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Monday, January 11, 2016

Land Loans

Before the Great Recession, real estate developers were making a fortune developing raw land. How did they do it? They bought farmland or scrub land, had it re-zoned, them made the "horizontal improvements", and quickly sold off the individual home-site lots for a small fortune to builders of homes.

Note: horizontal improvements are defined as grading the property, bringing utilities to each lot, and putting in streets, sidewalks, curbs, and gutters.

At the time, commercial banks were making lots and lots of land loans and A&D loans. An A&D loan is an acquisition and development loan structured like a construction loan, where the construction budget includes the purchase price of the raw land, the hard costs of the horizontal improvements, the soft costs - including an interest reserve and sales commissions, and a contingency reserve of around 5% of hard and soft costs.

During the bubble in real estate prices leading up to the Great Recession, commercial banks were drinking the Kool-Aid and making A&D loans up to 70% of total cost. Some commercial banks were even going as high as 80% total cost!  Can you say insane? No wonder there was a bubble.

As you know, the Great Recession destroyed the housing market, and land prices plummeted. The banks foreclosed, the banks took huge losses, and Federal banking regulators slapped the banking industry for being so stupid. Believe it or not, the losses in land development lending were often 80% - 90%...!!!!

Why care? Regulators have a long memory, and the absolute last loan that banking regulators want commercial banks to make today are land loans. Therefore, unless a developer is as rich as Donald Trump and has a banking history with a particular local bank going back for 15 years, he is probably NOT going to be able to get a land loan or a land development loan from a commercial bank.

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