Investors looking for creative ways to maximize returns in a competitive, hot-selling real estate market may be interested in buying vacant land, which has the potential to create outsized returns when held or improved.
“A client of mine purchased a downtown Atlanta vacant lot in 2012 for $1,500 and was recently offered $80,000 cash and decided to hold out for more,” says Bruce Allen, a real estate agent and attorney for Re/MAX Town and Country in Atlanta.
But experts say the asset class is unique and requires utmost caution and diligence. Unpredictable market trends over the long-term with few opportunities to earn income from vacant land make investing risky if not done right.
Experts offer the following advice before investing in vacant land.
Have a shorter, rather than longer, exit timeline. Sitting on land for the long haul is risky because it could go down in value, says Michael Ross, vice president of asset management and entitlements for Rockspring Capital, a private equity firm that specializes in land investment in Houston, San Antonio, Austin, and Dallas.
“Time is our greatest risk,” he says; that’s why Rockspring’s exit horizon is targeted at 18 to 36 months from purchase to resale once it’s ready for development.
Look for an income producing use pre-development. If your goal is to develop the land, look for ways to make money on it while that process is under way, says Danny Mulcahy, director of equity for Northstar Commercial Partners, a commercial real estate firm in Denver. Leasing the land or using it for agriculture, self-storage, parking or billboards can provide income during pre-development.
Get the right entitlements. Development-readiness involves doing the leg work to get the property zoned, cleared, subdivided and/or permitted for builders, also called entitlements, Ross says.
Entitling can add value to land and lead to big returns, but only if you’ve obtained the right entitlements for the marketplace, says Russ Moroz, first vice president of investment properties at Marcus & Millichap, a commercial real estate investment brokerage.
“Obtaining the wrong entitlements can make land virtually worthless,” he says. “Or leave you in a worse spot than if you sold the land without them, like if you agreed to certain obligations with nearby property owners in order to get your entitlements.”
Due diligence is necessary. It’s a good idea to do a title search and purchase title insurance, which protects the holder from financial loss due to defects in a property’s title, says Jordan Barkin, a real estate agent with Harry Norman Realtors in Atlanta.
If your goal is to build a single property, make sure the lot is actually buildable and qualifies for permits, says Matthew Briggs, chief executive officer of Briggs Acquisitions, a private real estate investment firm. Check for environmental restrictions or issues and planned zoning changes that could affect the property, he says.
You need to understand the utilities’ capabilities to handle the proposed development and how adjacent uses may affect your property. Research prior uses in case something was buried there or caused contamination, Mulcahy says.
Barkin advises also having a plot survey and percolation test performed by a licensed professional.
Buy in a high growth location at the right time. The key to successful land investment and development is buying where there is high demand and growth, Ross says. If you don’t have individual knowledge about areas to target, a third party market analysis is a good idea, he says.
Buying land within 15 to 30 miles of major urban growth centers is a good benchmark, says Edward F. Del Beccaro, senior managing director of Transwestern in Walnut Creek, California.
Investors can consider tech cities such as Seattle, San Francisco, Oakland, Denver, Austin and Los Angeles, where economists project 10- and 20-year job growth horizons, or land within three blocks of major highway interchanges, ports and mass transit. Underutilized, rather than vacant, land in these areas can be a great way to turn a profit while you work on redevelopment, Del Beccaro says.
Because land parcels and lots can decline by 75 percent or more in recessions, buying land at the right time is critical to making outsized returns, Allen says.
“Buying land at the bottom of the market and selling in the recovery offer the best opportunity for high returns and lower carrying costs,” he says. “Buying at the top often means having to carry through a recession, which adversely impacts returns.”
Take your time. A land purchase requires careful consideration and planning, so learn the ropes beforehand. Know your market at a granular level.
“It’s very specialized knowledge,” Ross says of land investment, noting investors in land development have typically worked for builders or in real estate beforehand.
“It takes years of learning to not walk into every bear trap that’s been laid out,” Ross says.
“Don’t let anyone pressure you into buying anything,” Barkin adds. “Deadlines are important but take the time to discuss your goals with your financial advisor. Do not expect to ‘flip’ land overnight for a profit.”