If you are interested in investing in real estate, you may have heard about stories of investors buying a land, holding it for a while, and then selling it for a ton of money. Buying a land may sound intimidating for new investors. So the question is, is buying land a bad investment or a good investment? It really depends on how much money and amount of work you plan to invest.
Before diving head first into buying every parcel of land you can find, I want to outline some considerations that question the merits of investing in land. Specifically, in this article I’ll cover the following topics related to land investing:
- What is Land Investment?
- Cons and Risks of Land Investment
- Pros and Benefits of Land Investment
- When Will it Work for You?
- Final Thoughts
What is Land Investment?
Broadly speaking, three types of land investment exist: 1) purchases for development; 2) purchases for speculation; and 3) purchases for flipping.
With land development, an experienced property developer purchases a plot of land with the intent of actually developing that parcel (or parcels) into some sort of income-producing property. Basically, developers build a property to sell and make an immediate profit, or to rent out for longer-term cash flow.
Regardless of which of the above profit strategies a developer takes, this sort of land investing includes two key prerequisites:
- Land development experience: Simply watching some TV shows does not make someone a successful developer. Successfully developing a plot of land into an operating property requires tons of experience, knowledge, and relationships with key players (e.g. surveyors, municipal zoning personnel, utility-connection experts, architects, engineers, etc).
- Capital: In addition to experience, developers need access to a significant amount of either debt or equity financing. Bottom line, it requires a ton of cash to actually develop a property. Purchasing the land is only the first part; developers typically need to then spend far more money actually finishing a completed, income-producing property.
With land speculation, investors undertake a much simpler process. They find a piece of land they believe to be in the path of development, hold it for a while, and then eventually (in theory) sell it for a profit once development encroaches. In essence, you buy a piece of land based on what you think the neighborhood will look like in the future.
What is land flipping?
Land flipping represents the final broad category land investment. In concept, land flipping generally parallels the theory behind house flipping, just with less work. Land flippers find a plot of land, make an offer significantly below the tax-assessed value, and, if accepted, then resell the land for a more appropriate market value.
Like house flipping, success in land flipping depends upon buying an undervalued piece of land. However, unlike its property parallel, land flipping does not require any rehab of the land. Land flippers typically buy and sell without actually doing any work (minus potentially minor landscaping for aesthetic purposes).
Cons and Risks of Land Investment
Having outlined the broad categories, I want to now discuss the drawbacks and risks of land speculation and flipping, specifically (if you’re considering developing a piece of land, I assume you already have the experience and understanding of risk associated with this strategy; if not, you probably should not consider that approach).
With land speculation, you cede control of profit. You invest in a reactive, not proactive process, as you need to actually wait for progress to come to you. In other words, if you buy a piece of land to the west of a city, convinced that development will continue in that direction, what happens if a major thoroughfare routes elsewhere? You have no control over that scenario and its associated impact on land valuations.
Furthermore, while waiting for this development to come to you, you need to pay the holding costs of owning land (property taxes and upkeep, even if minor) without receiving any associated income.
On the other hand, when you buy and rehab an actual property, you can (within a reasonable range), plan for after rehab values, because you have access to recent sales comps to forecast your own sales price. This allows for investors to actually plan for profits, not simply hope for them. Bottom line, you don’t need to imagine a future valuation, you can look to tangible, comparable properties to determine a current valuation.
With land flipping, profit margins represent the major drawback. Unfortunately, this approach just doesn’t include huge paydays. So, while land investors can make money flipping parcels of land, they won’t make nearly the same margins they would flipping houses.
Pros and Benefits of Land Investment
But, some benefits to investing in land do exist (otherwise no one would do it).
As stated above, most land flippers significantly underbid the tax-assessed values of land. Typically, this means these investors don’t spend more than $1,000 to $5,000 on a piece of land. As such, you don’t need to commit a ton of capital, limiting your downside risk (and potentially lowering the entrypoint for new investors).
Furthermore, land flippers do not, in general, have massive marketing costs. Most people just use mass mailers, a relatively cost-effective marketing strategy if focused on a limited geographic area.
Lastly, investors can flip or speculate in land anywhere, a reality many investors find appealing with this strategy.
When Will it Work for You?
Now, the important question: when will investing in land work for you? Considering the above, if any of the following three scenarios apply to your situation, investing in land will work for you:
- You are an experienced land developer.
- You want the lower risk and lower margins associated with land flipping.
- You are willing to accept a hands-off approach in the hopes of land speculation leading to a long-term return.
NOTE: In rare situations, investors can cash-flow land by converting it into a parking lot during the holding period, offsetting the holding costs typically associated with land speculation. However, buying a parcel of land in a high-enough demand area to warrant paid parking typically requires a massive investment, as you’re likely purchasing a parcel in a central business district.
If you don’t fall into one of the above scenarios, I need to argue against investing in land. Here at The Investor's Edge, we prefer to purchase income-producing properties. If you buy a house to flip, and the sale falls through, you can always adjust to a BRRR strategy.
With land investing, investors typically don’t have the safety net of a back-up strategy.
Bottom line, I prefer to do the least amount of work, for the most money, in the shortest amount of time possible, and investing in properties accomplishes these goals better than investing in land.
No matter what path you take as a real estate investor, financing is king. Without access to reliable financing, the best deals remain nothing more than wishful thinking. As such, one of the most important relationships you can build as an investor is with a reliable, trustworthy lender.
Learn how it all works by attending our next webinar.