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The Real Deal Los Angeles

A market grows for entitled LA properties

A strong market and a grueling entitlement process is fueling sales of shovel-ready sites and could be fueling speculation
By Dennis Lynch | September 07, 2018 12:00PM

330 N. Patton Street and Keller Williams Realty agent Shawn Kormondy (Credit: iStock)

Go on, take the money and run.

That was the temptation facing Thomas Agius, owner of a development property in Echo Park, after a two-year ordeal entitling it for a 32-unit multifamily development.

A few years earlier, the developer had high hopes for the 11,200-square-foot piece of land. He planned to develop the apartment building on the site at N. Patton Street, with a mix of units that would each have their own balcony.

But the grueling process to entitle the property took its toll.

Agius is one of a number of developers in Los Angeles who are struggling with a sort of post-entitlement hangover that leaves them with little appetite to break ground. Thanks to a strong market for entitled properties, they have a way out — sell their shovel-ready, recently entitled sites to builders at a premium, and then walk away with a profit — without ever having to lay a foundation.

The practice of flipping sites pre-construction has been done for decades. But a strong market for ready-to-build sites in L.A. and an ever-more-difficult entitlement and construction process have made it more popular in recent years, brokers and other real estate professionals told The Real Deal.

“They’ll look at the numbers and say it costs X to build this and I can do Y and make this much and get away,” said Pacific Union agent Dario Svidler, who grew up in a family in the development and construction business.

Entitled properties sell at a premium because of the risks involved in getting those entitlements. The entitlement process kicks in any time a developer wants to build something that is not allowed under a property’s existing zoning. It’s a request for an exemption from that code.

However entitled land ends up on the market, the phenomenon is likely driving up rents and condominium prices. It’s hard to quantify how much an entitlement is “worth” on the market, but one more sale between the purchase of land and the completion of a project is one more margin to hit. Studies have shown that longer entitlement processes lead to more expensive housing.

Joseph Gyourko, a Professor of Real Estate at the University of Pennsylvania’s Wharton School, has written about the impact of difficult regulation on housing supply and pricing. He wrote in a 2018 paper that the potential for a multiyear review process, often necessary when requesting an zoning exemption, “increases the expected costs to developers” and deters new housing supply.

“Any land with an entitlement becomes very, very expensive, so if you are a for-profit builder, what do you build? High cost housing,” he told TRD. “That’s the only way you can defray your high costs.”

In most cases, a developer will seek an entitlement. The City of Los Angeles Zoning Code was adopted in 1946 and the overall structure hasn’t changed much since then.

The city itself acknowledges that the existing zoning code is out of date and started its re.code LA project in 2014 to revise the code “to realize the needs of a 21st Century Los Angeles for all stakeholders.” Developers say an entitlement to build bigger than zoning allows is often the only way that a project will pencil out.

Projects under 49 units can get through the process in 9-12 months if there are no hang-ups, said Bob Champion, the founder of Champion Real Estate. Any project larger than that will certainly take longer. At that point, developers need to demonstrate they are exempt from obligations under the California Environmental Quality Act, or CEQA. If they can’t, they often need to conduct an environmental impact report that can extend the project’s timeline up to around two years.

Then there’s lawsuits. Most lawsuits brought against development projects concern the CEQA process. They can hold up a project for as many as five years, Champion said.

“It’s not like you start the entitlement process and you see this clear line of milestones that you have to reach,” he said. “All sorts of unexpected things come up.”

Champion’s company has sold off entitled sites before, but he said that was never the intention. In 2015, Champion sold a Hollywood property for $39.9 million, four years after buying it for half that. The proposed 250-unit project was held up over compliance with a local Specific Plan change that was later scrapped. By the time Champion got the green light, his institutional equity partner wanted out.

Besides the complicated nature of the process, city planners are simply overwhelmed by the number of projects they must review, Svidler said. Hiring at the Department of City Planning since the Recession hasn’t kept up with the pace of filings.

“We had a recession where they laid off tons of people and we came screaming out of it gangbusters, and now every Tom, Dick, and Harry thinks they’re the next big builder,” he said. “I spoke to a planner the other day and they said we won’t look at a project for six months.”

But where there’s risk, there can be opportunities. Some developers sell entitled land as a deliberate play, hoping to meet demand from risk-averse builders who want to skip the uncertainties inherent in the entitlement process.

They take on the risk that the process might fail or market conditions may change by the time they get an entitlement, but also reap the benefits if they can move quickly through the process and make a sale.

The buyer “in effect pays for risk being removed,” said Con Howe, a former Director of City Planning and now Managing Director of CityView’s Los Angeles fund. “For the seller, it can work out or you can lose your shirt.”

Some in L.A., like United Neighborhoods of Los Angeles president Casey Maddren, say the solution is political. He wants to see the City Council update the zoning code, Specific Plans, and neighborhood plans. But he doesn’t see any incentive for elected officials to do that.

The current system encourages speculation, he said, because it’s so common for developers to be granted entitlements. That creates space for speculators to scoop up land, entitle it, and flip it, he said.

“Why update it to let developers build by right?” Maddren said. “Leave it the way it is and they have to ask for permission. There’s a lot of people on the Council who get a lot of money from developers.”

But more often than not, a sale isn’t part of the original plan. Agius ultimately decided to sell. He enlisted Keller Williams agent Shawn Kormondy to move the property, and Kormondy is prominently advertising the entitlement. At the end of the day, he said his client isn’t interested in taking the project any further into the cycle.

“The construction costs are up, the will to build has gone down, and the market has charged up, too,” Kormondy said. “So the profit for selling entitled land was far greater than the risk of building.”

Agius will still likely walk away with a nice profit, though. He bought the site for $810,000 in 2014. Four years later, he’s asking for $3 million.