Investments: Raw Land

By Wing Luang

[Wing Luang is a partner in the Real Estate Industry practice in BDO New York office. This article originally appeared in BDO USA, LLP Real Estate Monitor newsletter (Winter 2013). Copyright © 2013 BDO USA, LLP. All rights reserved. www.bdo.com]

A recent report by the National Association of Realtors says investors have a new target in real estate: undeveloped land.

Buyers are snatching up land heavily discounted in bankruptcy proceedings from developers and banks that foreclosed on builders once money ran out for their projects. Investors then resell the land at a price that returns as much as 20 percent on their investment or, in some cases, hold the land planning to partnership with homebuilders. Said one portfolio manager, We are coming out of the mother of all housing cycles and residential land is the best way to play the ultimate recovery. Investors say the most attractive land to buy is a parcel that already has all planning permissions in place ready to start construction. Otherwise, the approval process for building approval can be costly and time consuming.

The attractiveness of raw land is its low cost when compared to that of developed property. The price paid for raw land may bear little or no relationship to its ultimate use, and can be significantly influenced by the landowner reason for selling. Types of landowners are varied, including working farmers, gentlemen farmers, estates, lenders that have closed on mortgages, government agencies and municipalities, builders and developers, and land speculators. Reasons for selling may include a need for ready cash or the bailing out of a defaulted loan

Diversified Locations

The (relative) low cost of raw land also permits an investor to obtain property in several different locations so that the risk of a major loss is reduced. On the other hand, raw land generates no income until it is sold or until the land is ground-leased to a buyer. In addition, until the landowner waits to sell or ground-lease the property, all carrying charges (taxes and perhaps maintenance of the land) must be paid.

Institutional Financing

The fact that raw land generates no income does not make it attractive to institutional lenders. In addition, future value may be difficult to appraise because a lender will not evaluate land on the same basis as a speculator- purchaser. A purchaser may be able to obtain a loan on the strength of his or her own credit, but this requires the risk of personal recourse. In some cases, mortgage financing may be available if the land is being used for some income- producing activity, something not easy to arrange.

Land Defects

An obvious concern for a buyer is to be sure the land has no defects that make it undesirable for development. Such features include the following: steep grades, poor soil conditions, subsurface rock formations or flat land that might have drainage problems and that has a high water table. Raw land may be subject to utility drainage easements. Finally, boundaries may be imprecise.

Zoning Regulations

Finally, even if land satisfies all other requirements, local zoning laws, building codes and related land-use regulations may prevent future development. A prospective land purchaser, usually an experienced attorney or broker, should check local laws and regulations.