3: Land development

The land developer buys the land with the paper enhancements from the land packager and improves the land to sell as finished building pads to a building developer.

This usually involves the construction of infrastructure such as roads and utilities and common improvements such as storm water retention ponds and recreational facilities.

A good example of the land development stage are master-planned community developers who construct the roads, utilities, and recreational amenities and then sell building lots to home builders.

Stage 4: Building development

The building developer buys the finished pad from the land developer and then does the vertical development by constructing the building improvements. During construction, the building developer may also attempt to lease the building so the finished building can be sold to the building operator.

Homebuilders are a good example of building developers.

From an investor’s perspective, each of the stages will have its own risk/return profile that is highly dependent on the particulars of each individual development project.

Development project cash flows are irregular by nature and don’t usually pay out consistent distributions to their investors.

Unless an investor is willing to tie up their investment for the length of the development project, they may prefer to get their development exposure through a more comprehensive investment vehicle that bundles real estate development exposure with other asset classes that do pay regular distributions.

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