Why land is your wisest investment ?
Land requires no upkeep
You don't have to be there to tend an empty parcel. Unlike apartment
buildings or commercial properties, you spend nothing in maintenance.
You don't have to worry about sloppy tenants or unpaid rent. In
fact, the land value keeps growing even if you NEVER see the property.
Land never wears out, nor depreciates
Nothing can destroy the land and since land is a fixed commodity,
its value MUST continue to rise as more people move into an area.
Detroit can build more cars, Wall Street can float more stock
issues, but there is only so much land and no more.
Land is the original inflation fighter
A recent articlel U.S. NEWS AND WORLD REPORT states that land
values rose at a rate three times as great as the increase in
the general price level over the last ten years. So you pay off
your land with dollars that are increasingly worth less. But your
growth rate keeps you at least even-and in most cases, pushes
you ahead of inflationary trends.
You have REAL financial security.
Land is an excellent tax shelter
Property taxes and interest charges in most cases are tax deductible.
Yet, at the same time, undeveloped property taxes are low enough
so as not to be a real financial burden.
Of all the forms of real estate ventures, investment in vacant
land probably provides the greatest opportunity for creativity
and profit. Simultaneously, it is no doubt the riskiest real
estate investment, requiring the most good luck. Ranging from
the simple purchase of an improved lot in a subdivision by an
individual who wishes to build a home, to the more complicated
accumulation of hundreds of unimproved acres to hold for future
development and subdividing, to the acquisition of a tract of
land in anticipation of rezoning for a more intensive use, land
is the real estate developer's and speculator's playground.
This section examines methods for estimating the profitability
of investing in vacant lots and acreage as a portion of an investor's
total property-ownership portfolio. The goal of most land buyers
is to own the right property in the right place at the right time
to command the highest possible return on an investment. Depending
on an individual's investment strategy, vacant land can provide
a viable alternative to the ownership of improved income property.
Raw acreage presents the investor with an opportunity to diversify
holdings, earn high profits and offset the risks of loss from
other investments.
However, high profits are inevitably balanced by high risks,
and vacant land investments are probably more affected by uncontrollable
outside events than any other type of real estate. Furthermore,
land is not depreciable for tax purposes, and a beginning investor
is well-advised to start a portfolio with an improved income property.
In this way, the investor can maximize profits through the use
of the tax shelters, however limited, that improved property provides.
When income taxes have been somewhat minimized through investment
tax shelters, the investor is in a stronger financial position
to speculate with vacant land.
Essentials of Land Investment Feasibility Studies
Whether the investor in vacant land is a speculator or a developer
of buildings, the property's location and physical quality will
have a significant impact on the success of the investment. Timing
strategies, farming losses, development costs and community attitudes
also affect the land investor's potential profits.
Property Location
Primarily, the location of land determines its potential future
growth in value. Although some enterprising promoters have earned
large profits from the sale of parcels of relatively isolated
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 neighboring 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 a parcel of 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
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 neighborhood 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 land. 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.
Property 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 neighborhood serenity.
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 investments because, by their very nature,
these investments are long term. In fact, real estate is often
considered to be a nonliquid 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.
Farming Losses
Although we have passed from a primarily agricultural society
to a highly industrialized one and are now entering an era of
services and informational systems, many parcels of land in this
country are still used for farming and ranching. When these activities
are the main occupations of their owners, the income acquired
is considered ordinary income and is treated as active income
for tax purposes.
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 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.
For most real estate investors, the opportunity cost on invested
capital forms the basic measuring unit for determining their investment
acquisitions. If, when sold, a property cannot develop a return
on the investment that substantially exceeds the loss of earnings
during the holding period, then these monies should be left on
deposit or invested more profitably elsewhere.
Community Acceptance
An investor in vacant land must become acutely aware of the legal
and political attitudes of local governing bodies. As noted earlier,
local government may have a direct effect on the future development
of a specific parcel of 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 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 Lot Investments
The opportunities for single-lot investments 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
Many people purchase a lot in anticipation of building a house
on it in later years. By acquiring a homesite 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 equity
necessary to secure a mortgage on the building.
Speculative Lots
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.
Rezoning residential land to a more intensive use usually raises
the value of the property, sometimes quite dramatically. For instance,
in one community, when a 600-foot block of residential property
was rezoned to retail commercial use, its value changed immediately
from $200 per front foot to $500 per front foot. No physical changes
were required to make the land more usable, nor were any additional
monies invested.
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 neighborhoods
are discovered, a meticulous search should be made to discover
those particular vacant parcels of land with rezoning potential.
Lease Vs. Resale
It is important for investors who purchase lots for resale to
carefully evaluate their personal financial positions before actually
selling. 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 land 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 land is not specifically depreciable.
Build To Suit
In an attempt to convert a vacant lot into income-producing improved
property, owners sometimes advertise that they will construct
a building on a lot that will satisfy the particular requirements
of a potential tenant. On the signing of a long-term lease and
the construction of the building, 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 build to suit.
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.
The economic position of a building 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 will generally
avoid the construction of a single-purpose building if at all
possible. Such buildings are usually difficult to rerent and are
expensive to remodel. Nevertheless, many single- purpose buildings
for fast-food franchises or 24-hour minimarkets are being constructed
for strong, AAA-rated national tenants.
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. However, 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 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 land 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.
Evaluating Land
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 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 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 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.
Subdividing For Speculation: 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. In addition, 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.
Interstate Land Sales Regulations
The Department of Housing and Urban Development (HUD) engages
in the regulation of interstate land sales. HUD's activities in
connection with the Interstate Land Sales Full Disclosure Act
are of particular significance for those investors contemplating
large-scale land sales promotions.
Authorized under Title XIV of the Housing and Urban Development
Act, the interstate land sales law is administered by the Office
of Interstate Land Sales Registration, U.S. Department of Housing
and Urban Development, Washington, DC 20411.
This law requires anyone engaged in the interstate sale or leasing
of 25 or more improved lots to register the offering with HUD
and to make available to each prospective lot purchaser or lessee
all facts pertinent to the legitimate use of the land. The terms
and conditions of any financing in existence at the time of the
sale or lease must be stated and the existence of any other liens
revealed. The probability for completion of promised off-site
improvements such as paving, parks, golf courses and marinas must
be given.
In addition to this data, the disclosure must also provide information
about distances to nearby communities over paved or unpaved roads;
provisions for placing contract payments into a special escrow
fund set aside for the purchase of the property; the availability
of recreation facilities; sewer and water services or septic tanks
and wells; the present and proposed utility services and charges;
the number of homes currently occupied; soil and foundation conditions
that could cause problems in construction or the use of septic
tanks; and the type of title the buyer will receive.
A buyer is protected in several ways against failure to comply
with the provisions of the full disclosure requirements. If a
prospective buyer has not been furnished a property report before
signing, the contract may be canceled and a refund obtained. Furthermore,
the buyer must receive a property report at least 48 hours before
a contract is signed and must have seven calendar days after for
a "cooling off" period. If the buyer wishes to cancel
the contract during this period, a full refund of any payments
will be made.
Criminal penalties of up to five years' imprisonment, a fine
of up to $5,000 or both may be imposed if a developer willfully
violates the law, makes an untrue statement or omits any material
fact required in the statement of record or in the property report.
In addition, the purchaser may sue for damages not to exceed the
purchase price of the lot, plus any improvements made thereto
and reasonable court costs.
Complementing HUD's requirements, a number of states have enacted
their own interstate land sales regulations as well. Administration
of such state laws is usually placed in the office of the state
real estate or land commissioner. In Nebraska, for instance, a
developer wishing to sell land located in other states must file
an application for permission to sell with the Nebraska Real Estate
Commission. The developer must pay a filing fee commensurate with
the number of lots in the subdivision and post a bond to guarantee
the timely completion of the off-site improvements promised in
the sales.
Prior to granting approval for interstate land sales in Nebraska,
the director of the commission, or a deputy, visits the land at
the developer's expense to verify personally the facts presented
in the application.
Both the federal Interstate Land Sales Act and the various state
laws regulating such sales have been developed to curb the fraudulent
activities of unscrupulous promoters of vacant land. Although
land promoters invariably earn relatively high profits, the purchasers
of these lots often can barely recover their investments.
Case 7.1:
1,280-Acre Land Promotion.
The profit potentials in a land-promotion program can be illustrated
by examining the case of a two-section (1,280-acre) parcel of
land, to be subdivided into 2,560 one-half-acre lots. These lots
will then be marketed within the state in which the property is
located.
The purchase price of the raw acreage is $1,000 per acre, and
it is estimated that it will cost an additional $500 per acre
to improve the land with roadways and basic utilities. An additional
$500 per acre will be needed for interest charges, carrying costs
and promotional fees. The sales price of the half-acre lots will
average $3,000 each, with 10 percent of the total sales to be
received as cash down payments. These monies will be allocated
for sales commissions and closing costs. The land contracts to
be secured from the sales will be discounted and sold by the promoter
for 75 percent of their face value. It is anticipated that the
project will take three years to complete. The financial analysis
appears below.
CASE 7.1 1,280-Acre Land Promotion
Costs
1,280 acres @ $1,000 per acre $1,280,000
1,280 acres improvements @ $500 per acre +$640
1,280 carrying costs @ $500 per acre +$640
Total: $2,560,000
Income
2,560 one-half-acre lots @ $3,000 each $7,680,000
Sales and closing @ 10% -768,000
Sales contracts face amount $6,912,000
25% Discount -1,728,000
Net Cash Receipts $5,184,000
Less Costs (above) -2,560,000
Net profit before taxes $2,624,000
28% Taxes(ordinary income) -734,720
Net profit after taxes $1,889,280
Return on total investment 73.80%
($1,889,280 $2,560,000)
Average annual return 24.60%
(73.80% 3 Years)
Note that this case includes discounting the contracts in an
amount of $1,728,000, a substantial sum of money. If the promoter
were to hold the receivables, the returns would increase dramatically.
However, the face amount of those receivables would not be immediately
available for reinvestment, as is the discounted sum. Thus, an
opportunity cost would have to be applied for the loss of earnings
during the contracts' holding periods, offsetting to a great degree
the higher profits.
However, note that the returns in this analysis are based on
the full amount of the investment, assuming that they are paid
in cash. More realistically, considering a leveraging investor,
the cash expended over the three years would include only the
$1,280,000 costs for land improvements and carrying charges, plus
a portion of the purchase price represented by an acceptable down
payment, such as 10 percent, or $128,000. The balance of $1,152,000
would be carried back by the seller of the raw acreage and would
be paid over time by the receipts collected from the subsequent
individual land contracts.
Therefore, the face amount total of the sales contracts, $6,912,000,
must be decreased by the $1,152,000 owed to reflect the promoter's
equity prior to discounting. The difference is $5,760,000, and
a 25 percent discount ($1,440,000) will result in a $4,320,000
cash flow before costs and income taxes. Applying the more realistic
cash investment figure of $1,408,000 ($1,280,000 + $128,000 =
$1,408,000), the returns are now as follows:
Total gross income
Sales and closing costs
Sales contracts face amount
Less underlying encumbrance
Promoter's equity in contracts
25% discount
Net cash receipts
Less costs (adjusted)
Net profit before taxes
28% taxes
Net profit after taxes
Return on cash invested ($2,096,640 $1,408,000)
Average annual return (148.90% 3 years) $7,680,000
-768,000
$6,912,000
-1,152,000
$5,760,000
-1,440,000
$4,320,000
-1,408,000
$2,912,000
-815,360
$2,096,640
148.90%
49.64%
Thus, leveraging actually doubles the bottom-line return of this
investment.
Subdividing For Development: 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 plats, 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.
The 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.
CASE 7.2:
160-Acre Mixed-Use Subdivision.
The profit potentials in land banking can be illustrated in the
development of a 160-acre parcel of land as a subdivision that
will contain a park, school, apartments, offices, stores and house
lots.
Assume a purchase price of $1,120,000 ($7,000 per raw acre) plus
$1 million allocated for engineering, platting, rezoning, improvements,
interest charges and other carrying costs. The project is expected
to sell out in two years because of its strategic location and
strong market demand. Of the total parcel, 15 acres will be donated
to the city for a park and roads, and 10 acres will be sold to
the local school board for $100,000. This price reflects the developer's
break-even costs for the 10 acres and, together with the donated
park site, establishes the amenities necessary to attract potential
home-buying families.
Anticipating a successful sellout of residential lots, contracts
for the sale of a 10-acre apartment site at $20,000 per acre,
a 10-acre office site at $30,000 per acre and a 15-acre shopping
center site at $40,000 per acre have been arranged in advance.
The balance of the land, 100 acres, will be subdivided into 400
individual house lots to be sold for an average price of $6,500
each. Sales commissions and closing costs for all properties are
estimated to be 10 percent of the total receipts. The financial
analysis follows:
CASE 7.2 160-Acre Mixed-Use Subdivision
Costs
160 acres @ $7,000 per acre $1,120,000
Improvements +1,000,000
Total: $2,120,000
Income
15 Acres donated for park -0-
10 Acres School site $100,000
10 acres Apartment site @ $20,000 per acre +200,000
10 acres Office site @ $30,000 per acre +300,000
15 acres Commercial site @ $40,000 per acre +600,000
100 acres @ 400 house lots @ $6,500 each +2,600,000
160 acres Total $3,800,000
Less sales costs @ 10% -380,000
Net cash receipts $3,420,000
Less costs (above) -2,120,000
Net profit before taxes $1,300,000
28% taxes -364,000
Net profit after taxes $936,000
Return on total investment 44.15%
($936,000 $2,120,000)
Average annual return 22.08%
(44.15% 2 years)
Note that in this case, as in Case 7.1, the bottom-line return
is a function of the fact that the entire investment has been
paid in cash. With the appropriate application of leverage, the
returns for the mixed-use- subdivision developer can be increased
substantially.
In this particular investment, the monies generated by the advance
sales of the school site plus the apartment, office and commercial
parcels ($1,200,000 total) would more than cover all of the $1
million cost of the land improvements. Then, if the purchase could
be arranged on an installment basis, the investor's cash outlay
could be reduced to zero and the excess $200,000 used as a down
payment. With this high leverage, the investor's returns climb
infinitely, creating exciting possibilities for land-banking profits.
However, it must be clearly understood that investment in unimproved
land is strictly a high-stakes gamble. It is the most unpredictable
of all types of real estate investment. No one can accurately
estimate when it will sell or for what amount. In an economic
slowdown, it is the first to suffer and the last to recover.
Foreign Investors
Much has been written about foreign investment in the United States.
Although these reports give the impression that foreigners are
owners of a large percentage of American real estate, the facts
reveal an entirely different story. A study by the National Realty
Committee and the Government Research Corporation indicates that
non-American investors own a little more than 1 percent of our
real estate. These foreign investors include groups from Japan,
Taiwan, Vietnam, the Middle East and some European countries.
Anyone involved with foreign transactions is responsible to report
large cash payments to the IRS; furthermore, they are liable for
unpaid federal taxes. So, investors and brokers be wary.
Generally, foreign investors purchase American property because
of
· the appreciation in the values of their own currency
when compared to the dollar;
· highly inflated values of real estate in their own countries;
· easing of restrictions by their own governments on foreign
investments; and
· perceived security of investments in the United States,
based primarily on the stability of our government.
http://commercial.realestate.com/Buying_to_invest/foreign_investors.asp
More than a dozen reasons to do business in Chile:
· Politically stable democratic government
· Stable legal system, with clear, non-discriminatory laws
· A free market economy, deregulated and competitive
· Sound, stable, non-discriminatory economic policies
· Constitutional quarantees for foreign investment
· Favorable economic outlook with very good investment
opportunities
· Extremely open economy, with low customs duties and no
non-tariff barriers
· Gateway to other Latin American markets
· Sophisticated service sector
· Highly qualified work force, with a broad range of excellent
specialists
· Highly developed, dynamic capital markets
· Modern financial system with up-to-date technology
· Tradition of profound respect for laws regulations
· A public sector with clear procedures and a modern regulatory
framework
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