Step Away from the Receivables!

The worst possible thing just happened.  Your contractor client has informed you that the down market has gotten the better of him.  He is moving to Hawaii to become a surf apprentice.  He left his office unlocked and wishes you the best of luck in getting your money back.  By the way, his accounting records aren’t very good….he apologizes for any inconvenience this may cause.

 What do you do?

 Your first reaction is probably to print out the accounts receivable and start making money come in the door.  By calling on the receivables too quickly, you may be neglecting significant assets called “underbillings”.

 What is an Underbilling?

In short, an underbilling (often referred to as “WIP”) represents the cost of services performed which have not been billed.  Depending on the billing practices of your client, this amount can be significant.

How do I Determine this Amount?

The first thing to do is make sure to close every open accounting month at the company.  All payroll and accounts payable invoices should be posted to a job.  The posting of costs is crucial because the payroll and accounts payable modules will interface with a job costing module.  It is the job costing module that will tell you how much money you’ve spent on each job.

Once you enter all the payables and payroll entries and post the costs to job cost, you need to find a report that tells you how much you have invested in each project.  Additionally, you need to find a report that tells you how much you’ve billed on each project.

For jobs that have costs without the corresponding billing, you probably have an underbilled job.

What do I do with this Information?

After figuring out which projects are underbilled, you need to find the contract or purchase order under which you performed the work.  Assuming the work is complete, you should execute a billing immediately.  By billing the job, this asset is transferred from an underbilling to a receivable. 

Now What?

Bring in the collections crew…you are ready to go to work.

How can Provident Real Estates Services Help?

Navigating the client’s accounting system will probably be more difficult than it sounds.  Provident can assist by quickly deciphering the client’s operating systems, billing procedures, and accounting system.

 

For more information on managing distressed construction and real estate estates, contact Steve DeCleene at sdecleene@providentres.com or Scott Thistle at sthistle@providentres.com.

Determining the Value of Residential Land

Determining the Value of Residential Land

As the real estate market continues to change quickly, properly assessing the value of land is becoming more critical to a bank’s success.  For purchasers of large tracts of residential lots and land, having the ability to determine the value of land is an important skill.  Developers almost never rely on appraisers. In fact, most see the appraisal as nothing more than an item that is necessary to satisfy their bank.  The reason for this is that an appraisal is unable to account for the details that go into properly estimating the value of a parcel of land.  

Bankers would be best served to act and think like buyers of land, not owners.  It is much easier and more accurate to determine the value of land prior to purchasing it.  Once the land is owned, most real estate professionals have a paradigm shift in that they seek to justify their investment value rather than challenge it.  Prior to purchasing the property, prudent professionals will seek the best deal possible and look for ways to devalue the property so that they can invest less on the front end. 

 

Vacant Land
Today (August, 2008) single-family land in Southeastern Wisconsin is trading for anywhere between $20,000 per acre to $100,000 per acre.  So what is your tract worth?  Here are a few simple questions to get you started:

1.       What is the zoning and attendant density?

2.       What is the actual lot yield?

3.       Are there any off site utility costs and required grading?

4.       What are the municipal construction requirements?

5.       What are new homes selling for in the target area?

Answer these five questions and you should have the basic information needed to determine what a lot is worth.

Density and Yield:
Always start here.  Zoning and density are the two simple factors to start with; if the zoning allows for three units to the acre versus two, the difference can be substantial.  At $60,000 per acre in land cost, three units to the acre amounts to $20,000 per lot in land cost whereas two units to the acre is $30,000 per lot.  That’s a 50% increase in actual land cost.  If you are a banker taking back property, the zoning will be on the plat.  If the plat is not yet prepared or recorded, you can obtain the zoning from the municipal zoning official.

Once you determine the zoning, it is best to figure the actual yield.  Zoning may allow for three units to the acre but you may only get two units to the acre after figuring out how much land is truly developable.  Many parcels in Wisconsin have wetlands or other environmentally sensitive areas that will reduce the actual lot yield.

Understanding how the municipality defines density is critically important.  Some municipalities define density to be the aggregate acreage divided by the total number of units – irrespective of land lost to wetlands or other environmentally sensitive areas.  Yet other municipalities define a target for units to the acre while imposing stricter minimum lots sizes.

For example, consider a 100 acre parcel that has 10 acres of wetlands and environmentally sensitive area. We must also factor in “non-lot” land.  In the real estate industry, we use the rule of 3rds. That is to say that 1/3 of the property will be used for Park, Storm water, and/or Right of way (roads).  To keep the example simple we are going to assume that the wetlands cannot be used for storm water management (this is not always the case).

This leaves approximately 60 acres of land for actual lots.  At two units to the acre, you should yield 120 lots (60 X 2).  If the zoning is based on the entire 100 acres (this is the norm), we could yield 200 total lots (100 X 2).  But what about minimum lots sizes?

Assume that this same municipality has a strict minimum lots size of 15,000 square feet.  At 60 acres of developable land with a yield of 120 lots, you would arrive at 21,780 square feet per lot (60X 43,560/120) – or about 1/2 acre lots.  On the same parcel with a 200 lot yield you would arrive at 13,068 square feet per lot – or about 1/3 acre lots (60X43,560/200).

If the municipality enforced the minimum lot size of 15,000 square foot the best you could get on this parcel would be 174 lots (43,560X60/15,000). 

 

Off-Site Utility Costs:
Off-sites can be the one area that causes extreme variances.  In fact, a developer can spend hundreds of thousands of dollars in upfront off-site utility costs that will have a substantial impact on the actual lot cost.  It will also materially affect the proforma from an interest carry standpoint because, for the most part, off-site construction is a large front end cost.  A call to the municipal engineer will determine if there is any off-site utility construction needed.  If off-site utilities are necessary, it is best to retain a reputable engineering firm or other professional to determine the actual costs.

Grading is another (if not the biggest) wild card and is generally the issue that causes the most problems from a cost overrun perspective.  Understanding a site and its grading challenges makes all the difference when trying to determine what the property is worth.  On a 100 acre parcel the grading cost could range anywhere from $100,000 to $1,000,000.  If a grading plan is not yet complete, hire a qualified engineering firm to examine this issue.

When determining the actual value of a parcel of land, developers factor these costs into their equation prior to making a purchase decision.  Appraisals by their nature are not equipped to adjust value for development costs.

 

Municipal Construction Standards:
Obtain the municipal construction standards and pay close attention to anything that falls outside the normally acceptable standards.  For example, road standards can have a big impact on costs.  Roads can change the cost of your lots substantially by increases in depth and/or width.  Also worthy of examination are the storm water requirements and water service requirements, as these factors can cause large swings in cost.  Besides the size of the water mains, which typically range from 6” to 12” in diameter, some municipalities may require the water service to be in ductile iron rather than plastic.  This can add as much as 50% to the cost of the water service.

 

Similar Home Sales in Area:
At the end of the day, a lot needs to have a home built on it to realize its full value.  New home values are driven as much by the land costs as by the bricks and sticks.  As a homebuilder, we apply certain standard to lot values that we do not exceed.  The most basic fundamental is the 25% rule:  if the retail lot price is greater than 25% of the total house and lot purchase price, then there is a problem.  For example, for a home/lot package priced at $225,000, your lot should not exceed $56,250.  In fact, the closer you can get to 20% for the lot price the better.

 

Case Study:
Let’s put everything we’ve learned together in a practical case study.  As a banker, let’s say you are forced to foreclose on a 100 acre parcel that is zoned residential with a zoning density of two units to the acre.

Before getting into the details of the parcel, we need to start with a snapshot of the market.  A qualified market study that determines which homes are selling and at what price is the best starting point.  If there is a limited active market or an excess supply of homes, then your values will be severely depressed.

Let’s assume that, based on the market research, you feel a market exists for homes in the $200K – $250K segment.  So what is that 100 acres worth on the open market?

First we determine that at two units to the acre the parcel could yield 200 lots (100 X 2).  The municipality has a strict minimum lot size of 1/2 acre (21,780 sq ft).  However, we have only 60 acres of developable land after we account for streets, parks, and storm water facilties.  At 60 acres, each lot would be about 13,068 square feet, which is smaller than the 1/2 acre minimum of 21,780 sq. ft.  As a result, our yield is reduced to 120 lots (60X43,560/21,780).

We were also able to determine that sewer service must be extended to the site.  The sewer is about 1,500 feet away and requires an 8” line.  This will cost about $50 to $60 per foot.  At $60 per foot the extension will cost $90,000 for the entire site.

We determined that there was nothing out of the ordinary with the municipal construction standards and, other than the sewer off-site costs, normal conditions should apply.  Generally speaking, we use about $30,000-$35,000 per lot in construction costs provided the grading costs appear to be in line.  On a project this size, a normal (or good) grading cost would be about $450,000 – or $3,000 per lot.  This site has some issues with grade and some potential soil problems.  We assume that an additional $300,000 in grading costs will be necessary to complete the construction so we add $2,500 per lot ($300,000/120) to our normal $30,000 per lot for construction costs.

Accounting for the off-site utilities and the grading issues, we will use a factor of $35,000 per lot in site construction costs.

The remainder is as simple as backing into the value of the vacant land.  At $35,000 per lot in construction costs and 12% for soft costs, we are left with a lot cost of $39,200 ((35,000X120)+12%/120) before land.  Earlier we determined that there was a market for homes between $200,000 and $250,000.  Assuming a $225,000 average total house & lot price, a retail lot price at 25% equates to a value of $56,250.  Simply deducting the $39,200 from the $56,250 will determine that the land is worth approximately $17,050 per lot or $2,046,000 for the entire site.  Translating this to a fair market appraisal, it is worth about $20,046 per acre before developer profit.  Depending on what type of profit is sought, we would seek to add between $6,000 and $10,000 per lot at a minimum.

 

The value of residential land is most significantly impacted by the value of homes that are selling in the market area and the specific site conditions that drive the construction cost.  Using comparables from land sales in adjoining municipalities that occurred months ago is not always the most accurate way to determine a parcel’s worth.  This method does not correctly reflect the costs that may or may not be necessary to develop the property.

For more information on valuation methods and development costs, contact Scott B. Thistle at Provident Real Estate Services ( sthistle@providentres.com ) or visit our website at www.providentres.com.

Mr. Thistle is a Managing Member of Provident Real Estate Services LLC and has seventeen years experience in real estate development.   Provident Real Estate Services, LLC is a real estate consulting group specializing in bank workouts and real estate disposition.