A developer wants to option 6 acres and pay part of the price in equity instead of cash.

Here is a scenario worth working through. A landowner has held a parcel for eleven years. It is zoned for multifamily by right, sewer is at the property line, and there have been three inquiries in a decade, none of them serious until now. The offer has two shapes. Cash at $1.35M with a 12 month feasibility period and two six month extensions at $25k each, nonrefundable and applied to price. Or $600k cash at closing plus a 9% interest in the development entity, which the developer says is worth roughly $900k at stabilization on their numbers. The second one is the hard one for someone who understands land and has never owned a piece of an apartment building. The open questions are these. What happens to the 9% if the project needs more money and the landowner has none to put in. What happens if they build it and it does not lease, given everyone here keeps saying the sun belt has too many units already. Whether 9% of the entity means 9% of anything after the lenders and whoever put up the real equity get paid. Also, plainly, if new construction pencils this badly right now, why does anyone want to build on that dirt at all? That part should bother the landowner more than the money does. A seller who is not in a hurry and does not need the cash this year holds the only real advantage in this negotiation. How would the room price the equity piece?

nicole_adeyemi SS3APRO 13

Answer

paulgrant17CapitalPRO

I'm nowhere near your league on this but I did read a land option contract line by line for a family thing last year and the part that mattered wasn't the price at all. It was who carries the property during the feasibility period and what triggers the extension.

Check who pays taxes and insurance for those 24 months. Check whether the $25k extensions are automatic on their side or need your consent. And check whether the option assigns. If they can sell the option to another developer without your sign off, you may end up with a counterparty you never agreed to, and the sale price they get for the option is theirs, not yours.

On the equity, the question I'd ask them in writing is where 9% sits in the waterfall. "9% of the entity" and "9% of the common equity after preferred return" are different animals and both get called 9%. Ask for a sample distribution at three outcomes: their base case, a case where rents come in 10% under, and a case where they refinance and hand back capital. If they won't run the down case, that tells you something.

And get someone who does this for a living to read the operating agreement. Dilution language on capital calls is where a passive 9% turns into 3% and you never signed anything to make it happen.

paulgrant17CapitalPRO

3 replies

Rena Expert

Your last question has a clean answer. New construction pencils badly against today's values, which sit 20 to 30 percent below the 2022 peak, while replacement costs have risen close to 39% since 2020. That gap is exactly why starts have collapsed and why pipelines in the more oversupplied Sun Belt submarkets are contracting 40 to 50 percent. A developer buying land now is not building into today's market. They are underwriting delivery in 2028 and 2029, after the current supply wave is absorbed and vacancy has compressed from the roughly 8.5% peak. If they're right about timing, they deliver into a thin supply year with firmer rents. That's the bet, and the land is the cheapest part of it to lock up because an option costs them very little to hold.

Which is the thing to price. A 24 month option with $50k of extensions is cheap optionality on your asset. You are the one taking market risk during that window, and if they walk you get the extension money and a property that is two years older with the same zoning.

On the equity structure, the mechanism to understand is the waterfall and the dilution provision. Contributed land is usually credited at an agreed value into the capital account, then it sits behind construction debt and behind whatever preferred return the cash equity negotiated. If a capital call comes and you don't fund, the standard remedies range from straight dilution to a punitive multiple on the funding partner's contribution. Both are legal and both are common, and which one applies is whatever the operating agreement says.

How the land contribution is treated for tax is genuinely consequential and varies with structure, so put that in front of your own CPA before you choose a shape.

Rena Expert

tylerbrooks9 AO1APRO 10

Parcel, what it comes down to is that you are being asked to swap a known number for an unknown one, and you have already said you do not need the cash. That is no argument for simply taking the cash. It is room to ask for both: cash at a lower price plus a smaller equity slice with a hard cap on dilution. The part to refuse is a passive minority position in an entity where the sponsor controls the timing of the sale. Eleven years of patience on your side, and then someone else picks the exit year.

tylerbrooks9 AO1APRO 10

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