Navigating the Acquisition and Entitlement Process

The acquisition and entitlement process is an essential pre-cursor to any ground-up development deal. However, navigation of these processes is often not well understood. Acquisitions and entitlements go-hand in hand: most developers will not acquire a property unless they are confident that they will be able to obtain the permits and approvals needed to construct what they intend to build. In this article, we examine both in more detail, including how each influences the other.

Most real estate developers will look at dozens, even hundreds, of deals before moving forward with an acquisition. In fact, even when a project proponent has determined they want to purchase a property, the road to closing can be quite long.

The acquisitions process is much more detailed than purchasing property. The process will depend largely on the type of deal, the size or yield, and the complexity of the property , as well as the deal structure of the transaction.

Let’s say we are looking at a raw piece of land. We start our analysis by looking at the land’s development potential. Has the property been developed previously, or is it raw land (a “greenfield” site)? The prior use of the land will influence what sort of environmental due diligence is necessary.

How We Source Deals

As noted above, we look at dozens of deals before moving into the due diligence phase in earnest. Most of the opportunities we see come to us through our industry connections. We have built strong relationships with local brokers and sellers who understand our development approach and investment philosophy; we have also proven our ability to negotiate fairly and execute on transactions. They will bring us deals that meet our investment criteria and then we pursue those in more detail.

We will also work with sellers directly. We have a feature on our website where someone can tell us about the property they are interested in selling, and then we will reach out with them to discuss in more detail.

Types of Deals We Consider

While we are always happy to entertain any opportunity that comes to us, and we place tremendous emphasis on the property’s location. We look at the micro location, including the market vitality, as well as economic drivers, access, amenities, and school district quality. For residential development, schools are a significant driver for new homes.

We then consider the property’s development potential – what we refer to as the “highest and best use” for the site. The highest and best use is largely determined by market dynamics and local development regulations or ordinances, which we research carefully. Based on what we would like to do with the site, we will then investigate whether the existing zoning will allow us to do so or whether zoning relief, such as a Planned Unit Development (PUD) or Conditional Use Permit (CUP)will be necessary. Often, we reach out to the municipality directly to engage city planners in these conversations. Their feedback on our high-level aspirations for the site is very informative as we consider the site’s development or redevelopment potential.

Then we look at the purchase price. We assess cost to acquire the property and develop it in order to execute our vision and while earning appropriate risk-adjusted returns for our investment partners.

The Due Diligence Process

When evaluating potential development opportunities, we use a detailed checklist to ensure there is no due diligence we have overlooked. Prior to any acquisition, we undertake a robust due diligence process that includes the following:

Market Research:

We look at current market conditions and what could be the highest and best land use for the site we are considering. Typically the local municipality will have the property guided for some type of land use or development in their local Comprehensive Plan.

Land Research:

Once we have a sense of the site’s highest and best use, we then look at whether the current land is zoned or guided for that use. We look at potential site constraints (e.g., site infrastructure, ability to provide parking, topographic constraints, and environmental considerations) and whether we can still build what we’d like to build given those constraints.

Financial Feasibility:

Based on our initial market research, we build a detailed pro forma that analyzes inputs such as total project costs, project rents or sales, financing costs, development costs, vertical construction costs, and ultimately, a return on our invested capital. This helps us understand whether there is enough upside to warrant undertaking permitting and development risk.

This due diligence process ensures that there are no fatal flaws that would stop the project in its tracks. If any significant concerns arise during due diligence, we may go back to the seller to try and renegotiate the deal. In some situations, the due diligence process will uncover obstacles that simply cannot be resolved and in turn, we decide not to move forward with the deal if the obstacle is insurmountable.

To mitigate risk, we build controls into our purchase and sales agreement that a) allow enough time to complete robust due diligence; and b) enable us to walk away from the deal prior to closing without putting significant dollars at risk.

What is the Entitlement Process?

The entitlement process refers to the process of obtaining all of the necessary permits and approvals from any applicable regulatory agency that has jurisdiction over the subject property. These approvals are what “entitle” the land and give the project applicant the right to develop the land in accordance with the plans that have been approved.

Generally, there are three types of entitlements:

Land Entitlements:

Land entitlement refers to the process of obtaining the permits, zoning changes, platting or subdivision approvals, and other regulatory approvals needed to develop or construct a building on a piece of property. Successful land entitlement is crucial for unlocking the value of the land and maximizing its potential for development.

Environmental Entitlements:

The environmental review often occurs at both the municipal/regional and state level and can be done concurrently while securing the land entitlements mentioned above. The relevant agencies will conduct a scoping review of the project to determine whether the project triggers any environmental thresholds (e.g., increased water/sewer usage, traffic) and whether the site has any wetlands, floodplains, woodland ordinances, endangered species, etc. that need to be considered or mitigated for.

Depending on the project’s location, this may require coordination with multiple local and state agencies or even federal agencies such as the EPA or Army Corps of Engineers. It is always important to understand which agencies will have jurisdiction over the site and for what reason(s).

Structural Entitlements:

These entitlements generally refer to the building permits that the local building department provides prior to construction. The local permit granting authority will typically require detailed review of construction documents and architectural plans at this phase. They review documents to ensure compliance with local building codes, zoning regulations, and safety standards.

Depending on where the project is located, the structural entitlements may vary. For example, in California, structures have to meet certain seismic standards – i.e., projects must be designed to withstand earthquakes. In other areas of the Country, structures may need to be designed to withstand tornadoes or hurricane-type flooding.

All of these entitlements must be in-hand prior to beginning development or construction. The entitlement process can depend on the type of project, its size, and location. In the most development-friendly communities, where a project is being built as-of-right (e.g., it does not require any zoning relief), the entitlement process may be as short as 3-6 months. The regulatory process can take 18+ months – or even years – for the most complicated projects. The timeline really depends on the nature of the process and the issues that need to be worked through prior to obtaining the necessary approvals.

Permitting Challenges

Entitling a project is no easy feat. There are entire firms and consultant groups who focus entirely on entitlements. They understand the complexity and nuances of the regulatory processes and can navigate clients through these processes effectively.

Here are some of the most common permitting challenges:

Market Competition:

In an urban area like the Twin Cities, where land is constrained, there are relatively few land development opportunities. When these deals do come to market, there is often significant competition. This drives up prices and can, in turn, cause some developers to take on permitting risk that they otherwise would not absent such significant competition. For instance, when faced with less competition, a buyer might stipulate that they permit the land prior to closing on the deal. This takes the permitting risk out of the equation. Similarly, they might negotiate the final purchase price based on what they are able to entitle (e.g., they’ll pay one price for the ability to construct a minimum 100 units and more money for each additional unit permitted).

Environmental Issues:

In addition to municipal regulations and zoning, projects may also be subject to certain environmental regulations. For example, a project may have to undergo environmental testing to determine if there is any soil or groundwater contamination that must be remediated, whether the project will result in habitat destruction, etc. If a project is located near wetlands, the developer may need to obtain boundary surveys and impact permits to mitigate any adverse impacts on the wetland ecosystems through measures like wetland restoration or the creation of compensatory wetlands nearby. The realm of potential environmental issues depends on the type, size, and location of the project. Mitigating environmental concerns can add significant time and cost to the permitting process.

Shift in Market Conditions:

In some cases, a project can take so long to get permitted that the market conditions shift in the meantime. For example, someone may have spent three years entitling an office building pre-Covid only to find the office market had collapsed by the time they secured their necessary permits. That project, which took three years to permit, may never ultimately get constructed, or may need to be re-designed and new entitlements secured. Similarly, the interest rate environment can impact what ultimately gets built and when. Several multifamily housing projects have been permitted nationwide, but as interest rates and construction costs have simultaneously climbed, many of those projects – as approved – will never get built because the deals no longer make financial sense.

This is a real permitting challenge that developers must watch carefully. Many applicants will only pursue new construction in areas where there is relatively certain permitting timelines to mitigate against shifting market conditions (e.g., in an area where they can relatively certainly obtain permits in 4 to 6 months vs. 2+ years).

Community Opposition:

Another challenge is community opposition. New development and redevelopment can end up getting extremely political. This opposition can come from city staff, the city council/planning board, and/or local residents and community groups. Projects that encounter significant opposition will face an uphill permitting battle.

To mitigate this risk, project proponents should invest in consensus building needed to build support and consensus around their projects prior before formally submitting for their approvals. Most savvy developers will ultimately have their projects approved, even if it requires them making changes to their proposed site plan and development project. For example, a developer might face concerns over how much parking they’re proposing and their proposed setbacks. They can take that feedback, integrate it into revised plans, and then resubmit their package to the City and regulatory bodies to show that they have listened to the community’s concerns and made adjustments accordingly. A sponsor’s willingness to make these changes shows that they are being a good community partner.

However, there are some instances in which the requested changes simply cannot be integrated into the plans (whether due to cost, construction feasibility, or otherwise); this is often when an applicant will withdraw their proposal from the City’s consideration. At that point, they might pull out of the deal altogether if it cannot be re-negotiated.

At Centra, we often meet with City staff prior to initiating the entitlement process in earnest. We show how what we are proposing complies with the City’s vision, comprehensive master plans, and/or zoning. We look to get a positive nod from staff that they would be supportive of our proposed project. This helps mitigate political risk as we move forward with the approval process.

One important note: any project that requires a variance, PUD, Comprehensive Plan Amendment or zoning change will require community support. In the case of a variance, all it takes is one abutter to challenge the approval for the project to be derailed. This can result in lengthy delays and expensive legal battles unless the issue with the abutter(s) is resolved. Project proponents are well-advised to identify any potential opposition by building strong relationships with their abutters, elected officials, and other entities needed to support a variance or zoning change.

Conclusion

The acquisitions and entitlement process always carries some degree of risk. There are often unknowns that developers need to then solve for as unexpected challenges arise. Project applicants should always conduct sufficient due diligence on their projects to ensure they are taking appropriate, calculated risks – ideally, these risks will be quantifiable and can be budgeted for in their pro forma.

If you are considering investing in a real estate deal, be sure to ask the sponsorship team about their approach to acquisitions, due diligence, and securing the entitlements required. Those who have familiarity with the local municipality and regulatory agencies should be well positioned to obtain their approvals; otherwise, the sponsor should have a plan in place to bring in the required expertise to be successful. Having the right team at the table is essential when trying to move redevelopment projects forward.