The “good old days” of formal redevelopment are over. Real estate developers no longer can negotiate to assemble development sites under the threat of condemnation. Silicon Valley developers now face serious challenges in assembling sites suitable for modern, larger-scale development. Assembled sites can offer the greatest potential profit margin, but they are very difficult to achieve.
I. Conducting Invisible Due Diligence about the Parcels to be Assembled. The main risks of assembling several parcels into a larger one are (a) paying too much, (b) losing the project to a current landowner or a competitor, or (c) committing to purchases that can’t be completed. Each of these risks is magnified by a loss of confidentiality regarding your site assembly efforts. Architectural and civil engineering input is necessary at the parcel selection stage, to be sure that the assembled site complies with building height, parking, floor area ratios and similar technical “performance standards.”
Problematic easements and other ownership problems must be identified as early as possible. Confidentially make sure that your proposed new use is compatible with the city’s overall land use policies and is politically desirable before contacting any property owners, but bear in mind that city officials are not bound to confidentiality and any written materials given to them will become a public record. Consultants should be given clear direction regarding what they can disclose to city officials during the due diligence phase, including confidentiality provisions in their consulting contracts.
II. Contacting the Property Owners. The greatest risk of failure arises after all confidential due diligence has been completed, and you must contact the properties’ owners. If one or more owners learn of the need to assemble multiple parcels, they can hold out for exorbitant sale prices and kill the project. Confidentiality, therefore, is crucial. Securing an option on each parcel without the other owners learning that you are assembling a larger site, however, is difficult. It often is advisable to use “fictitious buyers” for different properties, in order not to reveal the fact that multiple parcels are being assembled, and the extent of the assembly.
Once owners realize that you intend to assemble a site, they typically react by either (1) banding together to assemble the property without you, (2) raising the sales prices of all the parcels, or (3) holding out for an exorbitant price for the final necessary parcels. Managing the information available to the owners is vital. Require execution of a non-disclosure agreement (“NDA”) before revealing to each owner the price and other terms of your option offers. NDA’s should recite the exact information to be kept confidential and the harm that will occur to the developer if the owner breaches the NDA. A small payment to each property owner for signing each NDA helps ensure that they will be enforceable. They otherwise should be short, simple and specific about available remedies in case of disclosure.
NDA’s are enforceable in California, but their most powerful effect is as a deterrent. Structure each purchase option so that the deposit becomes non-refundable only upon execution of option agreements with all necessary owners. Provide for an extended due diligence period to allow plenty of time for assembly negotiations, and give the developer a unilateral further extension right. Make the options more generous than normal “market” terms. Be patient. If the owners band together to demand higher prices, you may have no choice but to deal with that directly, in effect by making “venture partners” of them.
III. Avoiding and Solving the Holdout Problem. Any parcel owner who refuses to sell except at a price that claims a large share of the assembly’s potential value is a “holdout” owner. If the owner is willing to sell, but at a wildly inflated price, there often is no alternative but to pay that price, short of rendering the entire project economically infeasible. An owner who refuses to sell in any circumstance can kill the project. More typically, a holdout owner simply wants a share of the “upside” of site assembly.
Once you control all necessary parcels, if the city supports your site assembly/redevelopment effort, it can provide “back end” assistance short of condemnation. It can waive or reduce numerous development in-lieu fees or exactions, or grant relief from or subsidize “quasi-public” project elements such as recreational features, public area landscaping, parking, etc., or even allow additional development density, to reduce project overhead costs or authorize additional profitability.
After the city provides a complete list of all fees and exactions arising from the entitlement process, along with your costs for processing needed CEQA compliance documents, staff time and related costs, there is no harm in going back to the current parcel owners and informing them that their option prices must be reduced, in order for the project to proceed. Precise practical steps will vary with each project and each set of property owners, because site assembly boils down to a series of negotiations. Without any local governmental assistance, the process remains challenging and risky, mainly due to the need for confidentiality in managing relationships with multiple property owners. Persistence, foresight, luck and common sense often make the difference in successful site assemblies, but they also offer a very substantial profit potential.