Speculative Investing In Land

The "speculative" investor
versus
the "developer"

 

Speculative Investing In Land
by Christian S. Peek CCIM
http://www.intercom.net/local/shore_journal/cpk10612.html

In this time of increasingly diminishing returns on many traditional investments such as CD's and "blue chip" stocks and bonds many investors are looking at alternative investment vehicles, which may offer the opportunity for much higher yields.

As part of this process many investors might want to consider investing in "pre-development" or "raw" land as part of their portfolios.

Who Should Invest?

I am sure many readers have a friend or relative who bought a piece of raw land for a relatively small amount which was sold some time later for an astonishing sum relative to the purchase price. Be forewarned, however, raw land investment is not for everyone. As with any investment that has the potential to yield tremendous returns there is a significant risk factor as well. The two main qualities of the successful land investor are patience and common sense and a willingness to spend the time and effort necessary to understand the risk / reward tradeoffs. It is necessary at this point to differentiate between an investor who purchases raw land with the intent of actively pursuing its development and the investor who seeks to speculate on the probability of an increase in value but takes no active role in development and more or less "sits" on the land anticipating a point where it makes sense to sell.

This discussion will be addressed to the "speculative" investor versus the "developer". Also, while recognizing there are many types of raw land speculation (ie housing developments, resort land, commercial land etc. ) this discussion will focus on the specific strategies utilized in speculation on commercial property.

In the situations we are discussing it is assumed the investor lives in an area where there are identifiable concentrations of significant commercial development but that there are also large undeveloped tracts as well. It is also assumed that commercial development in these areas is reasonably dynamic and ongoing. Speculative investments in land are based on the assumption that a demand for this product exists and are much more difficult to justify in economically stagnant areas. We will be directing our attention toward the undeveloped areas slightly beyond the centers of commercial development. The timeline we are looking at is approximately 3 to 7 years from purchase to development (and potential sale of the property) being realized.

Evolution of "Value" or "They Ain't Makin' Any More of It"

Although it seems a naive question to ask it is important to understand the origin of "value" in discussing what makes for a sensible raw land investment and what does not. In other words how does a particular piece of land become more valuable and how do you identify and understand the forces at work in this process in order to invest wisely.

At the risk of over simplification the key is to understand that the growth of urban commercial development requires the creation of "development land" to supply commercial demand and that there are several distinct phases to this process. "Development Land" in this context is land that is located in the path of commercial growth and has the accessibility, zoning and infrastructure of services necessary for commercial development.

Value is created or "added" in this process by the progression of the land through the stages of commercial development as a result of the efforts of developers who wish to sell the land to users, municipalities who wish to accommodate growth and generate tax revenues and ultimately users who are seeking the best location to market their goods and services. The astute speculative investor needs to be in the path of this confluence of forces.

The Early Bird Gets the Worm

The bottom line for the speculative investor is to make their purchase at a point in the land development cycle where growth is close enough in both time and proximity that a reasonable determination that it will be in the path commercial development can be made but to purchase before prospective commercial users for the land have entered the market and caused to values to accelerate.

In this land development cycle the most readily identifiable area(s) to find good land investments are at the stage in the development cycle where the municipal authorities have identified the area(s) where they wish to direct commercial growth but at least several years before the municipal infrastructure of services has been laid in. This type of property is often found just over the City municipal service boundaries in the County where urban (or suburban) and rural areas divide. This information is easily obtained by a visit to your local Planning and Zoning office. Most municipalities worth investing in have some sort of "Master Plan" document(s) for sale that specify the desired type and direction of growth for intervals of 5 to 30 years. A polite inquiry to a zoning official (who often spend a good deal of their time making these plans) can also be the source of some very good information about municipal attitudes toward growth in particular areas and current time lines for development of these areas.

Take these projected time lines with a grain of salt, however. Municipal investment in infrastructure development is based on available budget revenues. A second visit with the Municipal Public Works Department to inquire about the projected access to services in a particular speculative area will often give a more concrete indication as to where near term monies and development are targeted.

Assuming we have identified an area that has a reasonably high likelihood of being commercially developed at some point in the next 3 to 7 years we need to focus on specific properties within that area.

The next step is to contact an experienced Commercial Land or Real Estate Broker who is familiar with the area you are interested in (you may want to interview several) and explain precisely what your investment goals, timeline and general price range are. Explain that you are looking for market information and that there is a good possibility that the land you are interested in may not be formally listed for sale and that some digging is likely to be necessary to find the right property.

It is important to be very thorough at this stage. Only a select group of properties in an area bordering a commercially developed section are likely candidates for a worthwhile investment.

What To Look For In Selecting Properties

1. 1: Highway access: Look for a property with existing highway access and plenty of frontage. If your property is slightly off the main drag don't assume the City will grant access or lay in a road to your prospective property. Projected road access is often subject to change and traffic control is an absolute priority with most municipalities.
2. 2: Water and Sewer Access: A prospective development property must have access to planned water and sewer lines. Also, make sure the land will support a well and septic service. If our best laid plans go astray we still need to be able to sell the property.
3. 3: Clean environmental history: Don't assume all rural non-developed properties are clean. Some farm related uses can pose significant contamination hazards. Make sure any contract to purchase has a "subject to satisfactory environmental audit" clause.
4. 4: Soil types: Look for soil types with good drainage. Land with poor drainage means a prospective developer may have to do additional storm water management engineering and the land will be more expensive to develop and less attractive to the developer. Your County Extension Service should have a book of County soil maps available for reference and/or sale. If there is any question about soil quality you should include a "subject to satisfactory soil test" clause an any offer to purchase
5. 5: Topography: Look for as even a topography as possible. Hills and gullies (especially near the roadway) make for lots of expensive fill dirt and unhappy developers.
6. 6: Obnoxious Neighbouring Properties: Make sure the adjacent properties aren't involved in some sort of continuous noise or smoke (or smell) emitting quasi-industrial activity that would make a prospective developer think twice about choosing your parcel as a candidate for development.
7. 7: Easements Across The Property: Does a neighbouring land owner have an easement across the property that would interfere with development?
8. 8: Prospective Zoning: There are often several different Commercial Zoning Districts that the Master Plan(s) specify within an area targeted for future commercial development. Make sure that the prospective zoning specified for the property of interest has a sufficiently broad variety of inherent uses in order to maximize its marketability

Summary

There is much more that could be said about investing in speculative land. I hope the brief survey I have discussed has been informative.

Investment in raw land can yield spectacular returns on equity. You can also lose a bundle. The consistent winners in speculative raw land investment are those who are comfortable with the timelines involved, do their homework and stick to the basics. Even the most experienced developers can get burned when they forget these aspects. For informed investors speculative land investments can be a useful, valuable and entertaining part of a diversified portfolio.