Development land, as we often talk about on this blog, should be the residual claimant in a pro forma. Meaning, start with your revenue, subtract your costs and required margin, and then see how much money is leftover to pay for the land. This is, in theory, how you should value land.

It's also the most disciplined way to go about your underwriting. In fact, it can be beneficial to not know the asking price or broker guidance for a new site until you've completed this exercise. That way you won't bias yourself.

However, in practice, it can be difficult to do all of this. In a rising market, you might find that there's always some other developer who is willing to be more aggressive on their assumptions, which means they will be willing to pay more for the same piece of land.

And so if you want to be in the game, you might find yourself doing the exact opposite: starting with the land price and then trying to figure out how to make the rest of your model work. We've all been there.

During this stage of the cycle, you get punished for being conservative and disciplined -- you don't win sites. But when the market turns, discipline and conservatism get rewarded handsomely. You then become thankful for the deals you didn't do. And I'm sure that many prudent risk managers are feeling this way right now.

It is very challenging to underwrite new sites today. Many of the assumptions that go into a pro forma are unclear and unknowable. And so the spread between what developer's models are telling them to pay and what landowners want to sell for is often significant. That is why everyone is trying to find "creative deal structures" that can be used to close this gap.

At some point, though, the gap will actually close; things will once again feel clear and knowable. I have absolutely no idea when that will happen, but I do know that when it does, it will then be too late from a maximum opportunity standpoint.

Because that's how risk works. Once the uncertainty is gone, it's no longer a risk. And if it's no longer a risk, then you're not going to be paid for bearing it.

I have been writing about the startup Opendoor.com for over 2 years now. And I continue to believe that they are the most promising disruptor in the residential real estate space. 

Here is the first post that I wrote back in July 2014 after they raised their first round of funding. Here is the second post that I wrote after they launched in Phoenix. And here is another post that I wrote 6 months ago where I argued, once again, that they are doing something worth paying attention to. (This last post explains how the platform works.)

Well, about a week ago it was announced that they have raised another round of funding: a $210 million Series D. In all likelihood, the company’s valuation is now over $1 billion. Here’s the Techcrunch announcement where the message was: huge ass number; risky business model.

In response to this, Ben Thompson wrote a terrific and widely shared blog post called, Opendoor: A Startup Worth Emulating. I love his post because he says what I have firmly believed and argued for many years: Zillow and Redfin are not disruptive real estate startups.

This is what he says about Zillow:

“And yet, the most successful real estate startup, Zillow (which acquired its largest competitor Trulia a couple of years ago), is little more than a glorified marketing tool: the company makes most of its revenue by getting real estate agents — the ones collecting 6% of fees, split between the buying and selling agents — to pay to advertise their houses on the site. Certainly a free tool that makes it easier to find houses in a more intuitive way is valuable — Zillow has acquired the sort of userbase that allow it to build an advertising business for a reason — but at the end of the day the company is a tax on a system that hasn’t really changed in decades.”

And though very risky, he argues that Opendoor is far better positioned to shake up the status quo. 

Here are two of his key points:

“Sellers are uniquely disadvantaged under the current system, which is another way of saying they are an underserved market with unmet needs.” [Sellers are the side of the market that Opendoor is specifically targeting.]

“Opendoor has a new business model: taking advantage of a theoretical arbitrage opportunity (earning fees on houses sold at a slight mark-up) by leveraging technology in pursuit of previously impossible scale that should, in theory, ameliorate risk.”

And here’s what that could ultimately mean for the industry:

“Opendoor has many more reasons why it might fail than Zillow or Redfin, but its potential upside is far greater as a result. First is the immediate opportunity: sellers who can’t wait. However, as Opendoor grows its seller base, especially geographically, its risk will start to decrease thanks to diversification and sheer size; that will allow it to lower its “market risk” charge which will lead to more sellers. More sellers means both less risk and an increasingly compelling product for buyers to access, first with a real estate agent and eventually directly. More buyers will mean lower marketing costs and faster sell-through, which will lower risk further and thus lower prices, pushing the cycle forward. It’s even possible to envision a future where Opendoor actually does uproot the anachronistic real estate agent system that is a relic of the pre-Internet era, and they will have done so with realtors not only not fighting them but, on the buying side, helping them.”

I’m with Ben on this.