If you’re in the market for a solid, long-term investment, raw land – undeveloped land that has not yet been improved or built upon – may be worth a look.
Although raw land investments do come with potential risks and drawbacks, the benefits can be substantial if the right choices are made at the right time. Namely, undeveloped parcels can reap large returns if you sell to a motivated builder or developer in a high-growth area. You can generate monthly income by either reselling through owner financing or subdividing into leased lots.
Camille Baptiste, a real estate investor and educator with REIclub.com, agrees there are many benefits associated with raw land investments.
“One of the biggest advantages is low cost of acquisition,” Baptiste notes. “You don’t need a vast knowledge of home and building types, and you hardly ever have to deal with an inspection. There’s also low maintenance in terms of time and labor.”
Clearly, raw land investments offer big upsides. Here are 8 questions to consider when mulling over such an investment:
There are many different types of raw land, from plains, to mountains, to urban lots, to coastal land, to desert parcels. Not all raw land, though, is equal.
“There are millions of acres of raw land in the U.S.,” notes James P. Dowd, a CFA with North Capital who regularly advises clients on private real estate investments. “Most of it would not qualify as a suitable investment.”
Regardless of condition or location, raw land will always have some value; however, you’ll definitely see quicker appreciation and a better return in, or around, a developed area with a growing population.[Editor’s Note: Interested in additional insights on land usage and zoning? Check out this excellent webinar: “Zoning & Land Use 101.”]
If the land will ultimately be utilized for residential, commercial, or recreational purposes, you’ll want to make sure it has access to electricity, water, and sewage disposal, as well as unpolluted air. Depending on how you plan to utilize the parcel, you may also need to evaluate the proximity to utilities, schools, roadways, medical facilities, shopping, dining and recreation.
So, you must be prepared to pay taxes on the land without receiving any cash flow.
If you’re looking to re-sell for a quick profit, raw land may not be the right choice. It could be many years before a potential seller makes an offer.
Are you comfortable with the level of risk associated with purchasing undeveloped land? You may be faced with short-term cash loss, expensive development costs, and economic struggles that could prevent you from selling the land for a high enough price to generate a profit.[Editor’s Note: Risk is an ever-present aspect of financing, but you can’t let it inhibit your dreams. Learn how in “Life is Short: Defining the Risks and Rewards of Chasing Your Dreams.”]
According to Charles Hais of Queen City Financial Advisors in Cincinnati, Ohio, raw land investments are not for the unsophisticated real estate buyer.
“The investor must have sufficient wealth and income, and be prepared to lose all of their investment in raw land,” Hais says.
Furthermore, raw land investments offer a valuable hedge, but only for the savvy investor. Dowd explains: “Investments in land or other real estate offer a hedge against inflation in a diversified portfolio – but investors need to fully understand the value proposition of any such investment and should limit their exposure.”
It can be more challenging, Dowd explains, to secure a lender for a raw land purchase.
“Purchasing raw land with financing is risky, especially when there is no rental income and the investment return is expected to come from appreciation,” he says.
Also, you can expect to pay a bigger down payment—approximately 30% higher than a traditional mortgage—and with steeper interest rates. The overall term of the loan is usually longer, as well. In some cases, you may be able to avoid the higher interest rates by obtaining seller financing.
Like any real estate investment, timing is critical. To maximize your returns, try to purchase during periods when there is a surplus of properties on the market, which will drive down prices. Then, you can sell at a time of limited inventory, when sellers are more willing to pay more.
Find out the identity of the seller and ask how long they have owned the property. If someone is trying to get rid of raw land not long after buying it, it could be because they believe it will soon lose value.
“Before purchasing raw land, buyers should be sure to perform a title search, get the land surveyed, and check the area for any issues, such as flood zones or adjacent property uses,” Baptiste recommends.
Despite the risks and potential pitfalls, the savvy investor stands to earn a healthy return on raw land purchases—with the right mix of knowledge and foresight.
“Investors should do their homework before committing to any investment in land,” cautions Dowd. “Never invest more than you can afford to lose.”
Editor’s Note: This is an updated version of an article first published on 10/8/2014
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