Land Acquisition Guide
From Offer to Contract
Locating and acquiring the perfect tract of land to develop can be quite challenging. An experienced developer and its real estate broker can conduct initial due diligence to help avoid costly issues. However, more in-depth inspections and research are necessary before finalizing a purchase. Whether a buyer is planning on developing the site or holding for investment purposes for future resale, the required due diligence remains the same.
Bottom line, you need to determine if you can do what you want to do with the property, what that process is likely to cost and how long is the process likely to take?
Before you can get the process moving, as a buyer, you must decide what price you are going to offer for the property. By communicating with your broker, you can determine market values for comparable property, motivation of the seller, and the buyer’s ability to fund. Some initial due diligence on potential development and operation costs can also help you make a more informed decision on what the property is worth. This research can help you avoid having to renegotiate the price during the Contract. Once you are comfortable with the pricing and have all of your other required contract criteria defined, you can prepare a Letter of Intent to purchase. The basic outline of an LOI consists of the following:
Letter of Intent (LOI)
The LOI should have the following terms defined.
- Non-Binding Agreement
- Earnest Money
- Inspection Period
- Closing Period
- Contingencies/Additional Conditions
- Brokers and Commissions
- Exhibit A - Property Description (Site Plan or Legal Description)
So you now have an agreed-upon LOI between the Buyer and Seller. Now you need to prepare a mutually agreeable contract. There are many forms of earnest money contracts and purchase money contracts. In Texas, if you are a member of the Texas Association of Realtors, you are authorized to use their forms. We like to use the Texas Association of Realtors (TAR) Commercial Improved and Unimproved earnest money contracts. They are simple, seem balanced in protections, and have every imaginable addendum needed to cover a deal. Some attorneys will want addendums - especially “As-Is where Is” type addendums. However, the buyer should consider the ability to close within a given time frame and allow for adequate time in case of delays by the lender, title company, or with inspections. If a buyer is using outside financing, we prefer to see at least 60 days of inspection period to allow time for the lender to:
- formally underwrite and approve the borrower;
- conduct its review of the title commitment;
- Prepare, review and approve a property boundary survey, if needed;
- Conduct the appraisal and;
- Prepare a phase one environmental study.
So now you have successfully negotiated the Contract, all parties have executed the document, the title company has received a copy and sent out the receipted contracts. The date the title company sends out the receipted Contract to all parties will generally establish the Effective Date of the Contract, which is crucial in determining the critical dates tied to the Contract.
Now the real work - in the form of Due Diligence - begins. Some of this work may have started in the preliminary review of the site. Due diligence is broken down into six sections:
- Operating Expenses
Physical -This includes Site inspections, Drainage and Detention, Utilities, and Planning.
Site Inspections - This seems self-explanatory. Walk the site, review aerial photographs, view floodplain maps, adjacent property uses, and physical characteristics. We also encourage our clients to talk to neighboring owners, if possible, to see if any unknown concerns might affect the property.
Drainage and Detention - Enlist a qualified civil engineer to examine the site drainage patterns along with available city/county drainage. This examination will enable the engineer to provide preliminary calculations for detention on the site given a particular use along with estimates for required storm drainage within the parcel.
Utilities - (Water, Sewer, Natural Gas, and Electricity) - Your civil engineer can assist in determining available services for the site. Such research is covered in more detail in the “Utilities” section later in this article. However, initially, your civil engineer will access GIS maps to locate the nearest water, sewer, and storm drain lines and access the size of each. Discussions with the water and sewer provider must include its ability to provide the property necessary water and sewer capacity and what expenses may be associated with making those connections.
Planning - While partially covered in the Zoning review under “Title,” a thorough examination of the applicable Codes and Ordinances affecting a property are crucial. A “Pre-Development Meeting” with the local municipality is needed. The Zoning ordinances will tell you if you are allowed to conduct a particular use the target area. However, you need to understand the city’s requirements for developing the site. These can include traffic safety improvements (dedicated turn lanes, traffic lights, etc.), all of which can be incredibly expensive. There will likely be additional requirements for types of construction, access, parking, setbacks, landscaping, fencing, fire safety access lanes, fire sprinklers, drainage/detention, and much more. These, too, can add significantly to the overall cost of your development. The city or county may require that the property be re-platted to obtain a permit for any construction.
TITLE - COMMITMENT, DEED RESTRICTIONS, ZONING
Title Commitment (TC) - When a Buyer contracts to purchase property, they sign an earnest money contract and then submit same to a title company to handle the sale and ultimate transfer of the property. The TC provides insurance to protect buyers and ensure that they receive clean ownership (title) to the property and as well as disclosure of any liens, restrictions, encumbrances, and easements affecting the property. There are additional parts and endorsements available when obtaining a TC, and the topic is too involved for a paragraph.
Deed Restrictions - Deed restrictions are generally put in place by the initial developer. These restrictions protect the integrity and style of the development. These restrictions on the use of a property will show up as a recorded document and listed in Schedule C of your TC. Restrictions may prohibit or limit specific applications of a property as well as impose requirements for construction, setbacks, access, signage, and other physical implications. You should be careful to understand any restrictions imposed.
Zoning - Zoning is put in place by the city government and usually shown as a recorded document in the Title Commitment. It is similar to but more thorough and surprisingly more challenging to navigate than Deed Restrictions. See Planning at the beginning of this article for more information.
Operating Expenses - The expenses associated with owning a property can affect the feasibility of the planned use, whether that is investment or residential development for one’s personal use.
Property Taxes - The absolute most significant of the expenses is Property Taxes. In states like Texas, where non-homestead property currently has no protection from increases in assessed value, owners can frequently get hammered by increases in the valuation of over 50% in one year. While you can protest your appraisal, you can’t guarantee the success of those protests. You should maintain an understanding of the property’s assessed value while in Contract vs. the projected near-term market value. This understanding can help you get an idea of the worst-case scenario of possible property tax increases. The taxing entity calculates property taxes by multiplying the property’s assessed value by the taxing entity’s rates. The rates can vary drastically from just over $1 per $100 of valuation to almost $4 per $100. The title company will provide Tax Statements to evidence the current taxes. These official statements give the assessed value of a property and any property taxes due for the given year. Be sure to project your taxes based on the expected construction costs plus the land value to determine expected revised assessed values.
Property Association Fees - Properties located within a Property Owners Association usually have annual dues. Gaining a thorough understanding of these fees and putting in place an estimate of these fees for the developed property is essential.
Insurance - While this is a smaller expense relative to the others, if your property is in a floodplain, your insurance on improvements can be significant, and the lender may require that you carry flood insurance.
Utilities - If you are planning on developing a property, you will require Utilities to the site. Your ultimate use will determine the capacity needed for each.
Water and Sewer - As a continuation of the Physical Inspections for utilities, express the sewer and water requirement in the number of connections. For example, an apartment project usually needs one utility connection for every two apartment units. Each type of development has a separate ratio. Once you determine your requirement, you can visit with the local provider, city, or Municipal Utility District and work towards obtaining a water/sewer capacity letter that guarantees you the service you require. Depending on the development planned and its use, a land developer may be required by the provider to install additional improvements before connecting to the provider’s service lines.
Electrical - Unless you are a “heavy” manufacturing company, you will likely be fine with a standard line to the property. However, some operations require a separate substation.
Natural Gas - Again, unless you are a large user of natural gas, most standard supply lines will suffice. However, not all property has natural gas lines nearby.
Mortgage - Assuming the land purchase/planned improvements will require financing, it will be crucial to confirm terms available. A summary of the steps in the loan process includes the following items - Lender Package, Loan Commitment, Loan Documents.
Reports - At the core of due diligence are various reports prepared by qualified inspectors/engineers/experts to examine the respective data and form conclusions to help advise a buyer on the fitness a particular property. Not all of the reports mentioned are required by a lender to loan money on a given property. However, prudent investors/buyers should consider all reports discussed, if applicable.
Appraisal - This report forms an opinion of value based on three approaches, Income Approach, Cost Approach, and Comparable Sales Approach. A more detailed analysis of appraisals can be found here, XXX. The real estate brokers in the sale can be a good source of quality, relevant comparable sales for the appraiser. The appraiser is generally always selected by the lender.
Environmental Inspection - One of the main required reports of a lender - the Phase One report - is an Environmental study focusing on information already available and not any new physical testing. The lender may also require a physical test for asbestos the improved property, depending upon timing and nature of Improvements. This test is typically used only on land with Improvements. The engineer will gather numerous documents and information from various sources to research the prior/nearby uses of the property, any reported spills, hazardous generators, underground storage tanks, etc. and then decide if any Recognized Environmental Concerns or REC’s exist. Depending on the results of this report, the engineer may recommend further Phase Two testing, which could include materials from improvements, air sample testing, soil/groundwater sample testing. Most environmental testing never makes it to Phase Two, and when it does, it is usually related to Industrial type properties.
Wetlands Investigation - The Phase One study will indicate if there are any potential Wetlands which require further research. If so, then a formal Wetlands Investigation may be mandated to determine where development can occur.
Soils Test - A Soils Test determines the physical properties of the land. The Soils Study includes five main tests - Moisture Content, Specific Gravity, Dry Density, Atterberg Limits, and Proctor’s Compaction. The results of these tests will dictate the engineering design required for the drainage systems, sub-base for concrete paving, and foundation for any improvements. Poor soil may require costly select fill be added to the sub-grade to support paving improvements. For an example of a soils test, click here XXX.
Survey - The boundary survey of the property defines the boundaries, locates improvements, structures, paving, and fencing and notes any encroachments on the property. Title companies will require a proper survey of the property for their review and approval to close the transaction. Given an existing current Survey, the title company may accept the existing Survey along with an affidavit signed by the seller, indicating that no changes have were to the property altering the Survey.
Topographic Survey - To develop a parcel of land, it is necessary to determine the elevation of the property in a grid pattern, typically in 50’ or 100’ interval points. The height is crucial in the design of the site’s drainage, paving, and improvements. If there are any flood plain issues, these elevations become even more critical.
Assuming all has gone well with the due diligence and the buyer is ready to close, the title company, attorneys, lender and buyer/seller begin gathering the documents required for closing.
- Deed - The Deed is the document which officially transfers title from the seller to the buyer. The Contract will specify whether the Deed is to be a Special Warranty (also called a Limited Warranty Deed) or General Warranty Deed. The former only warrants the title from the date the seller gained ownership, and the latter ensures clear title from the time of land conveyance to the new owner. This article does not thoroughly go into the types of deeds and every nuance contained within. However, the main elements of a Deed are:
- Buyer and seller clearly defined
- Consideration was present and defined
- Description of the land to be conveyed - preferably a proper legal description with referenced Exhibit
- Signature of Buyer and Seller
- Actual delivery of the Deed and Acceptance of the Deed
- Note: A qualified attorney is required to prepare the Deed. The buyer’s attorney - if not the preparing attorney - needs to review the document as well.
- Final revised Title Commitment - The title commitment is one of the first documents delivered during the contract period. The earnest money contract defines Delivery time expectations. Revisions can occur numerous times over the contract period. The Contract also establishes the period within which the buyer may object to exceptions contained within the title commitment. Each time the TC exceptions are removed or modified, the title commitment is revised by the title company and distributed to the parties of the Contract until the TC becomes as “clean” as possible, given the various recordings affecting the property.
- Loan Documents - Lender documents tend to be one of the items to hold up or extend closings more often than any other requirement. Lenders generally take every minute all scheduled to prepare the necessary documents for closing. This more extended period extends the period a Buyer usually requires at least 45 days of inspection time if they are pursuing a bank loan to allow the lender time to complete all of their required tasks.
- Release of liens - Arrange for any liens on the property to be released before closing. These can include mortgage liens, contractor liens, IRS tax liens, etc.
- Replat - If a party requires a Replat before closing, evidence of this requirement must be provided to the buyer’s lender at, or prior too, closing.
As you can tell, purchasing property can be a complex process that shouldn’t be undertake lightly, nor without the support of experienced professionals.
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