Since 2020, media outlets have been portending of a Recession because they know it keeps us scrolling their feeds. The r-word is only going to hit your timelines more and more as 2024’s presidential election approaches. Regardless of whether or not a recession is imminent, there should be anticipation and excitement for an opportunity lurking in the Bear-market’s most important r-word: Real Estate.
Clearly a bear market depresses real estate, but scooping up foreclosed homes is time consuming and competitive. It is low-hanging fruit that pits you against novice investors. The shrewdest (and richest) players in the real estate space target Bank O.R.E.O.S. (other real estate offerings), where they purchase multimillion-dollar developments for 20%-30% of their appraised value.
During a recession, the biggest weights on a bank’s ledger are not foreclosed homes. In reality, the banks dread the developers who go belly up after commencing construction on land being held as collateral by the bank. Most developers default during high interest rate bear markets (think about having an interest-only loan at the end of 2020 and dealing with that throttle back). Immediately, the bank is stuck between Scylla and Charybdis. They are not developers so they loathe to finish development, and they also cannot hold the land against their books.
Usually, the reason people avoid those deals is they do not know how to assess the value of the foreclosed asset. I have personally seen half-gestated developments written off when they are 10x or 20x the value paid, or even for free by banks. Our firm has sat in on these deals at the highest level and can guide you on how to assess whether OREOs are worth the trouble.
The first step is negotiating with the Bank. Offering to close the deal at the right time (usually when they must balance their books) is critical. Negotiating a revised loan, obtaining a short sale, or simply buying outright, is a big value-add depending on what the bank needs.
The next step is to grasp zoning and permitting of the property. In land development, it is important to know that your customer is the builder. The best developers spend time studying the constructions that their target customers have finished, identifying what kind of footprint, what kind of setbacks, what kind of density, and what kind of lots (commercial, basement, 1-story, 2-story, etc.) builders want in the locale where the distressed asset exists. These conditions change frequently so it’s critical to work with a firm that understands them, and which of them matter the most.
Assessing value-add through zoning is important with distressed assets because local governments may give a re-zoning to avoid having land sitting vacant for years. The law protects us from arbitrary rulings on zoning. The Courts study existing uses and zoning nearby, extent that property values are diminished, whether the zoning promotes public welfare, all balanced against the hardship if a zoning is not given. Our firm has litigated these issues against local governments all the way to the Supreme Court of Georgia. The zoning and entitlement process is one of the biggest value-adds and a well-written contract should allow you the time to rezone.
However, understanding what is required of you, or your potential buyer, to complete the deal is paramount. Anyone who buys an incomplete deal from you will expect the same type of discount you expected from the bank. Learn the cost and process of land development. Development includes clearing land, grading (mass and fine), sanitary sewer work, storm sewer work, curb and gutter, and roadway installation. If you want to maximize your exit value, you need to do enough of this work to reach certain checkpoints.
Most development contractors will send you bids in different formats. Ask them to bid in similar formats (all pipe work in linear feet, all grading in cubic yards). You can better compare bids and understand their costs to negotiate fairer prices. The contract itself needs to properly address compaction of dirt and protection of the underground pipes. Your curb work needs to properly meet your local authority’s requirements on utilities and elevations vis-a-vis the lots/pads. Roadways must be paved with proper materials in the base, binder, and topping levels of asphalt. (Tip: save money by not preemptively topping a roadway, the builder’s construction equipment often damages roads, requiring the builder to do so anyway). Local governments will be most concerned about erosion control. Due to word-count limits I cannot elaborate on this or other issues like walls, hydrants, detention ponds, cut & fill.
Development is always controlled chaos and strong written agreements are the controls. To boot, many times the contractor will hire sub-contractors for different parts of these jobs. Timing, order of operations, and assigning checks and balances will save many weeks and many more dollars. The good news is that handling this aspect, while time consuming, also adds the most value to your bottom line.
There is a way for you to capture development model returns on investment, without having to pay 50% of your profits to a development entity, and without having to take singles and doubles when you should be taking fours and sixes (or home runs if you prefer). It is important to work with a firm that understands development, zoning law, and complex contracts. We’ve seen every aspect of this process and litigated some of them to the Supreme Court. When I was just starting my firm, I remember meeting an entrepreneur who told me, “I cannot wait until the next recession.” Oddly, I agree, and if you’re interested, let’s talk. ***
Nik Erramilli is the Managing Partner of Erramilli Law Group. He works on diverse business and real estate transactions and multifaceted civil litigation. California and Georgia Certified. Contact: Nik@ErramilliLawGroup.com. Call/Text: (650) 503-9314.