Finished lot revenue at today's builder pricing, or haircut it

Sorry @windlass, I saw the title and started typing before I noticed it was your thread. My answer to your own question is the haircut, and specifically the haircut on the cost side rather than the revenue side. I'd rather add 15% contingency to improvement cost and hold revenue flat, because I can defend a cost overrun assumption to a partner with change order history. Defending a price forecast is harder. Same effect on the margin, easier conversation.

Whatever you do, read the builder lot purchase agreement before you build your model around it, because the takedown schedule usually has an out in it. Most of the ones I've read let the builder walk with a defined deposit forfeiture, and some have price adjustment language tied to market conditions or to a market study at each takedown. A contract with a soft schedule and an adjustable price is not the same input as a firm number, and the model treats them identically unless you make it not.

So option three is only better than option one if the contract is actually firm. Half the time it isn't.

I hold flat pricing and stress it separately. One base case at today's lot comps, then a case at minus 15% revenue and plus 20% cost and plus 12 months, and I look at whether the deal survives or just becomes worse. Surviving means the debt gets paid and I get my capital back. If the stress case wipes out equity I want a much bigger base case margin to compensate.

Baking the haircut into the base case hides how bad the bad case is, because you've already spent your pessimism.

Reading this from the outside, is anyone actually able to sell finished lots into a weak market, or do you just sit on them? Sitting on finished lots sounds expensive.

@marlow you can usually sell, at a price. Finished lots are the one thing builders need to keep their operation running, so the bid doesn't go to zero the way raw land does. It goes down and terms get worse, longer takedown, deposits smaller.

On the main question I'll say what's wrong with the haircut approach as usually practiced. People haircut revenue 10% and leave the timeline alone, and the timeline is the bigger variable. A 30 acre deal with 24 months of entitlement in the model and 40 months in reality has 16 extra months of interest and taxes on the land plus whatever the improvement cost inflation did in the meantime. That is often a larger hit than 10% off lot price. If you're only going to stress one input, stress the calendar.

@ledger how do you even estimate the calendar as a beginner? Everyone says entitlement takes longer than you think, and then nobody says what to write in the cell.

@ember you can get at it empirically. Pull the last ten or fifteen rezonings and preliminary plats in that jurisdiction, find the application date and the final approval date in the public record, and look at the spread. Most counties post agendas and minutes online, though how much is available varies a lot by state and by how well the county keeps records. In one county near me the median was about 11 months and the slowest of the ten was 29. I'd model the median and stress toward the slow one.

What that misses is that the slow ones are slow for reasons, usually neighbor opposition or an offsite utility problem, so you can sometimes tell which bucket you're in before you file.

@compass that's the exercise I've been doing and it changed what I'm willing to bid, more than any revenue assumption did.

@windlass on your 30 acre deal, the question I'd ask isn't which version is sensible. It's what the deal looks like at the price the seller will actually take. If it only works at today's lot pricing with no cushion at all, you already know something about the price.