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Proactive versus reactive

Myer's Musings

Posted: August 9, 2008 7:21 p.m.
Updated: October 11, 2008 5:02 a.m.
1: of, relating to, or marked by reaction or reactance
2a: readily responsive to a stimulus b: occurring as a result of stress or emotional upset (reactive depression)
2 (pro- + reactive): acting in anticipation of future problems, needs, or changes
— Merriam Webster Online Dictionary

Two stories stand out in my memory regarding development during our family’s 12-plus years in the Santa Clarita Valley.

The first came from a former city editor of The Mighty Signal, who related the time when an anti-growth activist called to state that Lennar would soon “illegally” grind down a ridgeline and cut down heritage oaks in Stevenson Ranch.

The city editor, new to the SCV, quickly rushed a photographer and reporter over expecting to find sheriff’s deputies arresting construction workers, impounding bulldozers and confiscating chain saws.

Instead, he found unmolested construction workers acting under permits issued pursuant to development plans approved years earlier.

This incident best illustrated the reactive nature of anti-growth groups, also bemoaned by another SCV old-timer when he related how anti-growth groups seemed to shut down during times of construction downturns, while the fact remained that development plans continued in the background, now under the radar, to rear themselves years later with attendant emotional responses.

Now, I believe in the ability of property owners to utilize their property to the highest and most profitable use. In other words, I believe in development.

I also, however, believe the public should involve themselves throughout the process for two reasons.
First, transparency produces projects that provide the greatest utility for both the public and the property owner. Additionally, the involvement of the public forces elected bodies in charge of issuing variances and evaluating plans to focus on the issues of the entire community, rather than developer-identified issues and the known opinions of a few cranks.

In the middle of a construction downturn, the public and developer-monitoring organizations can easily inure themselves to any action.

Remain vigilant
The reasonable person should conclude, should he not, that without bulldozers humming and earthmovers shaking the ground, the business of permitting must also close down and we can all turn our backs on vigilance?

Here’s why. Let’s say development interests purchase 20 acres of land currently permitted for agricultural purposes, like a mule ranch, for $500K per acre, or a total price of $10 million. The developers will borrow 70 percent of the purchase price and invest 30 percent of their own capital, or $3 million.

The developer estimates that it will take three years and $1 million — primarily amounts paid to consultants to draft plans and permit requests — to change the permitted usage of the property from agricultural to a high-density, commercial and residential use.

The “cost to carry” (interest, real estate taxes, and maintenance) will run approximately $750,000 per year, so they will assemble commitments for total capital of the project of $6.25 million.

Their plans fulfilled, in year four they receive their permits. The land suddenly increases in value to $1 million per acre because land with permits in place commands more value than land without permits, so the total value equals $20 million.

To the unschooled, it seems the developers made a tidy profit of $6.75 million, the difference between the $20 million and their original purchase price of $10 million plus the cost of development and carrying costs.

But this discounts the power of financial leverage. Remember, the debt to the bank remains fixed. The developers really enjoyed the entire economic gain of $6.75 million, more than doubling their money invested of $6.25 million.

Triple their wealth
But, one states, no one will build right now, so this gain merely exists on paper. Not so! The developers can releverage the property at the higher value, refinance the existing debt and borrow an incremental $7 million to stock their war chest for further exploitation of the property, or just distribute the cash return to the original investors.

Now the investor holds no current investment in the property at all, other than the taxes incurred when the property actually sells. Take these simple numbers and throw the leverage up to 90 percent and the developers could triple their wealth by obtaining proper permits.

See the reason to stay proactice instead of reactive — even if nothing occurs currently other than permitting?

Tim Myers is executive vice president and chief financial officer of Landscape Development Inc. in Valencia. His column represents his own views, not necessarily those of The Signal.


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