Subdivision Profitability

Subdivision Profitability
David L. Fried, Ph.D.

Introduction:
When a county or city government approves a property for subdivision and development, the value of the property is multiplied many times. It is important to remember that this increase in value is largely the result of a decision made by our elected representatives.

Because the right to subdivide and develop property is not inherent in the property itself, but comes as the result of a public decision, public officials should ensure that subdivision and development benefit the community as a whole. In my view, they should make this determination BEFORE they confer to landowners and developers the huge increase in value that always occurs when subdivision and residential development is approved.

Under what circumstances is development beneficial to the community as a whole? What concessions and/or public investments should developers make in exchange for the opportunity to make huge sums of money? These are not easy questions to answer—but the decision process needs to begin with an accurate understanding of how much money developers stand to make in the business of residential development.

This short paper attempts to answer the following question: How much money is the county or city government giving to a developer when it approves a request for subdivision and subsequent development? To my knowledge, there are no publicly available documents that explore this question.

While developers are prolific in their dissemination of materials describing the public benefits of their work, they do not publish the rate of return on their investment, nor should they be expected to do so. Nonetheless, it is important to establish a baseline for further examination. To that end, and acknowledging that I have no special expertise in the economics of development, I offer the following figures. I invite developers, elected officials, and others more expert than I to respond to this draft text with their more informed comment and correction. My goal is better to inform the public as to the profitability of subdivision and residential development in Monterey County, so the public (and its elected officials) can then focus on the question of what sort of community benefits developers should be required to produce, BEFORE receiving approval for a future subdivision.

A Specific Example:
The following notes attempt to demonstrate just how big the profit motive is for a subdivision developer. I take as my example a subdivision that plans to divide up a large piece of land into many two-acre parcels, and to put a 2,500 square foot house on each one of them.

I have studied current listings of houses for sale in the North County area of Monterey County, and find that the median price (50% above and 50% below) is almost exactly $245 per square foot. This means that the selling price for a 2,500 square foot house would be 2,500 X $245=$612,500.

Information that I downloaded from ICBO (the International Conference of Building Officials) gives the construction cost for a dwelling in this area as $97.52 per square foot. ICBO notes that this number includes the building contractor's fee. Thus, the construction cost for a 2,500 square foot house would be 2,500 X $97.52=$243,798.

To get an estimate of the cost of the improvements and infrastructure that the developer would have to put in, e.g., streets, underground utilities, water (a well or a hookup to water company, and a distribution system), sewage treatment (sewer pipes with a hookup to a sewer system, or an individual septic system), a drainage system, as well as various county fees, I got information from someone whose work it is to deal with development costs in Southern California. He offered the following information. For Rancho Cucamonga, he uses $30,000 to $40,000 per home as the cost to provide necessary infrastructure. For Pomona, where the hookup charges are lower, he uses $25,000 to $28,000 per home. In rural areas, he uses $10,000 to $15,000 per home. I'll use the $40,000 per home figure. That will make the developer's profit look smaller.

For land costs, I used a single listing of a large, 143-acre parcel for sale in North Monterey County. It's the only one I could find. The people at Cottage and Castles Real Estate got me a print out. The asking price for this 143-acre parcel is $4,018,000, which means that the land is worth $29,098 per acre ($4,018,000/143). For the two acres that go with each house, the land cost would be $56,196 (2 X $29,098).

When you add up these costs, here’s what you find:

Comparing this to the selling price, you can see that the profit to the developer for each residence in the subdivision would be:

These figures show that the developer makes a $272,506 profit, per home, for getting the county to approve a subdivision. (The builder's profit is something else; it's already provided for in the cost per square foot figure). If the developer can put together a subdivision with 25, 50, 75, or 100 homes his total profit would be:

I've also looked at the numbers where the developer just goes through the subdivision process, but leaves the home construction to the buyers of the subdivision's parcels. Using a figure from a recent newspaper advertisement (today, as I write this, there is only one North County listing)—I found the following: 16 unimproved lots of 1 to 2 acres, in a gated community, are being offered at $295,000 each. I figure the cost of the land plus improvements, using the numbers used in this paper, are 2 X $28,097 + $40,000 = $96,194 per parcel. That leaves a profit for the subdivision developer of $198,806 per parcel, or 16 X $198,806 for the entire subdivision. That is $3,180,896 profit on the development of what is less than 32 acres of land.

Further Thoughts:
The above analysis shows that developers make a lot of money when they are allowed to subdivide and develop land—but what’s wrong with that? Am I against the profit motive? No way! But remember, this profit accrues to the developer because our elected public officials made a decision that allowed the subdivision and development of the property to go ahead. It’s fair to question what benefits the public gets—and this is where I begin to worry that the process is not working well for the public at large. In the end, there will be additional costs associated with new development—costs not borne by the developers—and these costs will come out of our pockets. What costs am I talking about?

The infrastructure to support intensified residential development in North Monterey County (and in other areas, too) is not in place. Our roads aren't good enough now, and with more development there will be even more wear and tear. In fact, the County already has a $200,000,000-plus unfunded requirement for road maintenance, to fix what's already broke. The same thing is true with respect to water. Right now, something needs to be done about the water supply, and this will cost a lot of money. The aquifer pollution problem caused by our reliance on septic systems has reached criticality in some areas, and it's going to take money to put in a sewer system and treatment facility if the situation gets much worse. Then there are schools, fire protection, police, etc. New residential development requires new services, and new services cost money. The cost implications are extremely significant—but the costs will come in the future, when the developer has taken the profit and has gone on to other things.

Conclusion:
In the Introduction to this paper, I asked the following questions: Under what circumstances is development beneficial to the community as a whole? What concessions and/or public investments should developers make in exchange for the opportunity to make huge sums of money? As I noted, these are not easy questions to answer, but before answering them, it is important to know how much money developers stand to make in the business of residential development.

I hope the numbers I have presented here help answer that question, and can be of some use to others. They are as fair and open an assessment of the reality of the matter as I could develop; in my view, the current system is pretty much a giveaway.

I live in North Monterey County, and I'd like to keep the area rural and agricultural. There's no rule that says people have a right to cut up the countryside into small residential parcels, and that the citizens of the area have to accept that. I'd also like to do what's necessary to protect the Elkhorn Slough, and to protect the Slough, we need to concern ourselves with the Slough's watershed, which includes most of North Monterey County. Residential subdivisions in the watershed are putting the long-term health of Elkhorn Slough in peril. Finally, I believe that, in general, people should live in urban areas---that new development should be in or immediately adjacent to cities, where the infrastructure is already in place and only minor expansions of the infra structure will be required to accommodate the additional population. I don't think that there is something uncaring about my having that opinion. It is a well-respected idea and has been around for a long time---the idea that cities are for people, that that is where people live. There's nothing wrong with that.

When the profitability of subdivision and development is taken into account, I think it’s a fair conclusion to say that developers should do a lot more for the public—to protect the environment and to provide needed infrastructure and services—and they should be required to achieve these public benefits BEFORE new subdivisions are approved.

David L. Fried, Ph.D.

July 10, 2001