Why Does a Developer Need Such a Long Escrow?

As land brokers, one of the most common questions we get is – why does a developer need such a long escrow? In order to illustrate the point, let’s go back to our fictional development company, J&R Development.

J&R Development has identified a parcel of land in their preferred submarket. They want to build a multifamily rental project and this parcel is the perfect size and location for such a development. Their favorite land brokers showed them the site but also cautioned with the phrase every developer hates to hear – “the owner doesn’t want to give time for entitlements”.

Unfortunately, the parcel currently carries the equivalent of agricultural zoning that will allow approximately 1 home per acre and is in the general plan for “Neighborhood”, a vague category that doesn’t define anything beyond a residential use.

The owner’s asking price is in line with other multifamily land sales in the area and actually lower than J&R’s residual land value after working through their underwriting. They make an offer above the asking price in hopes that will entice the landowner to allow them a long enough escrow to accommodate re-zoning the parcel prior to closing.

The landowner has no debt, no need for the sales proceeds and decides they will only sell at their asking price if someone can close in 60 days. J&R makes calls to various City departments and zoning attorneys. The feedback is favorable, so they feel comfortable their re-zoning case will be successful and come to an agreement with the owner to close in 90 days.

J&R immediately schedules a pre-application meeting with the City’s planning department and again receives favorable feedback from the staff. All of their due diligence studies come back clear, their earnest money goes non-refundable on day 60 and they close on day 90.

On day 91, the interest clock starts ticking – J&R owes their partners a minimum rate of return before their promote kicks in and the project becomes a worthwhile endeavor.

Their once warm reception at the City starts to cool as neighbors get wind of their planned project and start to come out against it. The protests from the surrounding communities start to pile up: increased traffic…blocked views…taxed infrastructure…out of character for the area…

No matter how many studies, concessions and guarantees J&R agrees to, they cannot get the residents on board with their planned project. Scaling back the project to something that’s acceptable to the neighborhood would make the project unprofitable and put them out of business.

Communications with the local City Councilperson go nowhere, as the Councilperson cannot go against their residents, particularly in this influential neighborhood in an election year.

So, here they sit, owning a parcel of land they cannot build their project on and no immediate resolution to get their money back. It’s a tough position to be in and J&R has a lot of tough phone calls to make to their investor group before determining a path forward.

Let’s break down some of the risks each party faced in the above scenario:

Risks to the Developer Closing before Zoning

• Zoning Denial Risk: Closing without first securing zoning risks the application being denied, preventing the intended development and causing substantial financial loss.

• Financial Liability: Without proper zoning, the land's value may not support the price paid for the intended use.

• Project Delay: Even with eventual rezoning, the process can lead to increased holding costs like interest, taxes and insurance, all without progress.

• Additional Costs: Rezoning often requires legal fees, consultancy costs, and community outreach expenses that become sunk costs if zoning fails.

Risks to the Landowner Allowing a Longer Escrow

• Reputational Risk: A failed deal due to rezoning issues could harm the property's reputation as a viable site for the intended use.

• Market Changes: The real estate market could shift during the rezoning attempt, resulting in a failed escrow.

• Opportunity Cost: If the market does change and their escrow fails, it’s not likely another developer can step up and close at their asking price anytime soon.

Risks to the Landowner of a short escrow: The main risk to a landowner who insists on a shorter escrow period is likely a significantly lower price than if they allowed the developer time to get the appropriate entitlements. This is a decision each landowner must come to based on a variety of factors unique to their situation.

We face these differences in preferred timelines every day and oftentimes find a middle ground that works for both the developer and the landowner.

If you would like to discuss what this might look like, please reach out!

Thanks,