Buying land is much more difficult than it would first appear. In fact, of all the property types, I believe it may be the toughest one to get right. Why? Keep reading and I’ll tell you.
You can’t afford it
While it is true that only land appreciates while a building depreciates, land investors must be prepared to feed a very hungry beast. “Land eats three meals a day” is a saying I heard a long time ago from someone that purchased land themselves. The saying is meant to be a warning because land is not typically a cash flow investment. Commercially zoned land often comes with hefty property taxes and let’s not even start with interest charges if you plan on financing it. Additionally, there are still maintenance costs associated with keeping the property. If you are buying the land as an investment, you are betting on the appreciation of the land, but not the cash flow. Thus, every year you hold the property, your internal rate of return decreases. See below for two scenarios that assume the exact same purchase price, sales price, and annual holding cost. As you can see, an extra three years has a large impact on your return.
Cash Flows
Year 0
Year 1
Year 2
Year 3
Amount
-$1,000,000
-$5,000
-$5,000
$1,500,000
NPV Discount Rate: 8%
Internal Rate of Return: 14.2%
Cash Flows
Year 0
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
Amount
-$1,000,000
-$5,000
-$5,000
-$5,000
-$5,000
-$5,000
$1,500,000
NPV Discount Rate: 8%
Internal Rate of Return: 6.6%
You don’t have a plan
I truly believe that the worst move you can make as an investor is to buy land without a plan. However, there are caveats. Say for instance that you are independently wealthy, and you want a place to park some money. Normally, the “plan” should come first. Maybe you want to build a self-storage facility, an office for your business, or develop a residential subdivision. These are all great ideas, and they can be successful with the right site. The danger comes when you fall in love with a property, and then start imagining what you can do with it.
You’re late
Every week I get a call from a prospective buyer that is looking for land in the next “hot” market. Each buyer is the same. They assume if they can get in now, the land will double in value in just a couple of years because of the road expansion, or the recent announcement by a large company that’s coming to town. The reality is, you are probably already late, and there’s a high probability that the big increase in value has already occurred. Those stories that you hear about farmers making a huge chunk of money off their land is mostly because they already owned their farm. They weren’t speculating on which land would be part of the new “hot” market, they were farming!
You don’t know what you’re doing
This one is a hard one for most people to accept, but land development is tough and complex. There are permits, development orders, engineering plans, surveys, permits, and more permits involved in turning a raw parcel of land into the next shopping center or office building. It takes patience and a team of qualified consultants who are paid, as they should be, for their expertise.
There are many variables that contribute to a successful land acquisition. If you are looking for a solid safe cash flow opportunity, buying land is probably not for you. But if you have a plan, the proper funds, and the right team surrounding you, it is possible to turn dirt into gold.
