Should finished lot revenue be underwritten at today's builder pricing or discounted

Sorry @luis_carrera, the title got read before it registered as your own thread. The answer to the question is the haircut, and specifically the haircut on the cost side rather than the revenue side. Adding 15% contingency to improvement cost and holding revenue flat is the sounder version, because a cost overrun assumption is defensible to a partner with change order history behind it. Defending a price forecast is harder. Same effect on the margin, easier conversation.

Whatever the approach, read the builder lot purchase agreement before building the model around it, because the takedown schedule usually has an out in it. Most of these let the builder walk with a defined deposit forfeiture, and some carry price adjustment language tied to market conditions or 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 will treat them identically unless someone makes it not. Option three only beats 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.

Worth asking from the outside: is anyone actually able to sell finished lots into a weak market, or does the position just sit? Sitting on finished lots sounds expensive.

@priya_n21 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, here is what's wrong with the haircut approach as usually practiced. Take a case where revenue gets haircut 10 percent and the timeline stays untouched, when the timeline is the bigger variable. A 30 acre deal with 24 months of entitlement in the model and 40 months in reality carries 16 extra months of interest and taxes on the land, plus whatever improvement cost inflation did in the meantime. That is often a larger hit than 10 percent off lot price. If only one input gets stressed, it should be the calendar.

@hannah_west29 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.

@bmoreno23 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.

@jessreyes12 that's the right exercise, and it tends to change what someone is willing to bid more than any revenue assumption does. @luis_carrera on a 30 acre deal, the question 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, that already says something about the price.