Buying vacant land is a different animal than buying developed property. It’s generally riskier, but the payoff can be enormous. If you’re buying to build your own home, you can save a lot of money on your home. If you’re buying as an investment to resell or develop, the returns can be significantly higher than traditional real estate.
That said, there are pitfalls to buying raw land. More specifically, here are four important things you should consider before you invest in undeveloped land.
#1: Understand the Market Drivers
Real estate investors often want to buy property in a growing market. Yet, even more important than the fact that a market is growing, is why. With developed real estate, this is important. With vacant land, this is the essential question.
Vacant land isn’t worth much on its own. The reason it’s a good investment is because it has the potential to be worth a lot. That’s what you’re paying for when you buy raw land. That’s why it’s so important to understand what’s driving the market.
Let’s say you’re looking at property in California. Property prices are on the rise, because tech companies like Google and Facebook are growing quickly. If that’s the underlying reason for growth, you’ll want to figure out if that trend is going to continue.
On the other hand, let’s say you’re buying property in developing countries. Prices are going up. But, after research, you find out that the prices are being driven by easy lending and low interest loans.
After looking into it, you find out that banks in the country have a lot of cash on hand because the US lowered interest rates to under 1%. US banks borrowed money from the government at low interest rates, then lent them back out to banks of developing countries, who lent it out to home buyers. Logically, this can’t continue – the US cannot sustain sub-1% interest rates forever. Therefore, if the primary market driver can’t be counted on, it probably wouldn’t be a good investment.
Don’t just look at growth. Look at what’s driving the market.
#2: Regulations, Permits and Zoning
Even once the land is yours, you can’t just build anything you want on the land. Zoning regulations restrict exactly what you can and can’t build. That’s why there isn’t a McDonalds on the corner of every residential block.
Before buying vacant land, make sure you understand all the zoning laws and regulations that govern your land. More specifically, here are a few things you should look into.
- Check your county’s long-term land plans. See if there are future highways, trains or other major developments planned for the area.
- Check the zoning regulations for your area. What can and can’t you build? Can you build a two story house? What about a three story house?
- Check the rules and regulations of the local homeowner’s association, if you’re buying residential property.
- Make sure to also get your property surveyed. Make sure that none of your neighbors have encroached on your land while it’s been vacant.
You’ll also want to check the county clerk’s office for liens or encumbrances against your title.
#3: Hidden Costs
There are a lot of expenses that come with buying land. Here are a few of them to look out for:
- Title insurance. Most banks will require title insurance before they’ll give you a loan.
- Real estate tax.
- Utilities. If you plan to develop the land, you’ll have to pay to get the gas lines, phone lines, water lines and sewage lines connected. You’ll often have to deal with different companies to get this done (e.g. the phone company for the phone line, the gas company for the gas line, etc.)
- Costs for getting your land surveyed.
- Building costs. There will likely be all kinds of unexpected costs during the construction process as well.
#4: The Cashflow & Finances of Undeveloped Land
The cash flow of undeveloped land is very different than traditional real estate. For one, undeveloped land produces no cash. That means it’s a pure expense. You’ll still have to pay expenses like taxes or homeowner association fees (depending on your area.) But there will be no cash to offset the expenses.
That means the payoff from undeveloped land is only realized when the market grows or when the property gets developed. Unless either of these two things happens, the land is just a big financial liability.
Banks know this, and generally require a bigger down payment for loans on undeveloped land. The higher down payment helps reduce their risk in case they end up having to foreclose on the property.
Commercial loans for developers however are treated differently. Developers with a track record, or developers with a strong business plan, can still easily get bank loans at competitive rates. Commercial real estate development loans are treated very differently than personal loans.
These are four things you should consider before investing in undeveloped land. Undeveloped land can be an incredibly profitable investment, assuming you know and can mitigate the risks.
Author Bio – James Andrews, the author of this guest article writes occasionally on behalf of NAI Maestas Real Estate in Albuquerque.