John T. Reed' review of Robert J. Abalos" book Investing in Land 1 Investing in Land Relatively little is written about investing in land. I welcome the opportunity to add to the subject here. When I first became interested in real estate investment, I assumed that meant raw land investing. However, I quickly learned that land' appearance is misleading. The simplest property type to invest in is single-family residential. Land is one of the most complex property types"”for reasons that laymen probably would not suspect. Match Everything has advantages and disadvantages, including land. In real estate, writers often advocate their property type or strategy as if it were the only one or the best one or devoid of disadvantages. That' incorrect. There is no good or bad investment in absolute terms. What investors should be doing is matching their personal strengths and witness and resources to the strategy and property type that best fits. Unique aspects As opposed to buildings, land has a number of unique aspects. Generally, it produces no income. In his book Investing in Land https://www.investinginland.com), Robert Abalos say there are a number of ways to earn income from land, e.g., Christmas tree sales, parking lots, farming, timber harvesting, and so forth. He' right, but much, maybe most, land, is not going to earn any income until someone puts buildings on it or sells it. Negative cash flow Abalos also points out that the carrying costs of land are relatively low. Perhaps so, but land is still generally a negative-cash-flow business until you sell. Financing Land is also very hard to finance through conventional lenders compared to homes and income properties. Abalos says this is because land generally does not produce income. I would add that land is also harder to appraise and takes longer to sell, all of which makes it harder to underwrite for loan-security purposes. Political risk Land has the most political risk of any property type. Political risk is a phrase most real estate investors have never heard of but that they should understand far better than they do. Political risk is the danger that government may promulgate a new law or regulation that will adversely affect the value of your property. Rent control, tax reform Rent control is the main one when it comes to existing buildings. The Tax Reform Act of 1986 was another example of political risk that affected structures (all income properties). But there are many political risks with regard to land. They include down zoning, laws that protect certain species that may live on your land, "wetlands" laws, permit cost increases, environmental impact report requirements, toxic-cleanup liability, and on and on. Abalos says that improved property goes down in value, but
land goes up. The way I would put it is that the value of the structure goes down with age as parts deteriorate and need to be replaced, but the underlying land value goes up, in large part because the property has a permit for the structure that has been on it lo these many years. On a net basis, this results in the almost universal appreciation of improved property. Unimproved land, on the other hand, can be downzoned and often is. Cannot forecast or control Furthermore, political risks are neither adequately predictable nor controllable, consequently, they must be avoided. I once hosted the head of one the major U.S. home builders at a meeting of a club I was president of. When I asked how they handled political risk regarding land they held to build homes on, he surprised me by saying that they did not own any land. How could one of the largest home builders in the world not own any land? He said they always arranged to option it and only closed and became owners moments before the first bulldozer blade hit the dirt. In other words, they only took title after all the permits and other political-risk hurdles had been cleared. They only owned buildings"”albeit partially completed ones; never unimproved land. Smart. Voters Why is there little political risk in structures rather than unimproved land? Because structures have inhabitants who vote. Politicians and bureaucrats rarely take action that angers homeowners. Vacant property Land is a subset of vacant property. As I have often commented, whenever you deal in vacant property"”land, buildings being extensively renovated, etc."”the speed with which you complete your sale not only determines how much profit you make, it also determines whether you make a profit at all. Or in the worst case, how much you lose. Owners of occupied rental properties can afford far more patience. "Don"t wanters" You often hear real estate seminar con men talk about getting bargains from "don"t wanter" owners. This gets a laugh from laymen. But in the real world, it is not very meaningful. All sellers are "don"t wanters." There are some sellers who are extremely anxious to get out of a property"”usually because of extremely bad tenants that they do not know how to handle. But in most cases, I suspect they get more than 80% of market value for their properties when they sell, so there is no great opportunity in "don"t wanters." No tenants With land however, there are generally no tenants. There are also few other management problems, so there are generally no extreme "don"t wanters" in the land business. Quite the contrary, because land carrying costs are relatively low, heirs often keep the properties for decades after they have decided they do not want them. Those who inherit buildings generally are in a great hurry to sell"”which is the main source of probate bargains. Management terrifies them. Large amounts of fast cash beckon. But those who inherit land often hang onto it for long periods because no one sibling wants to make the effort to achieve sell-the-property consensus of the others for such a small share of sale proceeds. Strategy As with buildings, I advocate a bargain purchase or upgrading strategy for making profits in land. Abalos seems to advocate the same thing. I am a little fuzzy on his approach because he uses different terminology including some phrases I disagree with. For example, he says to "Buy great land at fair prices, not fair land at great prices." That sounds like the opposite of what you should do to me. Profits are from the deal Investment profits come from the deal. Either you are buying the property for 20% or more below market value or you are paying market but see some unrealized potential in the property, the profit from which you are confident you can economically realize within a short period, like six months to a year. The phrase "Buy great land at fair prices" sounds like paying market value and confining your purchases to the most sought-after land. In my experience and observation, the best returns come from buying properties near the least desirable end of the spectrum and focusing on achieving a bargain purchase (20% or greater discount off current fair market value). In other words, I would rather you bought a relatively undesirable piece of land for 75% of its market value than a highly sought after piece of land for 100% of its market value. At times, Abalos seems to say that or something similar. Improvements Abalos says, and I have said the same myself at times, that land can be improved to increase its resale value. I think Abalos overstates it somewhat, saying that you can apply the William Nickerson apartment renovation formula to land. But you can and often should clean up land or improve it. Removing junk and debris is an example. So it cleaning up a stream or clearing out underbrush. Fences can be repaired or painted. Sheds can be torn down or repaired. As with building renovations, you must get a three-year payback for such expenditures of time or money. Fewer, but some In general, I think there are fewer opportunities to profitably improve unimproved land than there are to profitably improve buildings, but you should be aware that land is not devoid of such opportunities. Abalos provides a long list of examples of how to do it. There are also a great many intangible improvements you can make to land, like lowering the property taxes, getting better zoning, obtaining permits to build, and so forth. According to Abalos, some of these are difficult to do, but many are almost effortless. Checklist book To me, the great value of Abalos' book is as a checklist. That' not what he intended, but the checklist items are buried in the text. He comprehensively covers most of the things you have to check in your due diligence as well as a great many opportunities to increase the value by changing things or to make bargain purchases. Easier to diversify One of the disadvantages of real estate investing is that it is hard to diversify. Each property costs so much. Abalos points out that land is generally much cheaper so a given amount of money can buy more different parcels. Options are common There really is no compelling reason for it but the use of options is far more common in land than improved real estate. To the extent that you want to invest in options, this is attractive, but I have written that it is impossible to value an option so investing in them is pure gambling. In order to tell if a given option is a good deal, you must know the future market value of the property, or at least be able to predict it with some degree of accuracy. No one can do that. I know of a number of persons who sold homes on lease options with prices they thought were quite high, only to see the market value go even higher so they screwed themselves by selling the option. Taking back a mortgage Abalos, like perhaps a majority of real estate investment writers, recommends taking back a mortgage when you sell land. He says it increases the price you get. I oppose almost all seller financing if you are the seller. The correct way to look at the effect on your sale price is to convert everything you received into its cash equivalent then add them together. Convert to cash equivalent In most cases, you get some cash down payment and take back a mortgage for the rest. Cash is cash, but you must convert the mortgage you took back to its cash equivalent by seeing how much cash you could sell it for right now. Typically, the amount of the cash you received plus the cash resale value of the mortgage you took back is less than the amount you would have received if you insisted on all cash to you to begin with. Seller financing is an exercise in self-delusion. It must be noted, as Abalos does, that institutional lenders are generally far less willing to lend against unimproved land than they are to lend against properties with structures on them. Consequently, seller finance is the norm in land sales. Public company seller finance Abalos notes that many manufacturers of capital goods like cars, and appliances offer seller financing and cites this as evidence that seller financing is a good idea. I disagree. Those companies have access to very cheap capital through Wall Street. You do not. Those companies also have large staffs for whom extending credit and collecting delinquent debts is not a new activity or expertise. For the vast majority of sellers, it would be a new activity. Finally, public corporations do a lot of dumb stuff to pander to dumb stock market investors. Wall Street investors like growth and size. Adding a huge lending operation provides both. Accounting rules sometimes encourage public companies to do weird things that sole proprietors would never do. Another reason I do not like seller finance is that you have a sort of conflict of interest when you do that. Your ego wants a high sale price. But the decision to finance a piece of land should be made objectively without any such distraction.