Strategic Investment… What is a Covered Land Play?
With the hopes of COVID-19 restrictions beginning to ease across Texas and nationwide, many real estate developers and real estate investors are looking for opportunities in the hopes of an economic recovery to the devastation caused by the virus, namely opportunities that provide immediate cash flow. The covered land play (“CLP”) redevelopment strategy just might be able to fill that investment need to a T … as long as you have patience.
In real estate development, a CLP comes in various forms, shapes and sizes, but at its core, is when a real estate developer purchases property that is already producing income, yet the developer has a motivation to redevelop the property into something that can generate more operating income, the land can be repurposed into the highest and best use and, in the long term, can convert the property into an alternative use which serves a greater benefit to the community at large.
The Alternative Option – The Growth Strategy
Urban Sprawl has created countless opportunities where many developers acquire a tract of land along the outskirts of town, provided the land was in the anticipated growth corridor of the city. Why not … land was cheap, and the developer had a view that within the next five to ten years, the city or county would develop streets, sewer, water, drainage and other required infrastructure, and the acquired tract of land would soon be enveloped by development, commerce and activity. This development strategy is used quite often in all real estate investment classes … be it single-family lot development, multifamily, retail, office, mixed-use, etc.
However, what happens if there is a downturn in the economy or a slow-down in the real estate market? The real estate developer quickly morphs into a land speculator, hoping and praying that a “greater fool” will come along and purchase the land for a profit before they run out of money. Numerous real estate cycles witnessed over the past 40-years can illustrate that this identical situation plays out more times than you would care to guess. The cost of carry for raw land is extremely expensive. Between taxes, insurance, interest, maintenance, cost of capital, engineering, architectural design, land planning, city entitlements, etc., pretty soon the developer runs out of money … or at least investor fatigue sets in … and the developer and investors are overheard saying … “forget the cheese, just let me out of the trap!” So, they sell the land at a discount to live another day and to fight another battle.
The Alternative Option – The Covered Land Play Strategy
Now, take for example, the same developer is looking to develop the exact same mixed-use development. But instead of acquiring cheap, raw land and sitting on it in anticipation of the coming growth, they pay a little more and acquire an existing mobile home park on the outskirts of town. Not a sexy investment, yet the revenues from the month-to-month or quarter-to-quarter tenants, is sufficient to pay the property taxes, debt service, etc. until they are ready to start their mixed-use development efforts. This is a very simple example of a CLP. However, what if there was an in-fill site, near or adjacent to the central business district (CBD), as opposed to the outskirts of town. Does this strategy work there as well? The simple answer is … YES
A lot of planning goes into whether or not a piece of land (with an existing cash flow) is a prudent investment. It does not happen overnight as the developer is truly performing simultaneous due diligence and planning on two separate real estate projects. The first is the existing property analysis, based on the current use. The second is, of course, the long term, highest and best use of the property.
An Existing Case Study
One recent example of the in-fill, CLP is referred to as “Project Catalyst,” which is located near the CBD of Austin, Texas. Due east of Austin, between the CBD and Bergstrom Airport, is a stretch of road called East Riverside Drive. During the building boom of the early 1980s, many multifamily developers over-built student housing on both sides of Riverside Drive. It quickly became “the place to be” for the thousands of new students coming to the University of Texas. However, with the advent of the “new and improved” on-campus student housing in the 90’s, and the new Public-Private-Partnership strategy to building new amenities and resort style social life and living environment, new, closer-to-campus developments started to attract students away from East Riverside. So, along came higher vacancies, deferred maintenance, an increase in crime and all of the atrophy that one would expect in a declining and dilapidated area.
However, with all of this new development came a shortage of inexpensive land, and areas close to the CBD for new development. Furthermore, gentrification in near-east Austin (east of I35) has started to occur, and new development has replaced older, run-down single-family homes. Rents, acquisition and operating costs started to skyrocket and sitting here today, the CBD has living and office space costs that rival New York City.
In an effort to benefit from the CLP along East Riverside, the Austin-based development firm of The Presidium Group started to buy up thousands of units of these 1980-vintage multifamily properties. With a systematic approach, purchasing one at a time, they have amassed during the past 10-years over 3,000 multifamily units with an average occupancy of 96%, which aggregates to over 200-acres of contiguous land. As a result of their relatively low investment basis, the highest and best use is no longer student housing, as they now own a footprint that rivals the area of the entire CBD. More importantly, they have time on their side as the properties currently cash flow, and as a CLP, the holding cost of their larger scale, mixed-use development is minimized. This Project Catalyst development, and the overall redevelopment plan, is taking seven million square feet of land in the East Riverside Corridor of Austin, and the developer is proposing to convert it into various purposes. Class A multi-family housing, office spaces, retail, entertainment, arts and culture and hospitality are all part of the overall development plan, while there still will be a large student housing population generating income on the land as the development proceeds.
Benefits to the City
From an economic development standpoint, the city of Austin simply loves the overall strategy. Why not, a private developer is taking a crime ridden, run-down area of the city that contains a high population of homelessness, and creating a new vision which can help drive the economy, increase the quality of life and start producing exponential growth in tax revenues to fund the city’s ever-growing budget.
Now that the vision has been published in local media, others are starting to jump in. The Austin Chamber of Commerce recently was successful at winning the competitive bidding process to secure the relocation of the World Headquarters for the new Oracle Campus. Bringing over 11,000 new, high paying jobs, was a great win for the city of Austin. The location for these new jobs, is along East Riverside. Because of the vision of Presidium, without even starting an investing in its redevelopment plans, the vision has taken hold and the land values have started to grow exponentially.
PPP – The Capital Investment from the Public Sector
The leadership in each major city in America understands the benefits of economic development. If they can grow their tax revenues by adding jobs, attracting new retail sales tax, adding new property tax revenues to their coffers, etc. it enables the city to reduce their property tax rate to the citizens. As this tax rate comes down, and the citizens are able to put more money in their pocket, and as they spend the savings, it creates an exponential impact to drive the local economy. This is Supply-Side Economics at its core.
However, cities understand that economic development is competitive, and they need to fight to secure and incentivize companies, like Oracle, to bring these high paying jobs, new office space, new commerce, etc. to their area. Consequently, the economic development departments are constantly bidding on these packages and providing incentives for their relocation. In other words, if the city is willing to invest $10 million in new roads, sidewalks, greenspace, sewer, water, etc., and it benefits the target company as well as the current citizens, yet it also brings $50 million in new tax revenues, then that is a solid return on investment for the city’s capital.
There are many moving parts throughout the entire incentive process of a CLP, and the purpose of this document is not to go into how a PPP works or the myriad of tools available, but merely an illustration to provide clarity and reference. In Texas, many CLP’s have been executed successfully with the incentives provided by a Tax Increment Reinvestment Zone (“TIRZ”). A TIRZ is a special district that is created by the public sector with hopes of attracting new investment and assessed property values to areas that are in need of redevelopment. In short, as the property owners within the TIRZ boundaries pay their property taxes, a portion of these taxes are redirected by the public sector to be used to fund capital, or pay off bonds, used to help in the overall new development within the TIRZ boundaries. The property owners are paying the same tax as other areas of the city, yet the public sector has agreed to redirect and use such payments for a specific cause.
Being that there are over 200 different TIRZ districts in the state of Texas now, it is apparent that this has become a popular method to spark interest in redeveloping an area. The main goal of a TIRZ, besides simply raising interest in revitalizing the area, is to examine the potential value the land holds. Various members of local government (city, county, etc.) have different TIRZ districts under their jurisdiction, so communication with the local government is beneficial in the execution of one of these types of deals. Many times the local government wants to incentivize investment / redevelopment of certain areas that the city cannot do on its own, which is why TIRZ exists in the first place. Through finding an attractive piece of land within an existing TIRZ, or articulating the need to elected officials and communicating the development plans to the local government in hopes of their buy-in for the creation of a TIRZ, these efforts can be very helpful in causing a good development, to become a great development.
So … What is the Next Step of This Process?
Patience … Patience … Patience!
Simply put, this is a long-term strategy. Executing on the CLP strategy, is not something that you can jump into overnight, as it requires a well-thought-out short-term and long-term strategic plan. Again, the investor needs to perform due diligence on the properties being acquired, as the property owners need to look at the investment as a stand-alone investment. The investor needs to continuously ask the question of “if this is the only asset I am successful in acquiring as part of this strategy, is it a good, stand-alone investment?”
Secondly, this development strategy requires that the developer “walk softly and carry a big stick. As the CLP strategy plays out, the last ting that any developer wants if for the “cat to get out of the bag” too early. Once the acquisition process gets started, the developer must use pseudonyms or unrelated entity names, lawyers, title companies, etc. In other words, keep your mouth shut on the fact that the buyer is slowly aggregating property, and this news will start to leak out and will result in higher purchase prices for the overall development, It truly could be the difference between whether or not the economics of the large scale, mixed use development will work.
Third, the developer must have a better understanding of the goals and objectives of the city, county or other quasi-governmental entities. Ys, the redevelopment plans must be driven by the developer, but it cannot be a developer’s plan, or a mayor’s plan or a city managers’ plan, yet it must be the plan for and by the community citizens. You must have community buy-in, otherwise you will meet up with opposition in some of the most unusual places.
Fourth, you must understand the public sector’s willingness to provide incentives, and determine if there are any Capital Improvement Plans (“CIP”) budgeted over the next 5 to 10-years by your public sector partner. If there is a willingness, and if there are CIP items such as a library, school, park or open space, amphitheater, stadium, convention center, convention center hotel, etc., etc., then this can help with your overall land plan and design. If the public sector intends to floats bonds or allocate resources into one of these public sector projects, then perhaps it can be relocated and serve as a public-funded asset and anchor for the ultimate development.
Finally, you must have patience! Patience to prepare your strategic development plan … Patience to slowly and quietly acquire your multiple properties … Patience to negotiate with the public sector … Patience to diplomatically engage with the community and gain community support for the overall development.