Relatively little is written about investing in land. I welcome the opportunity to add to the subject here.
When I first became interested in real estate investment, I assumed that meant raw land investing. However, I quickly learned that land’s appearance is misleading. The simplest property type to invest in is single-family residential. Land is one of the most complex property types—for reasons that laymen probably would not suspect.
Everything has advantages and disadvantages, including land. In real estate, writers often advocate their property type or strategy as if it were the only one or the best one or devoid of disadvantages. That’s incorrect. There is no good or bad investment in absolute terms. What investors should be doing is matching their personal strengths and witness and resources to the strategy and property type that best fits.
As opposed to buildings, land has a number of unique aspects.
Generally, it produces no income. In his book Investing in Land www.investinginland.com), Robert Abalos say there are a number of ways to earn income from land, e.g., Christmas tree sales, parking lots, farming, timber harvesting, and so forth. He’s right, but much, maybe most, land, is not going to earn any income until someone puts buildings on it or sells it.
Abalos also points out that the carrying costs of land are relatively low. Perhaps so, but land is still generally a negative-cash-flow business until you sell.
Land is also very hard to finance through conventional lenders compared to homes and income properties. Abalos says this is because land generally does not produce income. I would add that land is also harder to appraise and takes longer to sell, all of which makes it harder to underwrite for loan-security purposes.
Land has the most political risk of any property type. Political risk is a phrase most real estate investors have never heard of but that they should understand far better than they do. Political risk is the danger that government may promulgate a new law or regulation that will adversely affect the value of your property.
Rent control is the main one when it comes to existing buildings. The Tax Reform Act of 1986 was another example of political risk that affected structures (all income properties). But there are many political risks with regard to land.
They include down zoning, laws that protect certain species that may live on your land, “wetlands” laws, permit cost increases, environmental impact report requirements, toxic-cleanup liability, and on and on.
Abalos says that improved property goes down in value, but land goes up. The way I would put it is that the value of the structure goes down with age as parts deteriorate and need to be replaced, but the underlying land value goes up, in large part because the property has a permit for the structure that has been on it lo these many years. On a net basis, this results in the almost universal appreciation of improved property. Unimproved land, on the other hand, can be downzoned and often is.
Furthermore, political risks are neither adequately predictable nor controllable, consequently, they must be avoided. I once hosted the head of one the major U.S. home builders at a meeting of a club I was president of. When I asked how they handled political risk regarding land they held to build homes on, he surprised me by saying that they did not own any land.
How could one of the largest home builders in the world not own any land? He said they always arranged to option it and only closed and became owners moments before the first bulldozer blade hit the dirt. In other words, they only took title after all the permits and other political-risk hurdles had been cleared. They only owned buildings—albeit partially completed ones; never unimproved land. Smart.
Why is there little political risk in structures rather than unimproved land? Because structures have inhabitants who vote. Politicians and bureaucrats rarely take action that angers homeowners.
Land is a subset of vacant property. As I have often commented, whenever you deal in vacant property—land, buildings being extensively renovated, etc.—the speed with which you complete your sale not only determines how much profit you make, it also determines whether you make a profit at all. Or in the worst case, how much you lose. Owners of occupied rental properties can afford far more patience.
You often hear real estate seminar con men talk about getting bargains from “don’t wanter” owners. This gets a laugh from laymen. But in the real world, it is not very meaningful. All sellers are “don’t wanters.” There are some sellers who are extremely anxious to get out of a property—usually because of extremely bad tenants that they do not know how to handle. But in most cases, I suspect they get more than 80% of market value for their properties when they sell, so there is no great opportunity in “don’t wanters.”
With land however, there are generally no tenants. There are also few other management problems, so there are generally no extreme “don’t wanters” in the land business. Quite the contrary, because land carrying costs are relatively low, heirs often keep the properties for decades after they have decided they do not want them.
Those who inherit buildings generally are in a great hurry to sell—which is the main source of probate bargains. Management terrifies them. Large amounts of fast cash beckon.
But those who inherit land often hang onto it for long periods because no one sibling wants to make the effort to achieve sell-the-property consensus of the others for such a small share of sale proceeds.
As with buildings, I advocate a bargain purchase or upgrading strategy for making profits in land. Abalos seems to advocate the same thing. I am a little fuzzy on his approach because he uses different terminology including some phrases I disagree with. For example, he says to “Buy great land at fair prices, not fair land at great prices.” That sounds like the opposite of what you should do to me.
Investment profits come from the deal. Either you are buying the property for 20% or more below market value or you are paying market but see some unrealized potential in the property, the profit from which you are confident you can economically realize within a short period, like six months to a year.
The phrase “Buy great land at fair prices” sounds like paying market value and confining your purchases to the most sought-after land. In my experience and observation, the best returns come from buying properties near the least desirable end of the spectrum and focusing on achieving a bargain purchase (20% or greater discount off current fair market value).
In other words, I would rather you bought a relatively undesirable piece of land for 75% of its market value than a highly sought after piece of land for 100% of its market value. At times, Abalos seems to say that or something similar.
Abalos says, and I have said the same myself at times, that land can be improved to increase its resale value. I think Abalos overstates it somewhat, saying that you can apply the William Nickerson apartment renovation formula to land. But you can and often should clean up land or improve it.
Removing junk and debris is an example. So it cleaning up a stream or clearing out underbrush. Fences can be repaired or painted. Sheds can be torn down or repaired. As with building renovations, you must get a three-year payback for such expenditures of time or money.
In general, I think there are fewer opportunities to profitably improve unimproved land than there are to profitably improve buildings, but you should be aware that land is not devoid of such opportunities. Abalos provides a long list of examples of how to do it.
There are also a great many intangible improvements you can make to land, like lowering the property taxes, getting better zoning, obtaining permits to build, and so forth. According to Abalos, some of these are difficult to do, but many are almost effortless.
To me, the great value of Abalos’s book is as a checklist. That’s not what he intended, but the checklist items are buried in the text. He comprehensively covers most of the things you have to check in your due diligence as well as a great many opportunities to increase the value by changing things or to make bargain purchases.
One of the disadvantages of real estate investing is that it is hard to diversify. Each property costs so much. Abalos points out that land is generally much cheaper so a given amount of money can buy more different parcels.
There really is no compelling reason for it but the use of options is far more common in land than improved real estate. To the extent that you want to invest in options, this is attractive, but I have written that it is impossible to value an option so investing in them is pure gambling. In order to tell if a given option is a good deal, you must know the future market value of the property, or at least be able to predict it with some degree of accuracy. No one can do that. I know of a number of persons who sold homes on lease options with prices they thought were quite high, only to see the market value go even higher so they screwed themselves by selling the option.
Abalos, like perhaps a majority of real estate investment writers, recommends taking back a mortgage when you sell land. He says it increases the price you get.
I oppose almost all seller financing if you are the seller. The correct way to look at the effect on your sale price is to convert everything you received into its cash equivalent then add them together.
In most cases, you get some cash down payment and take back a mortgage for the rest. Cash is cash, but you must convert the mortgage you took back to its cash equivalent by seeing how much cash you could sell it for right now.
Typically, the amount of the cash you received plus the cash resale value of the mortgage you took back is less than the amount you would have received if you insisted on all cash to you to begin with. Seller financing is an exercise in self-delusion.
It must be noted, as Abalos does, that institutional lenders are generally far less willing to lend against unimproved land than they are to lend against properties with structures on them. Consequently, seller finance is the norm in land sales.
Abalos notes that many manufacturers of capital goods like cars, and appliances offer seller financing and cites this as evidence that seller financing is a good idea. I disagree. Those companies have access to very cheap capital through Wall Street. You do not.
Those companies also have large staffs for whom extending credit and collecting delinquent debts is not a new activity or expertise. For the vast majority of sellers, it would be a new activity.
Finally, public corporations do a lot of dumb stuff to pander to dumb stock market investors. Wall Street investors like growth and size. Adding a huge lending operation provides both. Accounting rules sometimes encourage public companies to do weird things that sole proprietors would never do.
Another reason I do not like seller finance is that you have a sort of conflict of interest when you do that. Your ego wants a high sale price. But the decision to finance a piece of land should be made objectively without any such distraction.
At one point, FNMA offered to buy at current market discount rates any seller home mortgage originated in accordance with their guidelines. I urged readers who were doing seller finance to qualify for that program. The problem is that when you comply with the rules, and make the loan the way a loan should be made, you lose much of the puff-up-the-sale-price effect. In other words, originating the loan in a professional manner—credit check, appraisal, etc.—wipes out the delusionary component of the typical seller finance deal.
Abalos has an odd way of analyzing many deals. He seems to say that if you buy a parcel, then sell off enough of it to recoup all of your original purchase price, you have no money (“financial basis”) in the remaining parcels and therefor any sale of them is all gravy and you should treat them differently from properties where you still have part of your original purchase price in the property.
In the 7/99 issue, I reviewed the book Why Smart People Make Big Money Mistakes by Belsky and Gilovich. To them, putting money into various mental categories is a mistake they call “internal accounting.”
The correct view is that all of your assets are equal. A dollar is a dollar. The amount you have in a property is its current market value less any debt secured by it. None of your properties that have equity should be treated differently than any others. Whether you have received back your original investment in a given property is irrelevant ancient history. Use ROE (return on current equity) not ROI (return on original investment) when evaluating your properties.
Abalos also proves that some yields are far lower than investors think by deducting opportunity cost, inflation, and other things from the apparent yield. This is arguably double penalizing the yield. Plus, we are used to treating inflation and such as ambient. Therefore it is likely confusing to start adjusting for inflation.
Theoretically, you could do it as long as you adjusted everything you were comparing it to for inflation as well, but I fear than this process may result in readers comparing the knocked-down yield to unadjusted yields of alternative investments. That would make the investment being disparaged look inappropriately bad by comparison.
Abalos advocates bargain purchases which he describes as buying for less than “intrinsic value.” His definition of “intrinsic value” is a bit fuzzy. I think it’s simple. A bargain purchase is when you pay 80% of fair market value or less. In securities investing, from which Abalos acknowledges getting much of his approach to land investing, “intrinsic value” has a different and in my opinion, dangerous, meaning. There, it is a value that the stock market does not now recognize, but will in the future before you sell.
I believe that is a distracting concept in any investment category. In real estate, you can buy at a bargain price and sell for market by removing the cause of the bargain—like an ignorant heir who is hungry for immediate cash.
You can also often spot unrealized value in property—like the ability to get zoning improved. But these are very specific mechanisms for making a profit. “Intrinsic” value, which Abalos says is definitely not market, is too vague for me. Abalos generally talks about bargain prices and improving property values in ways that I agree with, but I think he muddies the waters by bringing in the stock market notion of “intrinsic value.”
Abalos dissents from the typical current guru by admonishing those with bad credit to straighten it out before investing in real estate. I agree.
In a baseball analogy, Abalos recommends that you try to “hit singles not home runs” in land investing. By that he means seeking significant, but not spectacular, profits by moving a property one or two steps toward development. “Hitting a home run” would be trying to take a property all the way from raw land to a finished, occupied building.
Abalos is adamantly opposed to your doing that. I agree, although I have know a number of very successful developers, including Landlording author Leigh Robinson who has developed several motels in recent years—also, the developer who built my home. He may overstate it a bit.
He accurately notes that developers have more than their share of bankruptcies and lesser financial difficulties. Indeed, he advocates the interesting and likely successful strategy of getting to know small developers so that you can buy into their current deals cheaply when they get into their frequent difficulties.
I wrote about one such investor who is a contractor who deals with developers. Over the years, he has bought hundreds of brand new homes at bargain prices from developers who could not sell their last few homes fast enough at market prices.
I have long believed that land was significantly more corrupt than investing in buildings because of the government/political permit processes. Abalos says that is a myth in his 18 years of experience as a land investor and land lawyer. I am glad to hear it. But I must note that I have seen more than a few news stories that seem to suggest otherwise. Abalos says those are the exception.
Abalos tries hard to kill the “myth” than land produces no income. But one such argument involves a land owner who operates a string of businesses with little relation to the land—growing herbs, selling them and a book on them to restaurants and through the Internet and a retail store in the local town. Too much credit is being given to the land and too little to the entrepreneurship of the land owner.
Abalos says there are two types of buyers: “financial” and “franchise.” He defines a “financial” buyer as one who seeks cash flow or bargain purchase. That’s the only kind I advocate.
He defines a “franchise” buyer as one who seek a property because it complements some property they already own. Abalos says they pay more than market value. My first duplex sold to a “franchise” buyer—an adjacent savings and loan who needed my property to end their status as the only bank in town that did not have a drive-thru. The classic franchise buyer was Walt Disney assembling the land for DisneyWorld.
I agree that such buyers will often pay more and that you should seek them out. I started to write a book once called the Owner’s Guide to selling Investment Real Estate. Among other things, it contained a checklist for searching for such “franchise” buyers as one of your initial marketing steps—adjacent property owners, similar property owners, similar business owners, and so forth.
Abalos has some planner type views. He sometimes uses words or phrases like “sprawl,” “out-of-control” growth, and “moderate” growth. I regard those sorts of words and phrases as anti-growth spin. But these discussions are only occasional digressions in his book.
Abalos says the land you buy must have “geologic quality” and says not to buy land that is under water at high tide, earthquake faults, or steep cliff faces. I would say that you should think twice about buying such land, but I have lived too long in California and on the Jersey Shore to agree 100%.
Some of the most valuable real estate in Wildwood, NJ is under water at high tide. Those properties are called piers. The land on earthquake faults in California is probably worth quadrillions of dollars.
You need to be careful what kind of structure you place there, but knowledgeable California real estate people would never agree that you should reject it out of hand.
The same is true of steep land. In California or any other place where land has very high value, it is worthwhile to build on steep slopes. As with building over water, the costs are higher, but when the location has very high value, you can economically build there. Abalos lives in the Richmond, VA area, although he has travelled to California and elsewhere.
In my old age, I have few remaining absolutes. For example, I used to say never buy property with a bad foundation. Then I talked to the world’s biggest residential foundation expert and became enlightened.
Abalos still has a bunch of such absolutes, like never use a home mortgage to finance an investment or business. I generally agree with the advice to never say never. There are a great many success stories in both business and real estate that had their start with a home equity loan. Like anything else, home equity loans have advantages and disadvantages.
There are a great many very interesting things in Abalos’ book. One is that botany can help you evaluate land better. A knowledgeable person can look at what’s growing on a parcel of land—or what’s not growing there—and draw many Sherlock Holmesian conclusions about its history and soil composition. Makes sense.
I have always shuddered at the thought of fighting with locals about my development. Abalos does not deny that is a pain that can kill the profit on a land deal, but he notes that there are many ways to avoid that problem, mainly by avoiding changing the character of a residential area. He says there is far less resistance when you are dealing with commercial or rural neighborhoods.
Another interesting and unexpected—to me—point Abalos makes is that inspecting land can be very dangerous—so dangerous that you should never do it alone. Why? Isolation-facilitated crime of the Deliverance variety. Also, there are natural and man-made hazards like poisonous snakes, mountain lions, bears, cliffs, wells, and mine shafts. Land inspectors may suffer exertional heat stroke, heart attack, or getting lost. Nowadays, growers of illegal drugs are a serious danger.
Here in the West, we hear stories about people falling prey to these sorts of hazards routinely. You need not only a companion, but also a cell phone that works on the land in question and a GPS receiver and map to know your location.
Tromping through the woods can also be dangerous with regard to infection, insects, rabid animals, puncture wounds, and so forth. If you are not an expert woodsman, you need to research the proper clothes, what not to eat or drink, and other outdoorsmen knowledge.
I know I learned a ton when I went through Army Ranger School. For example, never step on a fallen tree. They often contain bee hives and the bees will attack you. They did not teach us this. We learned it from painful experience. Other Ranger lessons: wear heavy clothing and glasses (even if your vision is 20/20) to protect you from thorns and branches, and immediately spray any cut with Bactine to prevent infection.
Abalos says leaving your vehicle in an isolated spot can be dangerous with regard to theft of the car or its contents or alerting violent criminals that you will be returning to that spot at some point. Rural police regard unknown vehicles with great suspicion. Let’s be careful out there.
Investors in improved property tend to take boundaries for granted. Usually, the boundaries of an improved property are fairly obvious, although you can get fooled on occasion. But with land, it can be really tough.
Landowners often tell you incorrect boundaries, either on purpose or by accident. Abalos says most land owner statements regarding boundaries are wrong—often by 100 yards or more. You must be a great map reader to avoid this problem. Nowadays, you can be greatly aided by global positioning system receivers. I would think they would be mandatory for land investors.
Abalos says that there are often old easements on land that can be removed. He says that in his home area of Richmond, VA, you can close a street and thereby convert two blocks into one larger one for a $50 fee. He did not say who owns the former street. He also says many easements can be ended with a letter from the owner of the benefitted land.
Abalos chastises investors who shy away from sharing thoughts on land with other local land investors. He says that’s a mistake. But he also tells of times when other land investors try to steal your deals. What I come away from his book with is the notion that you should try to share and get information from fellow local land investors, but not when it comes to a pending bargain deal that you do not yet have locked up.
In one of his first deals, Abalos was shown a home that had a large field next to it. The agent said the field was not part of the property. But when Abalos checked the property description, it was part of the property. A misleading picket fence separated the two parts of the lot.
Abalos had just graduated from law school and consulted with his ethics professor about whether he had a duty to tell the seller. Abalos went ahead and did the deal, but says he has regretted it ever since.
My advice on such matters has been as long as you pay all cash—including the use of institutional financing—and make no false representations regarding the fair market value of the property, there is no ethical issue. I also say that you must apply securities market suitability standards to any deal where the other party is being asked to accept something other than cash—like a lease option or seller mortgage.
In this deal, Abalos paid all cash. I think the seller had a right to recover her lost property value from the agent and any other so-called professionals who advised her in the deal, but not from Abalos. He was an arms-length buyer. He made a cash offer and she accepted. End of story.
I recommend Abalos’ book although I disagree with some of its big-picture investment analysis. The only previous good land books I knew of were Finding and Buying your Place in the Country by Les Scher and How to Make a Fortune Investing in Real Estate: The Land Game by Albert Winnikoff.