Traditional Model
A good development must start with the right piece of land. As any builder knows land is expensive to purchase, time-consuming to entitle, and costly to develop. The variables involved in acquiring, entitling, and developing land are also complex and nuanced to local markets. To handle these layers of red tape, builders often employ land departments at the division level to maneuver through the process.
As the building industry has narrowed to the larger production builder types, the burden to acquire, entitle, and develop land has led builders to expend an inordinate amount of time, money, and resources into land departments. Land departments, however, are non-revenue producing departments.
Contemporary Model
While subdivision developers have been around for as long as housing, production builders created a unique lot development industry in order to maintain a consistent pipeline of lots. Most lot developers rely heavily on feeding production builders their developed lot needs.
Here’s how it works. Production builders are set up to own no more lots than is necessary to enhance their efficiencies and returns. They enter into lot purchase agreements, often scheduled to last several years, with land developers to consistently maintain the number of lots they own. Most land developers in smaller markets like Alabama lack the necessary capital to consistently supply a meaningful portion of lots to keep pace with builders. The overwhelming supplier of developed lots remains a localized and independent enterprise that, as an industry, is strapped for cash to keep up with projected development futures.
The Future of Lot Development
Entering the 2008 Recession, homebuilders in a saturated building industry were holding a surplus of developed lots. We all know what happened: developers and builders went bankrupt, banks were stuck with assets worth pennies on the dollar, and builders struggled to pay the carrying cost of the lots. Since that time, the home building industry has recovered to record levels while the developed lot industry continues to limp along as a result of underfunding. This has resulted in depleted lot inventories. Birmingham alone is projected to consume all available lots within a few years. The lack of current inventory and new developments should get the attention of every home builder when it considers 1) that lot developments take an average of 18-24 months to complete and 2) lenders may seek to further restrict the flow of money to a development industry that requires cash in fear of repeating 2008.
To be fair, new developments are in the pipeline and will add to existing lot inventories, but it’s hard to deny that unless builders start to push for new developments and lots deals, home building could be facing a severe shortage of developed lots. At which point, instead of builders facing the 2008 surplus of inventory, they’ll be faced with an inventory shortage and steep competition for any available developed lots.
