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Real estate developers are stupid

Big Ben Myers of Bullpen Consulting doesn’t usually have strong opinions on Twitter (obviously joking), but I did see him respond to this tweet this morning:

The assertion he is responding to is basically this: “developers are stupid because they tend to hold onto land during downturns, instead of building through them.” On some level, I think I know where this line of thinking is coming from. It’s the whole Warren Buffet philosophy of “being fearful when others are greedy, and greedy when others are fearful.”

But what it ignores is development feasibility. Developers typically rely heavily on the availability of debt financing. First you need land financing in order to acquire the land, and then, once you have your entitlements, condominium pre-sales and/or any other requirements in place, you move onto a construction loan (which often “takes out” your land loan).

Maybe you have deep enough pockets to fund everything with cash, but most of the time that is not the case. And so if these debt facilities are not available to you, then you are not building.

The other part of this equation is that, during downturns, it can be harder to forecast your future revenues. What can I sell/rent this space for, and how long will it take to absorb? These are difficult questions in the best of times, but they’re even more difficult when you don’t have a lot of market activity/comparables to point to.

All of this contributes to debt being less available, especially for smaller developers. It also makes new sites difficult to underwrite. Because as we have talked about many times before on this blog, land should be the residual claimant in a development pro forma. Revenue minus development costs equals how much you can afford to pay for land.

If the math doesn’t work and if you can’t get financing, it almost certainly doesn’t matter how much “leading” you feel like doing. You’re not building.

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