Bulk Portfolios
COMIN 2027: Subdivision developers convert raw land into lots. These land developments typically have portions of raw land awaiting development in the future, lots under construction (i.e. work in process), and finished lots. Each of these components potentially represent a bulk inventory. And all are taxable. There are also different methods of valuing these components: cost, % completion, discounted cash flow over a sell-out period, etc.
Add to this scenario home builders who purchase (or at least agree to purchase) X number of lots in a bulk sale at a discounted price compared to the retail value of the lots. However, the take-down (closing) schedule of when those lots sales will occur is a point of negotiation between the land developer and the home builder. In addition, subdivision developers are (sometimes, many times) also home builders as well as land developers.
As with lots, there are typically homes under construction by each builder (work in process) and completed homes in inventory awaiting sale and/or closing. Again, there are different methods of valuing these components: cost, % complete, discounted cash flow over a sell-out period, etc.
It takes time to develop raw land into finished lots with street, utilities, common areas, common amenities, etc. It then takes more time build and sell houses. During the construction and sell-out periods, the owner incurs costs – cost of construction, costs for their personnel (administrative, construction management, on-site agents, etc.), marketing and advertising, model home(s), insurance, maintenance, and, of course, closing costs to purchase title policies, pay sales commissions, legal fees, recording fees, etc.
Development is an entrepreneurial venture with relatively high risk. That risk is undertaken in hopes of achieving a profit that rewards the developer for the risk. It should not be forgotten that the lenders almost always require accelerated recapture. When the lot or home is sold, the lender expects their interest PLUS (for example) 110% to 120% of the pro-rata loan amount attributable to the asset released. The result is that developer profit is intentionally pushed (by the lender) to the end of the project.
The risk, therefore, less about whether the assets can be sold, but WHEN – and the impact when has on actual profits. Most people would be surprised at how little these developers and builders actually make in pure profit AFTER they pay all of the costs, lender interest, loan principal, etc.
The point is that cost is an approach to tax valuation, but until the final lot, the final house, is sold, profit is a desired, but not a guaranteed outcome.