On today’s show we’re talking about risk taking when a good deal presents itself.
This past week, another investor who is developing a residential subdivision had their source of funding evaporate. The timing, a week before closing is awkward for the buyer. They have alternatives but are definitely going to be scrambling to maintain some level of control.
The challenge is that completing the due diligence in such a short time period is going to be difficult and there will be some corners cut in the due diligence process out of necessity. The true question is whether the risk being assumed in cutting those corners is enough to step back from the deal or not?
The value of the land is tied entirely to the development potential. If the land remains farm land, then the purchase price is too high. If the land can be fully developed as has been represented by the seller, then it’s a bargain.
If the land can even be partially developed, then it’s a fair price. So how does a buyer segment the due diligence in order to find that ideal balance between risk and reward?
We have an extensive due diligence checklist that we apply to our own projects. In this particular instance, the other developer has not completed what we would consider a complete due diligence.
When performing due diligence, the work falls into three basic categories.
- The specific submarket.
- The people
- The deal
In our case, we’re 100% comfortable with the specific submarket. We know that there is demand far in excess of supply.
The specific market we are focused on is Boise Idaho. This is the third fastest growing market in the country over the past few years.
We have all of the major national home builders now active in the market. Some home builders who had been absent are now competing with us for land.
We believe the purchase price being offered is a fair price. Somehow we need to get comfortable with the risk, knowing that the planning department has not made a recommendation to city council, and that city council has not voted on the entitlement.
At a price of under $20,000 per lot, the property is a fair price, provided they can be entitled. We believe that fully entitled lots will capture a higher price in the open market once shovel ready. The profit potential is there. But then we also need to look at the big picture and the downside risk.
At this moment we have land to develop about 500 homes in a single market. At what point do we become overly concentrated in a single market? When does the risk become too large? What percentage of the overall market do we alone represent in terms of growth?
At this stage, we don’t know if this new project makes sense yet. We’re going to be conducting our own due diligence and making an assessment of the downside risk. The upside is clear. The downside is not as clear. Unless we can get enough information to satisfy our own due diligence process, we will have no choice but to decline the opportunity. Tempting as it might be, we simply cannot sacrifice the discipline in our business for what might be a good deal, or equally could be dud.