Land Development Financing

Acquisition and Development Loans

A land development loan is an advance of funds, secured by a mortgage, to finance the making, installing, or constructing of the improvements necessary to convert raw land into construction-ready building sites. In other words, a land development loan takes an unimproved parcel and breaks it up into a number of smaller, improved parcels upon which homes or commercial buildings will be constructed.

The kinds of improvements we’re talking about might be subdividing, leveling, grading, building roads and bringing sewer, water and power to the site. These kinds of improvements are also known as horizontal improvements. A land developer might may, “I need $1 million for the horizontal improvements.” 

An acquisition and development loan (A&D loan) is a loan where a part of the proceeds are used to buy the property. The total project cost would include the cost of the land, the hard costs for the horizontal improvements, the soft costs (including an interest reserve and sales commissions) and a contingency reserve. The minimum cash contribution of a developer on an A&D loan is usually 25% of the total land development project cost.

As a general rule, the minimum cash down payment required for a land developer to purchase a piece of land is 30%. Please note that while many hard money lenders will not exceed 25% to 50% loan-to-value when refinancing a piece of land, many reasonable hard money lenders will finance up to 70% of the purchase price of the land, if the developer is putting down 30% in cash and ofcourse all subject to investor & market risk levels.

If anything other than cash is used as the down payment, like a seller-carried second mortgage or some “credit” for work already done, the size of the loan that the typical hard money lender will make will fall precipitously, probably down to the 55% LTV range. The 30% down payment must be in cash.

Land lenders will look carefully at the migratory patterns of the state. The population of the United States is on the move to warmer climates. The Southeast is enjoying a huge inflow of legal immigrants, especially North Carolina, South Carolina, Florida, Alabama, and Georgia. California is still a preferred state for many lenders, but it is actually suffering from a net outwards legal migration. Arizona, Nevada, Idaho are enjoying a large net inward legal migration, and Utah is still a popular destination.

The states of the cold Rust belt are certainly not great locations for land loans. Land lenders will usually scale back their loan-to-value ratios in Michigan (very depressed), North Dakota, Illinois, Indiana, Ohio, Pennsylvania, New York and New Jersey. Folks are moving out of these states in droves.

When underwriting a land development loan, the underwriter will look carefully at where the property is located in the entitlement process. If the land is zoned agricultural, and the nearby town is anti-growth, a reasonable loan-to-value ratio for a land loan might be just 10% to 25%. If the nearby town is pro-growth and the subject property is located close to the town and in the path of growth, a reasonable loan-to-value ratio might be as much as 40% to 50%, even if the zoning is still agricultural.

A parcel that already enjoys a tentative map for a residential subdivision might be eligible for a refinance in the range of 50% to 60% of value, especially if the current property owner got the property up-zoned. Be careful, however, of the property that is “just a few weeks” from a tentative map. That “few weeks” could easily extend into a "few decades" if the local Board of Supervisors votes against the map.

One of the first things a lender will want to know is, “What is the exit strategy? How are we going to get paid off?” If the borrower is just living off the cash he can pull out of the land until some unlucky hard money lender becomes the biggest fool, the loan is not one many lenders will chase. But if the land developer is an old pro and has a plan to develop three commercial pads and a condo project pad, each of which he will sell off, a land lender will be much more aggressive.