Transcript
Dean Wehrli:
Welcome to The New Home Insights Podcast, the John Burns Real Estate Consulting Podcast about all things US housing market. I’m your host Dean Wehrli. Today we take on another pretty hot topic in the real estate world. That’s land banking. So an increasing number of builders, including some of the biggest builders in the country are leaning on this strategy to spread risk, to expand their pipeline and really to be ready for whatever happens tomorrow. So to give us the low down on all things, land banking we have with us, one of the biggest land bankers in the country and that’s Steve Benson, he’s the CEO of Essential Housing, very active in land banking space. Steve, give us a brief, kind of little intro about you and also about Essential Housing and what you’re doing right now.
Steve Benson:
Hello, Dean. And thanks for inviting me to the podcast. It’s a privilege to be here and spend a few minutes with you. In terms of my personal background, I spent… I was a CPA early in my career, went into the home building business and worked with some of the largest builders in the United States managing divisions and regions and companies and the public home building sector.
Steve Benson:
And in 2001 began doing work in this space, what we call land banking. I joined Acacia Capital and at that time, Acacia was arguably the largest land banker in the United States In 2011, joined GSO, which is a subsidiary of Blackstone, a large private equity firm headquartered in New York. And I headed up their land banking platform, investment platform that we referred to as Community Development Capital Group. And about a year and a half ago, I guess it was in late 2019 joined forces with Angela Gordon, in a land banking project that I’m sure we’ll talk more in detail about, but Angela Gordon wanted to, along with its builder partner, Lennar Homes, wanted to revolutionize if you will, or transform the land banking business. And I started a project with them and they have branded if you will, the land banking business under the name of Essential Housing Company. So that’s sort of my background and I’ve been privileged to be with some of the largest capital sources in, in the US. And as you said, it’s a pretty active space right now.
Dean Wehrli:
Yeah. Yeah. Essential Housing is a, is a pretty cool name, but CDCG sounded like a hip Manhattan night spot of the ’70s. So that was kind of cool too. That part’s sad. So let’s start at the big 30,000 foot, the broadest level, pretend a lot of folks in the audience don’t really know the first thing about land banking. What is kind of the outlines, the basics of land banking?
Steve Benson:
Well, probably the best way to give you the basics is to just give you a quick overview of the life cycle of a typical land bank investment. It begins with a builder that has been… Talked to farmer Jones and decided to buy farmer Jones’s property to develop a large, a new home community. They gave farmer Jones, some walking around money while they got all of the entitlements and developments set up and ready to go. And just about the time they were ready to close on the property, they call their friendly land banker. We step in and we close on the property with the builder as our sponsor, if you will, of the development.
Steve Benson:
And on the day we buy the land, we enter into two agreements with the builder. One is an option agreement where the builder has the option, but not the obligation to acquire all the lots in the community under a, just in time inventory model so that they can buy lots as they need them to build a home for Dean Wehrli. And we enter into a construction agreement with them at the same time, which provides… It’s a general contractor’s agreement where we, as the land banker, hire the builder as our general contractor to install the improvements on our property. Over the rest of the life of the project, we fund all the land development improvements. As they begin selling homes, they buy lots from us. And at the conclusion of the investment, they’ve bought all the homes.
Steve Benson:
If you were to look, Dean, at the at option agreement and construction agreement, your first takeaway would be, these are pretty obnoxious documents because it seems like the builder still has all of the risk of ownership and development. And that is the case except for one area. And that is what we call market risk. So the land banker, if you were to say, “What are we really in the business of doing?” We’re in the business of taking market risk. We certainly provide capital to our builder sponsors and they really like that. We give them, especially with firms, the size of Blackstone GSO, and the size of Angelo Gordon. We have access to significant amount of capital that can help them in their raising money and having money available to build developments. But we then take the market risk.
Steve Benson:
If the price that we establish to the builder, for them to acquire the lots stays in the money and the market doesn’t go down, they’ll successfully purchase all the lots. And if there is some disruption in the marketplace, they do have the option to terminate the option, and then we’re left with the land to hold and sell it when the market returns. So that’s-
Dean Wehrli:
Ultimately, that’s one of the… Just the keys for your builder partner is just to spread the risk, right?
Steve Benson:
That’s correct. That’s right.
Dean Wehrli:
We’ll get into a lot more of those nuances as we go along, Steve, but let’s first, let’s step back. Sometimes is interesting to look at a little bit of the history. You mentioned you started with Acacia Capital doing this back in 2001. How far back does land banking go? Is it something that it’s hot now, but it has a pretty, a rich history? Does it reach way further back than most people think?
Steve Benson:
Well, when I joined Acacia in 2001, they had been in the land banking business for at least five or six years. So yeah, this is… Land banking has been around for a long, long time. I would say that in the early stages, it probably catered more to the large private builders that were looking for capital, but then as the optionality component came into play and public builders realized that they could, through these option structures control a large amount of a land inventory without having to carry those assets on their balance sheet. It became very attractive to the larger builders. And that’s when it really started to be put more in use by the publics.
Dean Wehrli:
I was just going to ask… What my next question actually was, how has it changed over the years? Is that the main way it’s been attractive? Because it allows these bigger builders to really kind of again, spread that risk and look a little sexier to Wall Street?
Steve Benson:
Absolutely. I think that it’s certainly changed in terms of where it’s being applied. And I would say early on, Dean, as the public builders saw that if they were able to land bank five, six, seven projects in a year that enhanced their returns and gave them a way to offload risk. But then through the years as these builders, especially the large publics, just became larger and larger and larger, doing a hundred million dollars worth of land banking for a public builders, doesn’t move the needle anymore. So what is really necessary is for them to be able to do it and do it at scale. So that’s kind of the frontier that we’re paving right now is can we take this thing called land banking and employ it at scale across… At a scale large enough to can really help the public builders achieve what they’re looking to do.
Dean Wehrli:
I guess you said mentioned what’s in it for the builder? Let’s talk about that and expand on that a little bit. The main sort of goal for the builder is to have this… To spread the risk by having this ability to kind of walk away potentially. How does that work? How would that work, in actuality?
Steve Benson:
As I said, we establish… There’s several different structures, but the structure that we use the most is one in which upfront the builder develops a business strategy, or has a business plan for a community. I say we need this much time to finish entitlements and get some lots on the ground. And so 10 months from now, we’re going to start buying lots at four a month because that’s what we all perceive and agree as the market absorption pace. They begin buying lots at four a month and there’s a… The builder is constantly and you know this from your time and in the market research field, the builders are constantly rationalizing the marketplace. The market’s going up, the market’s going down, they’re looking at their product offering. They’re looking at the pricing and the pace and trying to time that with construction.
Steve Benson:
But at some point in time in their rationalization of the market, they realize that the market has moved too far away from them, and they can no longer make a profit. They can no longer make a go of it in the community. And at that point in time, if it’s a land bank project, nobody’s ever called me and said, “We’re terminating our option tomorrow.” It’s a four, six month discussion that’s been going on and we see it coming and they know it’s happening and the option terminates. And then as I said, in my opening comments, we hold that for some period of time until we can find a replacement builder to finish the community.
Dean Wehrli:
Yeah. Are these deals sort of maneuvered on kind of a knife’s edge or would it take a pretty significant downturn for that kind of thing to happen?
Steve Benson:
Well, it’s a interesting question and probably ties back to how has the business changed over the last 20 years? Oh my God, did I just say 20 years. Have I’ve been doing this for 20 years?
Dean Wehrli:
Flies. Time telescopes. I swear to God things that seem like it was a couple years ago and you look back, it was seven. Yeah.
Steve Benson:
So, in the early stages, when I was making calls on builders, it was kind of like going down to the grocery store and you got to pick projects that the builder put out on the shelf that day. And so you underwrote it and you kind of had to know that these were the projects that you felt comfortable with and sort of your own, because you were buying the real estate, you kind of felt like you were the owner and had to really understand the real estate yourself.
Steve Benson:
In today’s market, first of all, we are making a margin so that there is a markup to the builder. There is a cost of land banking. So the builder has a motivation to take projects where they have strong profitability forecast and where they can afford the cost of the land banking at a project level and because of the scale involved and because of the nature of the capital, now that it’s in big capital, nobody ever wants to get in a position where you’re going to have an option termination.
Steve Benson:
So we tend to have the ability to work with our builder partner, if you will, and select the best of their best projects for land banking. It’s to their advantage, from a profitability standpoint and from an overall capital utilization standpoint, to provide us the best of the best so we can continue to do business for a long time together. So now that sort of changes the dynamic and has moved us from somebody on the opposite side of the table, buying the land, to somebody that is collaboratively designing a financing solution for Sleepy Hollow.
Dean Wehrli:
That makes sense. So it kind of has an inbred factor within these deals that… Or should make it likely that it would require a pretty significant market shock for these things to kind of go sideways, because you’re like you said, you’re looking at the best of the best and the most profitable markets. So there’s some… You know, right. There’s some buffer there, I guess.
Steve Benson:
That’s right.
Dean Wehrli:
What else is in it for the builder? Okay. There’s the part about Wall Street, right? It looks better for them to have a lot of that land off their books.
Steve Benson:
It certainly helps in their economics. We have several builder customers that find land bank capital useful for asset allocations. So, a builder might sit down with all of their operating divisions and identify and allocate X amount of dollars of capital to Virginia let’s say, to Northern Virginia. Well now of a sudden the Northern Virginia marketplace is doing really well. The divisions identified some great opportunities, but it’s now above its asset allocation. So now being able to get land bank capital to supplement what they’re doing can help them still maintain their asset allocations, but take advantage of good markets.
Dean Wehrli:
Would that come at the divisional level? So that decision, does the division actually seeking greater opportunity, they’ve gone beyond their asset levels. So, the division is looking for these deals or is that more HQ?
Steve Benson:
There are certain builders that are set up that way, where they give you the asset allocation. And if you want to exceed that, you need to help participate in finding some of that capital. So yes, sometimes our business development calls are made at the corporate level and sometimes there’s certainly made at the individual division level.
Dean Wehrli:
Okay. Okay. How about the cost of capital? Isn’t the capital cost another… Is it typically a little less cost of capital for you guys than other sources?
Steve Benson:
Yeah, our cost of capital to the builder, I mean, I think that what’s oftentimes interesting about the business is that everybody always wants to talk about the IRRs and what are your rates and all that other kind of stuff. But if I was to, in this context, if I was to help you best understand what the cost of… What the cost of land banking capital really is at the end of the day, after doing and literally hundreds, or maybe even thousands of land bank pro formas. If you’re a builder and you present me a project that has a certain amount of land and site development costs. So let’s say that you had a piece of property that costs a million dollar dollars and $500,000 worth of site improvements. That’s a million, five. We call that a million, five of project costs.
Steve Benson:
If we mark that cost up by somewhere plus or minus 10 to 12%. So we’ve added 12% to the cost, to the builder’s cost structure. That’s usually a tolerable amount because we’re adding 10, but they’re going to subtract somewhere between five and six because they’re not paying bank interest.
Steve Benson:
So they’ve got some incremental spread depending on what their cost of capital is. The sweet spot is kind of that 10 to 10 to 12%. If I run a land bank proforma, and I’m adding significantly more cost to that, it’s not good for the builder.
Steve Benson:
And candidly, if I run a land bank model and it’s substantially less than that, it’s not good for the land bank because we have to go and buy groceries at the grocery store too, and as the old joke goes, you can’t buy groceries with IRR, you actually have to have money. So we need to make both a gross margin on a dollar return, as well as an interest rate return. And so somewhere in that 10 to 12% range has usually been historically, I don’t care what the rates are or what everybody’s deal of the day is, that’s pretty much kind of the sweet spot in land bank.
Dean Wehrli:
And you mentioned a minute ago, if something does go sideways, if the builder does decide we’re going to walk away from those lots, your first option is just you resell those loss to some other actor in that market.
Steve Benson:
That’s right. So part of our underwriting process is we’re always kind of in the mindset, although we are completely committed to the customer, you always do have that notion in the back of your head. Well, in the unlikely event, there was an option termination. Is there somebody in the marketplace that could step in and build this community out? Is there somebody that has the skill and capacity to do that?
Dean Wehrli:
I have a friend who approaches marriage like that, by the way, also. Which is not a good call.
Steve Benson:
Not a good call. Yeah.
Dean Wehrli:
Hopefully he won’t know that I’m talking about him. He doesn’t listen to the podcast. So you look, you mentioned a minute ago, you look at a profitable market and that’s very attractive to you. Does that mean almost the converse that a more, I don’t know, a more vanilla market is less attractive to you, a market that doesn’t have those bigger highs and lows?
Steve Benson:
You know, I would say that there’s two answers to that question, Dean. One of them is certainly in a vacuum, we’re going to tend to prefer or tend to privilege those markets that are key primary markets, where there is predictable demand over the option period, that market that favors the particular strategy in terms of product and pace and price that the builder is planning on offering. Certainly that would make sense. At the same time, as you begin to scale the business and the builder wants to go into a new marketplace or wants to go someplace that is maybe considered a little bit edgy. Because we’re a good capital partner, we want to support them in all of their efforts. And we know that, especially at the public company level, they have regions and corporate oversight that helps a project out when it does hit a rough road. So we’re open to all those possibilities.
Dean Wehrli:
It strikes me then that has this kind of remote work revolution maybe made your job a little harder because it has opened up these markets that don’t have a long history of demand, but there’s a logic for them having a lot more demand lately. Does that make sense?
Steve Benson:
Well, most definitely. I mean, one of the greatest privileges that I have in the job that I have here is that I get to work with some of the brightest and smartest people in the industry. So believe me, I mean, our successful projects aren’t because of anything I’m doing, it’s because I’m able to stand on the shoulders of giants out there that are watching these trends. From the consultants, like John Burns all the way to the in-house builders that are boots on the ground and seeing that. And that’s really the key part of our underwriting is to understand the builder’s narrative, and how they’re seeing the market and why they think this is a unique opportunity that will help them be successful. And in turn us be successful.
Dean Wehrli:
How about in terms of product, in terms of housing product, you kind of look for, again, sort of very, vanilla is maybe not the right word, but very tried and true product. Are you more leery to go after something like say high density that might seem a little riskier?
Steve Benson:
Well, first of all, in a just in time inventory model, high density products typically don’t lend themselves. I shouldn’t say high density… Like condominium buildings or product that has a lot of units under one roof. It doesn’t really lend itself to land banking, because if you had a 20 unit building and you were ready to buy one unit, well, it’s really difficult for you to buy one unit and me to own 19. So, from a land banking standpoint, once you’re ready to buy that first unit in that 20 unit building, you got to buy all 20 units. So typically that type of product doesn’t lend itself well. So we find ourselves primarily, single family detached in either a fee simple or a condominium form of ownership. And we do a lot of condominium projects whereas there’s always this language differential. Condominium can mean the way that the ownership is conveyed to a unit. I mean, you can have a single family condominium, where condominium just means that you own your structure and have a undivided interest in all the land. We do a lot of condominium communities, but they are usually in a town home sort of configuration where the builder doesn’t mind buying eight units at a time or six units at a time. Then it’s very efficient.
Dean Wehrli:
Yeah. So you can do the… Like you said, they can buy those eight, that four, six, eight unit townhouse pod as their phase, that would be their buy for each month or each two months, whatever.
Steve Benson:
That’s right.
Dean Wehrli:
Okay. Okay. Do any locations alarm you? Are you leery of, I don’t know… Are you really looking for core areas or, like you said, you’re just following demand? Do you have any… Do you kind of shy away though from maybe infill where the market is less certain or the demand is less historically proven?
Steve Benson:
You know, during the… Because we’re in the business of taking market risk, we’re certainly going to look at those, again, privilege those markets that have a sustainable demand over the future of the term of the option. So we’re definitely interested in those. I would say that this has changed a lot over the years. It used to be that there were certain markets in the United States where the joke was that if you owned a pickup truck, a hammer, and a dog, you were a home builder, and there were plenty of developers that were willing to option you lots at $200 a lot. And the culture of those communities was that you would walk away from your options all the time, because after all, you only had $200 up. So those markets didn’t really lend themselves to institutional very well.
Steve Benson:
Today I would say that probably, really the outlying areas, maybe those areas that in the event of a downturn really showed a falling off the cliff, we might be cautious in those areas. And then to the earlier point, if the product is very, very unique and very specialized to a particular site, we may shy away from that. Unless the builder is willing to give us the permission to utilize the product, in the event, they should terminate the option in that specific location.
Steve Benson:
So I’ll give you a good example. We had a community not too long ago in Chicago, that was a wonderful community. It took the builder three and a half years to get their plans approved. The housing plans approved because the local approving authority was very particular on what was going to be built. Well, if they terminated their option, we didn’t want to have a replacement builder have to go through the same three and a half year process. So in this case, the builder said, “And if we terminate the option, we’ll allow you to build this product in this location only.” And that assigned us and our replacement builder the right to use them.
Steve Benson:
So anytime there’s sort of a bump in the way, I would say one of the things that makes us so successful at what we do is we’re pretty creative. We can come up with ways to mitigate the risk, not eliminate it, but mitigate the risk. And that helps us make the investment.
Dean Wehrli:
If you had to answer this question, and you do, what is more important to you? Is it being right about the absorption, the sales pace, or is it being right about the price?
Steve Benson:
Being right about the sales pace or being right about the price? You mean the average sales price?
Dean Wehrli:
Price versus pace in a deal. Yeah. What’s kind of, what has the greater risk, I guess, being wrong, maybe we pose it that way. If you’re wrong about the absorption, would that hurt you more than being somewhat wrong about what the expected price for given home is in a deal?
Steve Benson:
It’s a pretty even draw, but if you said I had to choose, I would say that I would lean more… I would be more concerned about being wrong about the price and here’s why. If we’re wrong about the pace. If the builder said, “We really think we’re going to be able to do six a month.” And they’re only able to do four a month. Most of the builders that we’re dealing with can afford to inventory those extra two lots a month, and it doesn’t all of a sudden, completely obliterate the reason that they did the land bank. They have the ability to inventory lots during the difficult times. And then when the market cycles back around or it’s the time of the year and they sell eight a month, they can absorb those lots. So I would say I’m more concerned about price than pace.
Dean Wehrli:
Let’s talk about the clients and how you look at potential builder partners. Essentially, you’re not just underwriting the market, but you’re underwriting that builder too. So is the track record of that builder critical to you? Are you looking at that and pouring over their history?
Steve Benson:
You know, I think it’s probably one of those things that you hear that’s said that almost sounds like it’s a trite statement that people say to look like they’re smart, but I’m telling you this from the bottom of my heart, that this is the case. At the end of the day, the most important thing to me is the people. And I’ll illustrate it this way for you, Dean. I can tell you and there’s probably going to be a few builders that are listening to this and they were going to say, “Yep. I think I was on the other end of that call.” When the builder calls and says, “Steve, I’m telling you what we have got some deals in,” I’m just going to use a city, “Nashville. And we’ve got five land positions that we’ve just lined up. Now, what we did is we took our top land guy from Dallas and we moved him out to Nashville. And let me tell you, he’s identified five land positions. We want to get those land banked.” By the time he gets to the word banked, he’s already got a dial tone.
Dean Wehrli:
Because yeah, you’re not trusting that guy coming over from Dallas to know Nashville is that?
Steve Benson:
Yeah. Trust is maybe a little harsh, but it’s look, we are very… Again, we’re in the business of taking market risks. So we want to know that the people that are in charge of the levers and the dials that are rationalizing that market, as it goes up and down, are really have the experience and are in tune with what’s going on. I don’t really care if a guy says it’s… If somebody tells me it’s six a month and it turns out there’s a slow down, that doesn’t concern me because we’ve all been in the real estate business long enough to know that there’s no way to compel the events to conform to the pro forma. We need somebody that can be dynamic and agile and manage the business. And somebody that just moved from Dallas to Nashville probably doesn’t have that fingertip ability that we’re looking for. So it’s really, the people’s important.
Dean Wehrli:
So when you’re looking at those builders or even that division is that you’re looking at those key folks who are doing the deals. And what else is there about a builder that specifically attracts you to partner with?
Steve Benson:
Certainly their experience in the market. Now, I mean, so there’s a risk if a guy from Texas came to Nashville, but again, what can mitigate that risk is that if they have a really strong regional president or somebody at the next level up that came from that market, or they’ve got the same operating team is in place. So, it’s the experience, the knowledge, and just, how you can kind of tell when you call up and see, how would I say this? It’s kind of like when I was a kid growing up on Saturday morning, you’d show up at the breakfast table and my dad would say, “So what’d you do last night?” And if you had the right answer, you kind of got off scot free. You went off and played ball that day, right. But if you had the wrong answer, I mean the bright lights came out, the Spanish Inquisition started, right? So you start your due diligence process and you ask somebody the first couple questions. And if you just feel like there’s too many holes in that story, then it’s time to really ask the question of, have they really done their homework and do they have a business strategy and something for us to underwrite and a real solid plan for the community?
Dean Wehrli:
Do you realize that you are the Spanish Inquisition in that metaphor, Steve?
Steve Benson:
That’s right. I am.
Dean Wehrli:
So, you’re… I mean, are you a little leery of those folks who seem a little salesey, a little over hyping? Do you get that sense? Do you try to kind of read that? You know?
Steve Benson:
Part of the… Look, I mean, I’m sure I’ve been there and you’ve been there where we might not, we might be going into a meeting, not be a hundred percent prepared. And if somebody’s trying to pull one over on you, you kind of get a sense of that right away. But if somebody says, “Look, I know you came here. I just don’t have all the answers yet, but I’ll tell you what, if you can sit down and help me understand what you’re looking for and how I can best get this project shaped up to…” I’ll work all night with them on that. So it’s just dealing with people that understand the job at hand, understand that we’re there to support them and their company and that we’re doing it in a collaborative fashion. We get along fine with all those folks.
Dean Wehrli:
Do you still… You talk a lot about public builders and it’s become a major space for them. Are you still work working though with private builders? Is this still a safe space for private builders?
Steve Benson:
Yeah. And so I don’t mean to exclude the privates and here’s the way I would distinguish that. And maybe this also fits into your last question of who’s a really good customer for us. We’re really interested. There’s two different ways to approach raising capital for Sleepy Hollow. Sleepy Hollow is my famous community that is my example community. And so that’s what I mean by Sleepy Hollow. If all you’re interested in and focused on today is to raise capital, to go big, to go build Sleepy Hollow. To me, that’s a tactical… You’re on a tactical mission to find financing for a project. As opposed to and I’ll say, generally speaking public builders, aren’t looking for a tactical solution. They’re looking for a strategic solution in how they can use land bank capital as a component of their capital stack.
Steve Benson:
So they literally don’t care which projects in the United States get the land bank. They just know that as part of their capital stack, they need 300 million in the next six months. And so this is really a sort of a… I’m whitewashing, private builders in a bad way. But to a certain extent, most private builders are still looking at tactical solutions for financing and I’m putting in a broad category, publics that are looking at more strategic use of land bank capital, exceptions on both sides of that rule. But that’s how I’m kind of holding them. So I should probably more… It would be more appropriate for me to say those builders that are using land banking strategically are the ones that were attracted to, as opposed to those that are using it tactically, because if you’re using it tactically, the first moment you have trouble with Sleepy Hollow, you’re out. I mean, you’re not thinking about this at a more strategic level.
Dean Wehrli:
Yeah. Yeah. But also, is it fair to say that very few privates, there are some, but very few privates have the scale and the scope to be strategic as opposed to be tactical?
Steve Benson:
Yes. I think that’s accurate. That’s what, I mean, one of our… You asked earlier what’s in it for the builder? That brings up, when you think about strategic use of capital, we’ve supported several large private builders and public builders in an acquisition of a new builder and a new marketplace. So, builder A is going to go in and acquire builder B and they need to raise a lot of capital real fast. Well, they can go to Wall Street and if they’re a public company and maybe get the capital, but the time it takes to do that, especially with the scale that we have in the capital that we have committed from our investors, we can really be a quick solution for them in an acquisition form where in that acquisition, don’t know if it’s on or it’s off until the day that you’re going to close and then you need the money. So, those are builders that are using land banking more strategically then.
Dean Wehrli:
- Let’s talk about risks since risk is such a big part of land banking. What is the biggest risk for you in a land banking deal? Is it the obvious? Is it the builder walking away or?
Steve Benson:
Well, I mean, the builder walking away isn’t really the risk. That’s kind of the consequence of the risk, right? That’s what happens. I would say our biggest risks are, certainly the market doesn’t perform as the way we intended. I mean that is a risk to us because that means that we’ll now own assets that are non-earning assets for some period of time before we can dispose of them. I think we also have the risk of, we tend to only invest or we, at this point in time, we only invest in what I call work in process land inventory. So inventory that people are out building homes on. Not land, that’s going to sit there and not be put into production for three years. But even property that’s work in process land inventory can run into a buzz saw with an approving authority, with an inspector, with a wetlands issue. It’s all of the… So our risk is no different than the home builder’s risk in the sense that we have to confront all the risks that we don’t know, that are going to arise in the future.
Dean Wehrli:
And is that the same then for the builder, or does the builder have other risks that aren’t the same as yours in a given deal?
Steve Benson:
No, I think in that context, those are pretty much the risks that the builder’s facing that we’re kind of facing with them. Now, as we’ve scaled the business, one of the things that we’ve done is work with the builders in a way to say that they’ve helped us on the market risk and in a certain way that I can explain in a moment and they’ve looked those and said, well, we had a really good builder, and I wish I could say who it was, but probably isn’t appropriate. We had a builder several years ago that we land banked a community, and out of the clear blue, a bunch of rain happened in the area. And the local approving authority completely changed what its grading regulations were going to be, or design was going to be for hillside communities of which this was one and they said, “Well, wait a second, but we’ve already designed it in conformance with the plans. And you’re basically changing plans. You can’t do that.” And the approving authority said, “So sue me. Because we’re doing it.”
Steve Benson:
Right. Well, this is a dilemma that by all accounts is going to take either a lot of money or a lot of time to fix. And the builder came to us and said, “You know, you’ve got X millions of dollars invested in this project. It’s probably not a land bank project. Would you mind if substituting that into this project over here that is, and we’ll buy you out of this one while we fight the battle.” I mean, that’s sort of the standup company that’s looking at your capital more strategically and realizing that they have a problem that they’re not going to try to put on us to solve. So, that’s an example of where we work with the builder on those sorts of risks.
Steve Benson:
And by the same token during the great downturn, one of the biggest challenges that land bankers face is that the market all of a sudden went down, and now bring back the human element people started to flinch. Either the land banker got nervous and said, “Well, we’re going to cancel your option.” Or the land banker’s lender got nervous if they had some voice in the game or the builder flinched and said, “We got to terminate because we don’t have anything.”
Steve Benson:
So we now as part of a land bank structure have provisions that give us all an ability to kind of hit the pause button and let calm minds make the decision as opposed to panic mode. So, we’ve built in structures to these land banks that help to mitigate some of the risk of the human being element and the, what happens if something comes out of the clear blue sky that nobody expected happens.
Dean Wehrli:
Is that one of the key reasons you’re not looking to take in entitle entitlement risk, because the time factor in entitlement is such a, just a long span. You don’t want to try to guess the market that far ahead?
Steve Benson:
Yeah. We break entitlement risk into, or entitlements, into two broad categories. One is what we call discretionary entitlements. And the other one is called administrative entitlements. Administrative’s the easiest one. That means if you show up at the right meeting at the right time with the right piece of paper, you’re going to get your approvals that you’re seeking. As opposed to discretionary, which if you show up at the meeting and the approving authority has some subjective capability to say, “Well, we don’t like this because we just decided we don’t like you.” Or that the process is so uncertain as to how you’re going to get there, that it makes it sort of discretionary.
Steve Benson:
We don’t mind taking administrative risk. We just shy away from the discretionary risk. So if there’s a discretionary risk in the prop in the… So we close on a lot of property that doesn’t have a final map, for example. That would be the sort of in most jurisdictions, the epitome of no more entitlement risk. Virtually every project that we close on, doesn’t have a final map, but we have been able to satisfy ourselves that whatever is outstanding is fairly administrative in nature to get there. And we have some certainty about it.
Dean Wehrli:
I have literally known a city that truly has not done approvals because they didn’t like the person and you know what, they weren’t a hundred percent in the wrong. What I’m thinking of. So you’re looking at the market. I mean, you got to do that. Are you constantly just gauging metrics and things like that to understand both the wider market and those specific markets that you’re looking at?
Steve Benson:
We’re certainly staying in touch with the market. And I certainly… We’ve been throughout my career in land banking going all the way back to Acacia and through. So geez, that is like over 20 years now. I’ve known John for that period of time. And John has been our biggest supporter and providing us both research and consulting services on every one of the investments that we do. He’s been the lead on, gosh, I’d have to say over 95% of that work. So we certainly rely heavily on the work that John does for us and his entire team. And then we’ve got the added benefit of we’ve got all of the builders that are local market experts, the ones that are actually turned in the dials.
Steve Benson:
So do I consider myself a market expert? I kind of consider myself as a I guess in that regard as a broker of knowledge. I mean, I get a lot of feedback from a lot of people about what’s happening in the markets and am able to compare and contrast that and draw our own conclusions for our investors, but we don’t have to go and source all that stuff ourselves. There’s plenty of people that are out there that are helping us in that regard.
Dean Wehrli:
Then I’ll ask you to do dip into your crystal ball for a second. And how do you see this current market kind of playing out over the next, let’s just say even near term, the next year or two?
Steve Benson:
Oh, I think I’m probably in with most of the consensus. I think that we certainly are seeing the wind at our back right now. If there was anything that concerns me about the market, kind of traditional market research privileges, looking at the past, trying to project what’s going to happen in the future. Now I’m not saying that there are people that are looking at the future and trying to figure out where we are. But I would say, in my opinion, as a general rule, we tend to privilege… Take what we know from the past and project it forward. I think during the great housing recession, the housing industry fundamentally changed. In my era when I grew up and even when my parents grew up, there was a significant amount of my identity that was wrapped up in the car I drove and where I lived. When I finally moved to Arizona, I was going to live in Scottsdale because that’s where I want… I’m on Scottsdale. I’m going to live in Scottsdale. I’m not going to live any place else. Right.
Steve Benson:
Because my identity was wrapped up in that, I think during the great housing recession, my kids looked at me and said, “Why do you live in Scottsdale?” “Well, because the values are here. The long term values are here and going to play out.” And they looked at me and said, “So how’s that working for you, dad?” “Well, it’s not working too well right now.” So people’s identity shifted away from I was plenty fine in my 20s to sit home on Friday and Saturday night and sit down and look at my coupon book and see how good I was that I lived in a nice home. And I think people’s relationship to where they live fundamentally changed. I think in March of, I’m picking, I’m trying to pick some arbitrary date, I think sometime in March or April of 2020, the world fundamentally changed again with COVID and the possibility that brings in a recurrence that brings. That has people now, again, completely reevaluating their relationship to where they live and what they use their home for.
Steve Benson:
And then you look at the multitude of lots that are in the planning stage that takes two, three, four years. And we got 45 foot lots, 50 foot lots and 60 foot lots because that’s what sold the last couple years. The only thing that I am very curious about is do we really have a handle on what those fundamental shifts are? Because I think they were just starting to reveal themselves when COVID hit. I mean, after that long of a period of time. And so that relationship to housing and how we’re going to house people in the future and how the economy is going to house people in the future is really a big deal and be something that my kids and their kids will have to grapple with. But that’s the one thing I see that’s going to affect us over the next long term.
Dean Wehrli:
That’s a great point, because it is kind of to the point of how this remote work has I think revolutionized housing. And my strong belief is that this demand for these outline areas and for different kinds of housing product was always there, it was just unrealizable and untapped because you couldn’t make it work in terms of the commute to work. So it was there. So, it was because people argue, oh, we’re pulling this demand from the future. No, we’re not because that demand was long been there. It just couldn’t be realized. And now it can.
Steve Benson:
Excellent point. Yeah. I agree.
Dean Wehrli:
What’s the best case scenario then for the market going forward? Is it just kind of an easing back and dethrottling of the craziness? And kind of what would serve your needs best in the nearest, say the next year or two?
Steve Benson:
Well, what serves us best in the land banking business? I mean, candidly is a little bit of that confusion and that uneasiness because that’s where people want to look at rationalizing their own balance sheet and using alternative forms of capital that… And then the activity that some of the builders are seeing in their ability to grow their business, even though they’re big now, being able to go into these new markets that are emerging as well as go into markets where smaller builders just can’t survive anymore. Growth has always been good for land banking business, because it’s again, available, immediately available capital that can be intelligently deployed on a strategic basis. So all those are good factors for our business. And I think it’s healthy for the overall home building business as well. So I think those will continue to happen. I think we’ll see that.
Dean Wehrli:
Do you see… Let’s end with this, Steve. Land banking does seem like a win-win for both parties. Do you see this escalating and land banking become an even more, a bigger part of the picture here going forward?
Steve Benson:
Yes. I think that, again, as I said earlier, I’ve had the great privilege of being able to work with literally the smartest people in the industry. And we sat down on this project that we’re working on right now with Angela Gordon and had the great privilege to deal with the folks at Lennar that said, we want to transform the way builders finance their work in process inventory. Now we use a land bank structure. So it feels like land banking. Everybody’s calling it land banking. But Dean we’re doing something that is truly transformational in nature that I think if we look beyond, oh, well it looks like land banking and that’s all it is.
Steve Benson:
It really does have the opportunity to do something that could be extremely helpful to the rest of the industry. And I think as the footprint continues to grow that more will take advantage of it. As I mentioned, the biggest problem with this business has been its ability to scale. And I’ll leave you with this kind of example on that, because I think it’s important not to pat ourselves on… I’m not offering this as a way of patting ourselves on the back and saying, “Hey, look at what we did or look at what I did.” But more to point to this notion that there is a future that is untapped in this whole business. And the example is this. As I said, I’ve been doing this now for 20 years. And through the years in a really… If the cost of a piece of property is $20 million and there’s $10 million worth of improvements, on the day that we buy the land, we say we originated a $30 million investment. So that’s how our scorecard looks.
Steve Benson:
In a really good year, I would originate $500 million worth of land bank investments, maybe in a slow year, 350. And I think one year we had a really good year and got almost up to $800 million in 12 months. Over the last 12 months, we’ve originated three billion in land bank investments, what we call land bank, and we have an equal amount… And we’ve just closed on a second fund where we have the ability to duplicate, to double that feat over the next two years, each year for the next two years. So we have enough capital to deploy to builders that are anxious to transform the way they finance their work and process inventory to the tune of 10 billion over the next two years.
Steve Benson:
So, we’re doing something that hasn’t been done before and that’s actually pretty dog gone exciting. And I think that’s probably what’s got a little bit of the buzz in the industry over land banking. But the folks that we’re working with right now realize that this transcends land banking. We’ve kept the things working and added to some things that were necessary. So I call that the transcend and include move. We’ve moved up the notch in terms of the level of our sophistication, dropped away the things that weren’t absolutely necessary. And I think the future as these builders continue to grow and continue to need capital that this will become a larger component of their capital stack and-
Dean Wehrli:
Right on.
Steve Benson:
And I appreciate you giving us just a few minutes of your day and some space to plant that seed with people and how have them really see it in a new way.
Dean Wehrli:
Well, I appreciate you coming on, Steve. It’s been great. Thank you so much for coming on the podcast.
Steve Benson:
Wonderful. Thank you. It’s always good to see you. Appreciate it.
Dean Wehrli:
Right on. Okay. That was Steve Benson for The New Home Insights Podcast. I’m Dean Wehrli, and we’ll see you next time.
