Due Diligence on Master-Planned Communities

Initial Underwriting

Careful underwriting of an investment in a master-planned community requires a comprehensive analysis of every major element of a proposed development, including:

• Physical characteristics of the land (topography, natural amenities, view opportunities, drainage, easements, soils, geology, biology)

• Locational characteristics (neighboring land uses, convenience to freeways, access to employment centers, proximity to entertainment and shopping)

• Development and environmental issues and constraints (flood plains, wetlands, riparian habitats, endangered species, drainage requirements, grading requirements, availability of infrastructure)

• Entitlement status of the project (General Plan Amendment, Specific Plan or Area Plan, Development Agreement, Environmental Impact Report or Statement, subdivision maps including Master Tentative Tract Maps, Builder Tentative Tract Maps and Final Maps)

• Other entitlement features of the project (map expirations, federal and state agency approval requirements, moratoriums or limits on development due to ballot initiatives, conditions of approval)

• Market potential for the residential components of the project (evaluation of regional growth trends, patterns of job growth and housing growth, demand generators, consumer segments, market image, comparable communities, future competition, overall supply-demand balance, appropriate amenities, competitive position of the project, expected pricing and absorption by product type)

• Market potential for commercial and industrial uses (reflects degree of urbanization in the market area, timing of similar development in competitive new communities, and importance of critical mass in establishing the project as a viable location for these uses)

• Development costs and phasing plan for the project (reflects well-conceived land plan that is consistent with evolving product mix characteristics over time, as determined by changing consumer segments as the market and project matures; infrastructure phasing plan should minimize up-front costs without losing market penetration and economies of scale)

• Infrastructure financing plan for the project (should provide for effective use of tax exempt bonds according to the requirements of the city or county and the local marketplace)

• Cash flow projections (should accurately present the revenue and cost assumptions for the project, with supporting analysis of every aspect of master-planned community development that impacts the financial results, including such fine points as master homeowner association funding, utility reimbursements, inflation assumptions, development financing, and umbrella marketing reimbursements)

• Sensitivity analyses (measure the impact of variations in certain key assumptions, such as price appreciation, land absorption and future real estate cycles)

Ongoing Management Reporting

Developers should provide monthly status reports, quarterly budget updates and periodic discussions on entitlement, development and marketing objectives and strategies. Thorough, detailed management reports to the investor should be derived from a customized reporting system that is already providing regular updates to the executives of the development company; the information can then be summarized and repackaged for use with equity partners.

Committed Long-Term Partners

An investor who is fully informed from the outset about every significant element of a proposed master-planned community, and is updated regularly by high quality management reports, is less likely to take a negative view of externally driven shifts in entitlement, development or marketing strategies. A sophisticated developer will strive to provide this degree of comprehension, with the benefit of having not just a concerned long-distance investor, but also a fully committed long-term partner.