Wednesday, July 05, 2006

The Million Dollar Land Grab

When it comes to land, there is no real concept of value that is rational, when you apply it to real estate.

Let’s take farmland; $5,000 per acre with water rights will allow a good return to a farmer. Right now, a farmer would have to clear over $325 per acre in order to have a better return than interest income on the same amount ($5,000) from the bank. An 80 acre farm would net $26,000 per year.

It’s not uncommon for land developers to go into farmland and buy up, say 20 acres. A good market price would be $80,000 per acre.

In California, some of this farmland can fetch 1 to 2 million an acre. The contractor buys the land and then, subdivides it into lots. In some areas, the contractor can literally build 16 houses per acre. That comes out to $62,500 to $125,000 per lot. Now add water sewer, gas etc for lot development and permits, and you would add in about $40,000 per lot. An acre is 43560 square feet. Let’s say 10% of it is road. That leaves 39,000 square feet divided by 16 houses, which equals a lot size of 2,500 feet. The contractor is committed to fixed cost for land of $102,500 to $165,000. Now figure the cost of house construction. The contractor probably can construct a house in a range between $75 to $100 per square foot. If we use 2,500 square feet as an average house, then we have construction costs from $187,500 to $250,000 per unit. Add in the land cost range we used and you get the contractors cost of production between $290,000 and $415,000.

Land-----------$1,000,000 per/Acre----vs--------$2,000,000 per/Acre

Lot Cost----------------62,500------------vs-----------125,000
Construction Cost---187,500------------vs-----------250,000
House Cost---------$290,000------------vs---------$415,000

Right now in California, that house is attempting to be sold for $650,000.

Step back for a moment and look at the picture from a different perspective. My figures are rather arbitrary, but examine two groups, the farmers and the builders. The farmer can sell half of his 80 acres for 40 million dollars. The contractor can make $250,000 to $350,000 per lot on the sale side (by the acre, its 4 million to 6 million).

Now, enter the home owner that decides not to sell at these prices and wait for the market to come back. A lot of these houses up for sale are 20 to 30 years old. Who wants to buy and old house when they can buy a brand new one for a lesser amount?

What if I was to tell you, that the house’s cost(my figures), actually included the builder’s profit added in. What if the contractor’s cost per lot dropped $50,000 (in a depressed market).

The farmers selling raw land and the contractor, are not going to stop their business arrangement, their price is determined before the first shovel of dirt is moved. There is an awful lot of money to be made. From farmer to contractor, compare it to a fire storm of immediate wealth.

Does the contractor want the homeowner to hold out for a higher price? You bet he does! He can beat any “used home,” in town at a lower price. He’s in it to make a living; the homeowner is trying to get out alive. The longer “used real estate” prices remain high, the longer the contractor has a “premium” return. A good contractor can’t help but make a profit at these prices, and as prices go down, his land acquiring prices go down.

The one thing that can contradict this is oversupply. More aptly labeled "miss-allocation of resources." The ability to create money at such a fast rate can stimulate an overproduction, which ends in a collapse. The fantastic rate of return and growth in construction real estate, supports the suggestion of an impending collapse of the industry.

As a foot note, I used 16 house per acre, I have lived in an area where it was closer to 20 houses per acre. As for construction costs on condos, which I skipped over, they can be constructed as cheap as $39 per square foot.

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