For potential real estate investors who find tenants and building maintenance to be constant headaches, buying undeveloped land may seem appealing. If you are buying land in an area that is expected to see increasing demand in the coming years, you should be able to earn a return on your investment. This is called buying into the path of progress, but of course the trick is to buy before everyone realizes that the new development is heading in your direction.
When buying undeveloped land, your investment may take longer to pay off, so you should be particularly aware of your cost of property capital.
You can even hit a home run if you can identify a land that others don’t currently see the future value to hold. However, it is not easy to identify many years in advance which communities will experience rapid population and employment growth. Land prices in areas that people believe will be the next hot spot are already selling at a premium. This has happened in most major cities with new sports facilities (especially because these decisions are often disclosed long before the vote of municipal leaders or the ballot initiative). You don’t have many opportunities to get a head start – or if you’re wrong, you could own expensive land for a long time!
Investing in land certainly has other disadvantages and risks:
- Care and Feeding: The land needs money all the time to pay property taxes and liability insurance, and to keep the land clear and free of debris when it’s probably producing little or no income. Although land is not high maintenance compared to tenant-occupied property, it almost always requires financial nurturing.
- Opportunity costs: Investing in land is a waste of cash and, of course, buying the land costs money. If you buy the land with cash, you have the opportunity cost of tying up your valuable capital (which could be invested elsewhere), but you will most likely deposit 30-40% in cash and finance the balance of the land price. purchase instead.
- Expensive Mortgages: Mortgage lenders require much higher down payments and charge higher loan fees and interest rates on loans to buy land because they view it as a more speculative investment. Obtaining a loan for the development of land is difficult and more expensive than obtaining a loan for a developed property.
- Absence of depreciation: you do not benefit from tax depreciation because the land is not depreciable.
- Cost of capital: Make short-term and long-term projections for the length of time you own your property.
On the revenue side, some properties can be used for parking, storage revenue, or maybe even growing Christmas trees in the Northwest or grain in the Midwest! (After making sure you’ve complied with local zoning restrictions and have the appropriate insurance.)
Although large-scale land investing is not for the novice real estate investor, savvy real estate investors have made their fortunes by taking raw land and securing the proper rights, then selling (or better yet, subdividing and then by selling) plots to developers. commercial and residential properties (primarily home builders). If you decide to invest in land, make sure you:
- Do your homework. Ideally, you want to buy land in an area that attracts growing businesses and lacks housing and built-up land. Take your time to really get to know the area. This is not a situation where you should take good advice from someone to invest in some faraway property in another state. Nor should you buy raw land just because you heard that irresistible opening price announced on the radio for the government surplus land auction at the convention center this Saturday.
- Know all the costs. Count up your annual carrying costs (running property expenses such as property taxes) to see what your annual cash flow loss may be. What are the financial implications of this cash outflow – for example, will you be able to fully fund your tax-advantaged retirement accounts? If you can’t, count the lost tax benefits as another cost of owning land.
- Determine what improvements the land might need. Execution of utility, water and sewer lines; build roads; landscaping; and so on all this costs money. If you plan to develop and build on the land you buy, research these costs. Make sure you don’t make these guesses with your rose-tinted sunglasses on — upgrades almost always cost more than expected. (You should check with the planning or building department for their list of requirements.)
Also, make sure you have access to the land or have the right to enter and exit through a public right of way or other people’s property (known as entry and exit). Some people foolishly invest in landlocked properties. When they find out later, they think they can easily get an easement (legal permission to use someone else’s property). Fake!
Understand zoning and environmental issues. The value of a piece of land depends heavily on what you can develop on it. Never buy land without fully understanding its zoning status and what you can and cannot build on it. These tips also apply to environmental limitations that may be in place or may come into effect without warning, diminishing your property’s potential (without compensation).
This potential for surprise is why you should research the layout of the planning department and neighboring communities. Attend local planning group meetings where appropriate, as some areas that are anti-growth and anti-development are less likely to be good places to buy land, especially if you need permission to carry out the type of project you have in mind. Through the empowerment of local residents who sit on community councils and can influence local government officials, zoning can suddenly change for the worse – sometimes you may find that your property has been downgraded – a zoning change that can significantly reduce what you can develop on a property and therefore the value of the property. See the sidebar “Dangers of Downzoning” in this chapter for more details.
Determine your cost of real estate capital