Investment Land Feasibility

Before any investor would undertake to make any kind of purchase of investment land, they would obviously wish to know as much as possible about it, and the context within which they are making the investment land decision.

The Core Elements of Land Investment Feasibility

  • Land Location
  • How to Buy Land
  • Land Features
  • Investment Timing
  • Opportunity Costs
  • Community Acceptance
  • Single Lot Investments
  • Residential Lots
  • Speculative Lots
  • Lease vs. Resale
  • Building to Suit
  • Acreage
  • Acreage for Resale
  • Evaluating Land
  • Land Promotions
  • Land Bankers

Land Location

Primarily, land location determines its potential future growth in value. Although some enterprising promoters have earned large profits from the sale of parcels of relatively isolated building land, well-situated property is more likely to increase in value.

For instance, land lying within a three-mile area on either side of a major highway connecting two neighbouring communities is almost certain to increase in value over time. Generally, communities tend to grow toward each other, developing increased demand and higher values for intervening properties. And, as a rule, the closer to the highway the land is situated, the higher its potential value.

Similarly, the purchase of raw acreage at the periphery of a community by an investor who wishes to hold the land for appreciation requires an educated prediction of the direction in which the town or city will expand. An incorrect estimate of future growth patterns will result in the investor's waiting longer for profit realization. And as the waiting period increases, the time value of money affects the average annual rate of return.

This relationship of location to value is equally applicable to single lots and large tracts of land. For example, a lot purchased on a major arterial street in anticipation of future rezoning for a more intensive use may prove to be an extremely profitable investment if the neighbourhood grows in that direction.

The reverse is also true.

Another example would be a lot that is located on the exterior boundary of a subdivision and that overlooks a large, vacant parcel of building land for sale. If the lot is to be used for the construction of a home, then the development of a shopping center, office building or other commercial activity on the larger parcel may diminish the lot's value.

How to Buy Land

When seriously considering whether to buy land or not, you will make a decision based on all of the information available to you and those experts who advise you.

Assuming for one moment that you do decide to buy land, and instruct your solicitor to draw up the contract, they will amongst other things conduct the necessary legal searches. These searches will include an examination of the possibility of future developments directly affecting your plot. It is certainly a good idea to make yourself aware of the possibilities before buying land, if only to save yourself wasting time and effort with a site that turns out to be impractical or undesirable.

For example, someone just about to buy land in an area where a road-widening scheme is being planned or a new by-pass being considered, or where land development is about to take place to build an industrial estate, would be well advised to look elsewhere.

The planning department of the local authority will be well-placed to advise you of any planned developments before buying land. In particular, you should ask them what "use" the surrounding land has been designated, and whether or not there are plans to change this status. With an accelerated rate of house building looking set to start soon in the UK, there may well be new highways planned close to your development land.

The local highways department have maps and details showing approved road schemes and those under consideration as proposals. You may even be able to get access to information about other planned schemes before they become public knowledge!

Before you buy land, take steps to protect your investment. As well as the local authority, before you buy land, you can talk to the local shop-keepers and also the neighbours. This has the advantage that you might also get to hear about ideas which have yet to be formally proposed.

Investment Land Features

The physical features of vacant land, such as topography and soil composition, are as important as location in terms of future profitability.

A parcel of land's physical features may be economically advantageous to one owner and disadvantageous to another. For instance, sloping foothill land is inefficient for farming but desirable for high-priced homes with attractive views. Likewise, unimproved acreage near a large city may be less useful for cattle grazing than for development as a suburban bedroom community.

Purchasers of single lots within a city must also be aware of the physical characteristics of their land. A lot's location, contours, drainage, soil quality and rezoning potential affect its value.

Interior subdivision positions are essential to the buyer of a house lot, while railroad tracks and highways are significant features of an industrial parcel. Retail and office developments require access to major traffic arteries with high traffic counts, while apartment and mobile-home dwellers seek public transportation facilities and neighbourhood serenity.

Land Investment Timing

"Buy low and sell high" is axiomatic to any investor seeking a profit, and proper timing has a great deal to do with both of these accomplishments.

Timing is a particularly important factor in real estate investment because, by their very nature, these investments are long term. In fact, real estate is often considered to be a non-liquid investment. Often, it is easy to buy real estate but quite a bit more difficult to sell it; in some unfortunate instances, it can become impossible even to give it away.

Land speculation requires a greater awareness of timing than many other real estate investments, because most land does not produce income during the holding period. It is held by the investor pending a rise in value. The longer this interim holding period, the lower the investment's annual yield will be.

In addition to the land's initial purchase price, the investor must make cash expenditures for mortgage payments, property taxes and improvements to the land. Unless the property can be leased for some income-generating activity, vacant land requires constant financial support during its investment life.

Depending on a lot's location and characteristics, some owners will seek to minimize their holding costs by renting their properties as parking or used-car lots during the waiting period. Owners of larger parcels have found it expedient to develop farm or ranch operations while waiting for the property to appreciate in value.

Leasing the land to tenant-farmers on a profit-sharing basis will often produce enough tax-sheltered income to carry an investment.

Investment Opportunity Costs

Whereas mortgage payments and property tax cash outlays during the holding period are fairly obvious, opportunity costs for the equity invested in the land development are all too often ignored.

While the interest paid on a debt can be easily identified as a cost for maintaining the investment, the interest not earned on the cash invested in the property must also be included as a holding cost. The rationale for this practice is based on the present-worth principle. If this money were invested, it would generate a profit. Therefore, the money not earned on the capital invested should be considered as carrying costs.

Land development speculation requires a greater awareness of timing than many other real estate investments, because most land does not produce income during the holding period. It is held by the investor pending a rise in value. The longer this interim holding period, the lower the investment's annual yield will be.

Community Acceptance

An investor in vacant land must become acutely aware of the legal and political attitudes of local governing bodies. Local governments may have a direct effect on the future development of a specific parcel of self build land. Some communities have passed growth management legislation that requires developers to have their infrastructure (streets, sewers, sidewalks utility lines, etc.) in place before they offer their properties for sale.

Others have raised other barriers to development. For example, if a community practices a no-growth policy, it may be difficult, if not impossible, to secure the cooperation necessary to have subdivision plans approved and/or necessary utility services installed.

The future value of self build land often depends greatly on the availability of gas, electricity and sewer services. Some communities control their growth by refusing to issue permits for the installation of these utilities.

Because a local moratorium on gas or sewer installations can destroy the timing strategy for a particular development, an investor in land should carefully select those parcels that can be developed with as few potential difficulties as possible.

In the long run, growth management may result in ever-increasing prices for developments and serious shortages of land for housing.

Single Lots of Investment Land

The opportunities for single lots of investment land include those individual parcels purchased for residential construction and those that have the rezoning potential for more intensive, and therefore more profitable, uses.

In the first instance, the investor acts as a developer, albeit on a small scale. In the second, the investor is a speculator seeking to profit from the gain in value of the rezoned lot.

Residential Lots of Land

Many people purchase a lot in anticipation of building a self build house on plots of land for sale on it in later years. By acquiring a home site at current costs, such a buyer hopes to profit from its growth in value over time. Simultaneously, many of these buyers, unable to purchase a lot for cash, enjoy the opportunity to make affordable payments over time so that the debt on the lot will be paid in full prior to construction. The free and clear land then becomes the tequity necessary to secure a mortgage on the building self build houses.

Speculative Investment Land

In addition to residential lots purchased for future use, investors also buy strategically located vacant lots in anticipation of a rise in value and profitable resale.

Generally, these speculative lot purchases are based on the possibility of a successful rezoning of the property for a more intensive use than single-family residences. Included in this inventory are lots physically suited for multifamily apartment projects and office structures as well as for commercial and industrial developments.

Successful rezoning requests are based largely on the subject property being located in an area of use compatible with that being sought by the property owner. Good land-control practices usually prevent any spot zoning, require the applicant to prove conformity to the general land use plan and follow adopted pollution-control ordinances.

Rezoning activities are sometimes costly and time consuming.

Any rezoning proposal requires the satisfaction of numerous individuals who hold vested interests in the outcome of the proposed change, as well as the approval of the community's planning agency.

Any objections by adjoining property owners and other affected persons, sometimes expressed eloquently and often vehemently at public hearings, must be overcome by the applicant. However, the rewards are usually worth the efforts required to obtain rezoning.

When purchasing vacant lots with possibilities for growth in value, an investor must make a careful examination of the community to identify potential areas of expansion. Once these neighbourhoods are discovered, a meticulous search should be made to discover those particular vacant parcels of land sales with rezoning potential.

Lease vs. Resale

It is important for investors who purchase building plots for sale to carefully evaluate their personal financial positions before actually selling. In fact, it may be more advantageous to lease, rather than sell, the property.

A lease develops certain advantages for both the landowner and the tenant. The owner benefits by securing an income stream into the future. In addition, at the expiration of the lease, the reversionary rights to the Plot Sales are retained, as well as any improvements made thereon by the tenant.

Long-term land leases also provide the landowner with an asset-the lease-that can be capitalized on. By pledging the lease as collateral, the landlord can secure cash from a lender- tax-free cash that can be used to purchase additional investments. Thus, the landlord continues to own the leased land and can expand the investment portfo- lio accordingly.

The primary benefit to a land-leasing tenant is leverage: the leasehold interest acquired under a long-term land lease can be pledged as collateral for a mortgage to construct a new building.

With a loan sufficient to pay for the costs of construction, the developer may be able to leverage 100 percent and avoid investing personal funds in a project. In addition, the rent paid by the tenant for the use of the land is considered an operating expense in the year that it is incurred.

Thus, by paying rent on land rather than owning it, a tenant is effectively gaining the benefits of "depreciating" the land over the life of the lease. Remember that plot sales is not specifically depreciable.

Building Land to Suit

There are a number of ways to look at the suitability of a building plot of land for development.

In an attempt to convert a vacant lot into income-producing improved property, owners sometimes advertise that they will proceed with land development and construct a building on the lot that will satisfy the particular requirements of a potential tenant.

On the signing of a long-term lease and the construction on the building land, the landowner becomes a landlord in the traditional sense. At the expiration of the lease, the landlord continues to own both the land and the vacant building, which can be rerented or converted to a new use.

The difference in economic positions between an owner of a vacant parcel of land and an owner of a vacant building is of critical importance to an investor in deciding whether to initiate land development and begin construction.

In the first instance, the property owner pays relatively low property taxes and faces no continuing property-maintenance problems.

In the second, the owner's taxes are higher because they are based on the value of the building as well as the land. In addition, the empty building requires continuous care, repair and protection. All of these factors must be borne in mind when considering land development.

The economic position of a building land owner is more vulnerable, so the landowner who solicits a tenant on a build-to-suit basis will negotiate rather firmly for a lease that will completely satisfy investment requirements over the term of the initial lease period. To provide adequate protection against the increased risk, the rent will have to be arranged to develop an acceptable return on the investment as well as a timely return of the investor's cash outlay.

As a further precaution, a build-to-suit landowner participating in land development will generally avoid the construction of a single-purpose building if at all possible. Such buildings are usually difficult to re-rent and are expensive to re-model.

Nevertheless, many single-purpose buildings for fast-food franchises or 24-hour minimarkets are being constructed for strong, AAA-rated national tenants.

Land Acreage

Investors in raw acreage can be classified as either speculators or developers, as can purchasers of small lots.

A larger land parcel can be bought for resale as a single unit or for subdividing into either improved or unimproved lots. In the former situation, the investor acts as a speculator, holding the land for growth in value, then selling the tract intact.

When raw acreage is subdivided, the investor who sells the land in small parcels after few or no improvements have been made is speculating in land promotions, whereas the subdivider who improves the raw acreage with roads, sewers, water, and other utilities and amenities before selling lots is a land developer.

Land is often worth more as one wholly integrated and cohesive unit than it is as a number of individually owned separate parcels. This concept is called agglomeration, plottage or assemblage.

To apply this principle of ownership and value, a major farming or ranching enterprise would seek to control as many adjoining acres as possible to attain more efficient production.

Similarly, the total of the individual values of lots in a block could be worth less than the entire block as a single site for a large shopping center. In this case, the value increase is a function of a change in use as well as the efficiency of single ownership.

Plottage can have a reverse effect on the value of acreage for speculators and developers.

When quantities of land are accumulated for investment purposes, the total value of the individual smaller parcels is usually less than the value of the total property when finally acquired. However, if the speculator or developer decides to subdivide this wholly owned property, the sum of the sales prices of the individual lots often greatly exceeds the value of the property as a single unit.

This concept will be examined in the next chapter in a discussion of conversion of rental apartments into condominiums.

Acreage for Resale in One Unit

In regions of the country where the greenfield land is fertile, very little acreage speculation takes place. Productive land is usually held by individual farmers or ranchers. On the death of the owner, the land is passed to family heirs. Speculation in acreage is most common in areas of the country where the land is relatively unproductive.

The value of land is not based merely on its productive capacity. Depending on intended use, location can become the key factor in determining value. Land speculators are not as concerned with soil fertility as they are with locational advantages or disadvantages that will affect the future desirability of the land for developers and/or builders. Accessibility to nearby major highways and communities; availability of water, gas and electricity; and proximity to natural and man-made amenities, such as nearby lakes, woods, golf courses or ski slopes all increase the profit potential of investments in raw acreage.

Speculators in unimproved greenfield land for sale range from the small investor, who buys 5 to 40 acres located on the periphery of an expanding community, to the large investment syndicates, which purchase thousands of acres to hold for future resale. Regardless of the size of the investment, however, the philosophy is always to buy right to net a large profit.

Large profits are often less than they appear to be. For example, throughout its holding period, raw acreage requires the payment of such basic carrying charges as property taxes, interest and opportunity costs. Although taxes on vacant acreage are relatively low, the compounding effects of opportunity costs must be included when analyzing the feasibility of an investment in acreage. Remember, there is usually no cash flow to provide offsetting income during the years between purchase and sale.

Assuming a property tax rate at a cost of 1 percent per year plus an opportunity (interest) cost of 9 percent per year, the value of the land will have to increase at least 10 percent annually just for the investor to break even when the property is sold. When an investor's desired profit rate and an appropriate percentage ratio to cover monies needed for the costs of a sale (for example, commissions, title policy premiums, legal fees, income taxes) are added to this 10 percent rate, required annual increases in property value of 15 percent to 20 percent are not unreasonable.

This rate of increase means that the property must double in value every five to seven years if the costs of investment plus a profit are to be earned. For example, even if the value of the land increases 100 percent over a ten-year holding period and the property owner sells for an amount twice what was originally paid, the annual rate of return would be only 10 percent (100% 10 years = 10% per year). At a 10 percent value increase annually, the investment may not yield an amount of return adequate to cover both carrying costs and anticipated profits. Thus, it is vital that an investor make an effort to identify future value-growth patterns by carefully investigating trends in local property values.

Land Evaluation

The evaluation of raw land depends to a great degree on its future, rather than its present, use. Thus, an investor must be able to predict the type of eventual use as well as the time when this use will become feasible-not an easy task.

The most popular basis for evaluating land is the comparative approach, whereby similarly zoned parcels of greenbelt land that sold recently are said to establish the value. This is after adjustments have been made for location, size and date of sale.

A more comprehensive approach is advisable, because the existing zoning of the greenbelt land may not be its highest and best future use. The time value of money also must be considered. Careful attention should be paid to an opinion of future use by analyzing the area's demographics, employment centers and traffic counts. This information would form a basis for projecting the number of acres that would be in demand for each use classification (i.e., residential, business, industrial and so on.

In addition, a careful forecast should be made of when the property will be ready for development. The factors to consider in this analysis include supply, demand, availability, growth patterns and distance from existing development. Some effort should be made to project building costs and rents to estimate what a developer might pay for the land in the future.

Finally, to derive the present value of the greenbelt land, an appropriate investment return must be established. When improved properties are being sold for close to a 10 percent capitalization rate on an all-cash basis, raw land requires the investor to double this figure to account for the increased risks involved. Thus, a 20 percent annual return requirement should be applied to project the future sale price.

Land Promotions

Many land-promotion schemes are the consequence of speculation in raw acreage. The promoter buys a large tract of vacant acreage at wholesale prices, divides it into smaller parcels and resells these smaller, usually unimproved, lots at retail prices to buyers scattered throughout this, as well as other, countries.

These lots are marketed through various promotional plans and advertising media. One of the more common marketing methods is to invite prospective buyers to a free dinner during which salespeople extol the virtues of the property through lecture and film.

Often, these dinners are followed by an offer of a trip to the site, with any costs for traveling reimbursed by the promoters after purchase of a lot. Generally, the various large companies involved in such land promotions follow a format of marketing the individual lots as second, or retire-ment, homesites.

The financing designs of both the original purchase of raw acreage by the promoter and the subsequent sales of lots to individuals are the most important elements in this form of real estate investment.

A purchase of land for use in a sales promotion usually requires the seller of the raw acreage to carry back a substantial portion of the sales price as an installment land contract or purchase-money mortgage. Thus, after the promoter makes an agreed-on cash down payment, usually about 5 percent to 10 percent of the purchase price, the landowner will accept a lien on the acreage involved for the remainder of the sales price. This balance is to be paid by the promoter on some regular amortization schedule. Under a land contract, the seller retains legal title to the acreage until the terms of the contract are met, usually the requirement that the balance be paid in full.

Most land-promotion property is sold to subsequent small-lot owners with any underlying financial arrangements left intact. As a result, each individual sale is made subject to the lien of at least one existing encumbrance, the installment contract or purchase-money mortgage between the promoter and the seller of the acreage. The existence of an underlying encumbrance poses a serious threat to the purchaser of an individual lot if the promoter does not make payments as required. The small-lot owner may be financially hurt in a subsequent foreclosure of the master lien.

To offset this problem, most legitimate promoters will secure a recognition clause in their original financing agreement in which the vendor or mortgagee agrees in advance that if the promoter should default during the term of the agreement, the lender will respect the rights of subsequent lot owners and honor their contracts.

Alternatively, a release clause may be inserted in the land contract under the terms of which individual lots may be released from the master lien after a certain agreed-on percentage of its balance has been paid by the vendee.

The sales of lots to individual purchasers are generally designed as installment land contracts. Most buyers of these promotional lots make small cash down payments and the balance is carried back by the selling company to be paid in regular monthly installments. Frequently, the seller's signature is not notarized, and, consequently, the contract is unacceptable to the appropriate county office for recording.

A promoter hopes that the initial sales campaign will generate enough individual sales to quickly develop the cash flows necessary to meet the required underlying contract payments. Sometimes it takes a few years to reach this break- even point, and the promoter must be prepared to meet payments and operating costs with other funds. A promoter can offset a cash shortage either by selling the individual contracts secured through early sales, a process called factoring, or by pledging these contracts as collateral for a bank loan to meet operating expenses. Once a break-even point has been met, however, continued sales will generally result in substantial profits.

Because they recognize the complexities and possible pitfalls for the consumer in this form of land promotion, both federal and state regulatory agencies carefully supervise such programs. All interstate land sales must conform to the requirements of the federal government's Regulation Z. The promoters must prepare and distribute to all prospective lot purchasers a full disclosure report describing the subject property and the complete financial arrangements of the transaction. Many states require that the promoter post bonds in amounts adequate to complete any promised improvements to the land, such as roads, golf courses, clubhouses and lakes, before granting the promoter permission to market the lots.

Investment Land Bankers

Speculation in acreage places an investor in a somewhat passive role while waiting for values to rise to the point where profitable sales can be made.

On the other hand, development of acreage into subdivisions requires an investor to play a more active role in order to effectively market the inventory of lots. Often, investors or builders purchase raw acreage situated on the boundary of an expanding community, improve the property, subdivide it and sell lots or build houses, apartments, offices or shopping centers on the land.

A developer who improves raw land for construction purposes and maintains an inventory of lots as a function of this ongoing business is called a land banker. Besides the purchase price of the unimproved acreage, the costs of land banking include property taxes, interest, off- site and on-site improvements, engineering, site development, plat acceptance, sales commissions, insurance and costs incurred because of timing constraints. The skills, risks and responsibilities required of the land banker-developer make this a very specialized segment of real estate investment.

To begin the development process, a land banker purchases a parcel of raw land, usually 160 acres or more, and prepares plats and maps of the property designating street locations, lot sizes and the general plan for the entire proposed development.

These plots, usually drawn by licensed civil engineers, are submitted to the appropriate community regulating agencies for approval of design and zoning. After meeting local governmental requirements, including submission of a full environmental impact study, the subdivider will proceed to physically prepare the land and sell lots to both individuals and builders.

Depending on the amount of acreage involved in the development, the resulting subdivision may follow the style of surrounding neighborhoods or may acquire a distinct character of its own. Many large-scale developments include land designated for the location of a school and/or a park, including swimming pool, tennis courts, clubhouse and, perhaps, even a golf course.

Most well-planned subdivisions include a set of restrictions itemizing the type, design and quality of the improvements to be constructed on the lots therein. These subdivision restrictions are recorded and become covenants that run with the land so that each lot buyer and subsequent homeowner is required to observe these restrictions. Their enforcement becomes the responsibility of the neighborhood association formed after the project is completed.

Restrictions are designed to create an economic and physical homogeneity within a neighborhood, important for maintaining property values. By restricting lots to residential construction, incompatible uses are eliminated. By requiring a minimum square or cubic footage for each house, an economic floor is created, limiting the neighborhood residents to those who can afford to purchase a home of the specified size.

Many builders do not have the financial capacity, the expertise or the inclination to become involved in land development. Such builders prefer to leave this type of real estate investment opportunity to those with proven skill in the field. Smaller builders are usually content to purchase lots from a developer-land banker, either singly or in packages of from 5 to 50 lots, depending on their needs. The prices paid for these lots reflect the developer's cost of acquisition, preparation and desired rate of return on the investment. For smaller builders, this technique of land acquisition is much less costly and demanding than an active entry into the field of subdividing.