For prospective real estate investors who feel that tenants and building maintenance are ongoing headaches, buying undeveloped land may seem appealing. If you buy land in an area that is expected to see increasing demand in the coming years, you should be able to get a good return on your investment. This is called buying in the lane of progress, but of course the trick is to buy before everyone realizes that new development is moving in your direction.
When you buy undeveloped land, your investment may take longer to recover, and therefore you should be especially mindful of your real estate cost of capital.
You can even hit a home run if you can identify land that others currently don’t see the future value of owning. However, identifying many years in advance which communities will experience rapid population and job growth is not easy. Land prices in areas that people think will be the next hot spot are already selling at a premium. That’s what happened in most major cities with new sports facilities (especially since these decisions are often made known well in advance of a vote by city leaders or the ballot initiative). You don’t get much of a chance to get ahead of the curve, or if you guess wrong, you may own expensive land for a long time!
Investing in land certainly has other drawbacks and risks:
- Care and Feeding: Land requires constant cash to pay property taxes and liability insurance, and to keep the land clean and free of debris, while most likely producing little or no income. Although land does not require much maintenance compared to renter-occupied property, it almost always requires financial nourishment.
- Opportunity costs: Investing in land is a drain on cash, and of course buying the land in the first place costs money. If you buy the land for cash, you have the opportunity cost of tying up your valuable capital (which could be invested elsewhere), but you will most likely put down 30 to 40 percent in cash and finance the balance of the purchase price.
- Expensive Mortgages – Mortgage lenders require much higher down payments and charge higher loan fees and interest rates on loans to buy land because they see it as a more speculative investment. Obtaining a loan for land development is challenging and more expensive than obtaining a loan for a developed property.
- Lack of Depreciation: You don’t get depreciation tax deductions because the land isn’t depreciable.
- Cost of Capital: Make short- and long-term projections for how long your property will last.
On the revenue side, some properties can be used for parking, storage revenue, or even to grow Christmas trees in the Northwest or grain in the Midwest. (After making sure you have complied with local zoning restrictions and have adequate insurance).
Although large-scale land investing is not for the entry-level real estate investor, savvy real estate investors have made fortunes by taking raw land and obtaining the proper rights and then selling (or better yet, subdividing and then selling) the parcels. to developers. of commercial and residential properties (primarily homebuilders). If you decide to invest in land, make sure you:
- Do your homework. Ideally, you want to buy land in an area that attracts rapidly expanding businesses and has a shortage of housing and developed land. Take your time to really get to know the area. This is not a situation where you should take someone’s good advice to invest in faraway properties in another state. You also shouldn’t buy raw land just because you heard the compelling opening bid price announced on the radio for the government-surplus land auction at the convention center this Saturday.
- Know all the costs. Calculate your annual carrying costs (ongoing property expenses such as property taxes) so you can see what your annual cash drain may be. What are the financial consequences 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 may need. Execution of utility lines, water and sewage; road construction; landscaping; and so on everything costs money. If you plan to develop and build on the land you buy, research these costs. Be sure not to make these estimates with your rose-tinted sunglasses—upgrades almost always cost more than you expect. (You should check with the planning or building department for their list of requirements.)
Also make sure you have access to land or the right to enter and exit through a public right-of-way or someone else’s property (known as an in-and-out). 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). Wrong!
Understand zoning and environmental issues. The value of the land depends largely on what can be developed on it. Never buy land without thoroughly understanding its zoning status and what you can and cannot build on it. This advice also applies to environmental limitations that may exist or may go into effect without notice, diminishing the potential of your property (without compensation).
This potential for surprise is why you should research the layout of the planning department and nearby communities. Attend local planning group meetings, if any, because some areas that are against growth and development are less likely to be good places to buy land, especially if you need permission to do the type of project you have in mind. Through the empowerment of local residents who sit on community boards and can influence local government officials, zoning can suddenly take a turn for the worse; Sometimes, your property may have been downzoned, a zoning alteration that can significantly reduce what you can develop on a property and therefore the value of the property. See the sidebar “The Dangers of Downsizing” in this chapter for more details.
Determine your cost of real estate capital