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Development Project Profitability Diagnostic Review
July 1st, 2006
Over the past 10 years the home building industry has been enjoying record sales and profits however, the increasing costs of land, development impact fees and material prices coupled with slower home sales and stabilizing home prices will soon begin to erode the builder’s profit margins. The erosion of profit margins may be slowed if the builders begin performing diagnostic reviews of their development projects to ensure that they have done all they can to reduce infrastructure costs and to determine that they have or are receiving paybacks from municipalities as well as all applicable development impact fee credits.
Increasing Development Costs
Over the past two years the development and home building industry has experienced significant material cost increases as illustrated by the table below:
|
Construction Costs | |||
|
Material |
1Q 2004 |
4Q 2005 |
% Change |
|
Asphalt ( ton) |
$28 |
$46 |
64% |
|
Cement (ton) |
$95 |
$114 |
20% |
|
Concrete-Ready-Mix (cubic yard) |
$66 |
$100 |
52% |
|
Steel Rebar (ton) |
$515 |
$1,130 |
119% |
|
Structural Steel (ton) |
$1,080 |
$2,450 |
127% |
|
Lumber (board foot) |
$0.45 |
$0.65 |
44% |
|
|
|
|
|
|
Source: Rider Hunt Levett & Bailey | |||
Additionally, municipalities have continued to increase their development impact fees to offset the raising cost of materials. Examples of recent development impact fee increases include the following:
|
Development Impact Fees | |||
|
Municipality |
Previous |
New |
% Change |
|
Maricopa |
$400 |
$5,176 |
1,194% |
|
|
$9,771 |
$13,582 |
39% |
|
Apache Junction |
$2,527 |
$3,409 |
35% |
|
|
$12,942 |
$17,025 |
32% |
|
Coolidge |
$4,647 |
$5,059 |
9% |
|
|
$5,028 |
$5,233 |
4% |
|
|
|
|
|
|
Source: Central Arizona Homebuilder’s Association | |||
A standard development project diagnostic review typically covers but is not necessarily be limited to, the following areas:
A. Land Secured Financing
The builder should be utilizing and maximizing land secured financing vehicles including Community Facilities Districts (“CFD”) and Municipal and/or County Improvement Districts (“ID”) wherever possible. These financing vehicles allow the developer to issue bonds at tax exempt interest rates for the construction of public improvements. Typically, the obligation to repay the bonds is passed on to the end users of the project and is amortized over a 10 to 25 year period depending upon the type of taxing district utilized.
The determination of whether or not the CFD and/or ID financing mechanisms are being utilized to the extent allowed pursuant to the requisite agreements a review should be made to ensure that the amount of funds available for public improvements is being maximized. Additionally, diligent and detailed accounting and record keeping should be implemented to ensure that all known and expended reimbursable costs are accounted for so as to avoid leaving any money on the table.
To the extent that the builder is not implementing land secured financing as part of their regular development program, the merits of special district financing should be considered by management as an integral component of the company’s development and financing strategies.
B. Allocation of Costs to Benefiting Land Owners
Many times the construction of public improvements related to a large project benefit other surrounding land owners at the expense of the developer. It is in best interest of the developer to include specific language within their development agreement with the municipality to allow for benefiting land owners to be charged their fair share allocation of the costs of the public improvements for which they have received benefit as-soon-as-possible in the development process. This may be done through inclusion of the benefiting land owners within the boundaries of the land secured taxing district (e.g. CFD and/or ID) or through the establishment of a reimbursement district (“Reimbursement District”) related to these benefiting land areas. In the case of the reimbursement district, an objective event should be established in the agreements for the payment of the benefiting land owners fair share costs. For example, we typically suggest that upon the recordation of a final plat map by a benefiting land owner, the full amount of the fair share cost allocation obligation be due and payable to the developer. Furthermore, developers should consistently and diligently review their agreements to ensure that they are beng implemented and that the funds are being distributed appropriately.
C. Excess Capacity
If a project is conditioned by a municipality to finance and/or construct public improvements which are in excess of its demand requirements, such excess capacity costs should be provided by the municipality however, most municipalities are not typically willing and/or able to provide such financing. In such an instance, the reimbursement for these excess construction costs should be paid by those benefiting from such improvements through the establishment of a Reimbursement District. To ensure that these funds are being collected and the program administered properly, an audit of the collection of the funds should be performed to ensure that the program is being administered properly and that the builder is receiving their cost reimbursements in a timely manner. To the extent that such programs are not being administered properly, the situation needs to be brought to the attention of the municipality’s staff and the problem resolved.
D. Development Fees
It is vital that development impact fees for which a development project is subject to be thoroughly reviewed to ensure that they have been appropriately calculated as well as determine the extent to which development impact fee credits may be available to the developer. Additionally, an audit of the municipalities accounting for and collection of development impact fees should also be undertaken as allowed by Arizona Revised Statutes 48-463.05 to ensure the proper treatment of such funds by the municipality to ensure such credits are available.
Conclusion
With proper diagnostic assessment as described in the preceding paragraphs, along with the planning and inclusion of a comprehensive financing plan within annexation and/or development agreements with municipalities, the builders will be in better position to mitigate the impact of escalating construction costs.
Carter T. Froelich is the Managing Principal of the Development Planning & Financing Group (“DPFG”) office in Phoenix,
