Due Diligence on Land Development Deals Should Begin Prior to Contract
I have been negotiating and closing real estate development deals for a long time. In nearly every case, my developer clients have come to me prior to executing a contract to discuss the due diligence that they have already done on the property and what will need to be done going forward. We discuss the proposed use of the property, the current zoning and land use, the necessary land use to construct the proposed improvements, what other approvals will be required and the seller’s willingness to allow us to obtain all these approvals prior to closing. The client has generally assembled all or most of his team and has a pretty good idea of what he wants to accomplish and what he will be capable of getting approved, subject to further research and subject to the give and take of the zoning and land use process.
Perhaps at this point a Letter of Intent has been discussed or even executed; the basic financial terms agreed to. However, my job is about to begin – prepare a contract. It will be most important to hash out the contingencies, specifically the contingency for approvals. Although the seller is prepared for this, we both might have strong opinions about the required time frame to obtain the approvals. Some of this will be based on the amount of time the buyer needs to prepare plans. Some this might depend on seller’s desire to approve plans, particularly if the property is part of a larger development. Sellers want to make sure buyers don’t miss rigid deadlines. Buyers, on the other hand, need leeway for governmental delays, slow engineers and architects and even slow response times from sellers. There is give and take between the parties.
Extensions of time periods may be built into the contract or subsequently negotiated. Additional deposits or extension fees are part of this discussion. Are they applicable to the purchase price? Are they refundable or non-refundable?
I write about this because I am working with a client who recently came to me with a fully executed contract for property on which he wants to build a high density (for the neighborhood) multi-family, multi-story apartment building. the property is only about 1.25 acres and currently has a single family house with an ancillary garage or some other building on it. The property is zoned for residential/agriculture. The contract has a 120 day due diligence period followed by an immediate closing. The purchase price reflects the desired use of the property, but not the current market value or as is use. The client had not assembled any team or professionals and, other than a brief meeting with city planning and zoning staff, had done no investigations to determine whether we could build what he wanted to build.
We have since met with the city and determined that the city is in the process of initiating a re-zoning of the property to a favorable designation. However, the density will not provide the desired number of units, leaving the client roughly 15 units short. This city does not allow variances for density and there is no possibility of re-zoning to another classification. The economics of the deal would not work without these units. The zoning classification will allow mixed use, meaning that the client can put office/retail on the ground floor. With about 10,000 square feet of office/retail in addition to the apartments, the client believes the economics are very favorable. Tthe client has not yet assembled his team and the due diligence deadline is rapidly approaching. We have a team that has submitted proposals that are awaiting the client’s approval.
But, that brings us back to the seller. The seller’s expectation is to close immediately following the 120 day due diligence period. This is the problem with executing a contract before understanding what is permitted and what will be necessary in order to build your project. The seller, unfortunately, has medical issues and needs cash. Fortunately, non-refundable extension fees solve the seller’s cash needs and we will be able to extend the contract for the 10 months necessary to obtain the approvals.
The work is just beginning. The project needs to be designed in order to be approved. We need to now work with the engineer to prepare a site plan in accordance with the proposed zoning ordinance. The client needs to describe his vision to the architect to design a building that the city will also like. Working with a good land planner who will act as the quarterback to keep everyone on task, including surveyors, civil engineers, landscape engineers and me, we can get this project approved within the 10 month time frame and the contract closed.