Will the FDIC Have to Give Lots Away?

I get calls all the time from private equity investment funds looking to purchase notes on residential subdivisions.  I also list my fair share of FDIC and bank-owned developed lots and raw land.  As I go about the business of trying to sell this "dirt," I've noticed some troubling trends.  The first sign of trouble began in 2008 when the deal activity started to fall noticeably and we attributed it to the bid-ask gap meaning that there was too large a difference between what buyers would pay and what sellers would take.  Then we saw sellers slowly reduce their asking prices and the conventional wisdom was that seller's would eventually reduce their price to the buyer's bid and the market would hit a bottom and deal activity would resume.  The incredibily frustrating thing is that so far the bid-ask spread has remained pretty much the same percentage wise even though sellers continue to drop their asking prices.  Most offers come in at between 30 and 50 cents on the asking price for raw land and lots.

Now this means there aren't too many deals being done in the land business right now. The main exception has been with several notable funds who have picked up a  number of developed lots over the past 2 years from some of the larger Georgia and national banks willing and capable of selling their foreclosed land and lots at whatever price the market will bring.

The rest of the market activity in vacant land and lots amounts to a lot of talk.  That brings me back to the conversation I had with an equity fund out of Michigan last week.  They were considering buying a loan on a 150 lot subdivision in Fairburn.  All improvements are complete including the top coat of asphalt.  The note is non-performing and would need to be foreclosed upon and any back taxes brought current.  The cost to foreclose and clear any tax liens together with what the investors pay the bank would be their total initial investment.

Since developed lots don't produce a revenue stream, the key to determining the investor's ROI is to accurately predict two things:  holding time and exit price.  That's what the fund analysts want to know when they call me.  I usually throw out some recent transactions to show worst case exit pricing and then give them a "your guess is as good as mine" on the time required to hold the property.  Most are budgeting 4-6 years right now.

The problem I've had recently is that I cannot even give a good exit pricing estimate because deal activity is almost non-existent and listings that I have at under $10,000 a developed lot are not getting any offers in less desirable markets.  In the better markets along the northern suburban corridors, deals are still happening albeit at a snail's pace - but on the south, east and west sides of Atlanta, activity is at a dead stop.

So the $64,000 question is, "What are these lots worth in less desirable markets."  I heard one pundit on cable news say that a good portion of the developed lots in the current inventory never should have been developed and will never be built on.  I wouldn't go that far - I expect almost all of the developed lots to be built on at some point.  For some lots, the hold may be much longer than most investors are willing to wait.

Let's assume a market will exist for lots in less desirable markets in 5-6 years.  Let's assume the taxes are $400 per lot annually and the cost to mow the grass and maintain the detention pond is another $200 per lot annually.  Without factoring in the cost of money, inflation, etc. - the lots would cost $3,600 to hold.  Add to that the cost to foreclose and pay off back taxes and we can reasonably assume our investment in each lot would be around $5,000.  Most of the investors I speak with are looking for pro forma returns of 25% annually. 

 A six year simple return would require the lots to sell voer $12,500 each in 6 years.  In my opinion that's a best case scenario - what if the market doesn't return for 12 years - at that time the lots would need to sell for $20,000 to accomplish the same 25% annual simple return on investment.  When demand returns for lots in these less desirable markets, I strongly believe the lots could go for $15,000 - $20,000 each. 

There's one major flaw with my analysis.  I'm assuming today's investors pick up the lots for free.  Is that the only price that will get these lots moving?