There are numerous ways to make money investing in property. One investment approach does not actually involve property at all, at least not at the time of purchase. In this type of investment, you will be purchasing the land that a future property will sit on. Learn five risks you could face when you invest in property.
What Can Be Developed on Land?
The possibilities of what land can be used for are endless. While zoning requirements will restrict what can be built on a specific parcel of land, in general, anything can be developed on a raw piece of land, including the following:
- Single-family home
- Multi-family home
- Office space
- Retail space
- Mixed retail and residential space
- Strip mall
- Parking lot
What Is Your Goal in Purchasing Land?
Before you actually purchase a piece of land, you have to decide what your goal is for the investment. There are several different strategies to consider and it is not a one size fits all approach. Two different investors could have two very different approaches to the same piece of land. In addition, the same investor may have two different approaches for two different plots of land.
Consider these seven strategies to consider when buying land:
- Buy and sell: In this approach, you are basically flipping the land. You believe you purchased the land below market value and are hoping you can find another buyer who is willing to pay at or more than market value. You are hoping for a quick sale with little to no additional work on the land on your part.
- Buy and hold: In this approach, you buy the land and hold onto it for a period of time. You believe the land will appreciate in value. You will still have to pay taxes on the land, as well as any additional costs to maintain the land during this time. This is a common approach in areas that are being re-gentrified. The investor purchases the land in the hopes that they can sell it to a developer in the future as the area becomes more popular.
- Buy, develop, and hold: In this approach, you are purchasing a raw piece of land with the intention of developing the land yourself. For example, you could build a complex of townhouses that you will rent out to residential tenants. You could also decide to build a strip mall, which you could rent out to retail tenants. Another option could be to develop a bed and breakfast which you will run and manage.
- Buy, cultivate, and hold: In this approach, you are more interested in using the actual land, than building property on the land. For example, you may want to grow crops on the land, use it for livestock, set up a Christmas tree farm or set up a vineyard. You will actively manage the land and hope to make a profit off of what the land can produce.
- Buy, go through the entitlement process, and sell: In this scenario, you will purchase the land and then go through the process of having the property zoned for a specific use. For example, there may be a plot of land that was zoned for commercial use, but now that the area has developed, it would be an excellent site for a new high-rise residential building. If you are able to get the land rezoned for residential use, it would make the land more valuable to potential developers and more desirable, as it is one extra step they do not have to do themselves.
- Buy, develop, and sell: In this case, you buy the land with the intention of developing the land yourself and then selling it to an end-user. For example, you buy the land, build a new construction home and then sell it to a buyer who wants to live in it. As another example, you set up a vineyard and sell it to a buyer who will manage and run the vineyard.
- Buy, develop, and rent: Finally, you could develop the land and then rent the land to someone else. For example, you may buy land and decide to put a parking lot on it because there isn't ample parking in the area. The owner of a multi-family property nearby asks if they can rent a lot from you because they do not have enough parking for their tenants.
Risks to Consider When Buying Land
An undeveloped piece of land certainly seems to hold endless possibilities. However, you will soon discover that there are many restrictions and challenges you will face as you try to develop or sell this land. The government may restrict the type of property that can be built or the way the land can be used. You may encounter environmental problems, such as flooding or contaminants.
Five Risks of Buying Land to Be Aware Of
One major problem you could encounter when buying land is zoning issues with the way the land can be used. Every town has a land-use plan. This basically divides the town into different areas including commercial, residential, agricultural, industrial, historical, or even mixed-use.
Use of land: The first issue you will have to deal with is the way in which the land can be used. If the land is zoned for residential use and you plan on building a residential property on the land, then you have no problem.
However, if you want to change the way the land is zoned, you may have a battle on your hands. For example, the land is zoned for residential use and you would like to build a commercial property on the site. Some of these zoning classifications are decades old, so the town may be open to a reclassification of the land if the new function makes sense with the town’s current layout. Other times it is not so easy.
You will have to petition the town in order to get the land re-classified. Many towns will want you to show that there has been a substantial change to the neighborhood that will warrant the change in zoning. You will have to submit a proposal of what you will build on the site. You will have to show that your development is compatible with the existing land development plan the town has and that it will not have any negative effects, such as causing nearby areas to flood or increasing traffic.
There will likely be a public hearing. Even if you can get the town council on board, you may have a separate fight on your hands with neighbors who will petition to prevent you from being able to build.
The second factor to consider when purchasing land is the size of the development you will be allowed to build. When building or improving a commercial property, there will probably be zoning requirements for the land to building ratio or how large of a structure or other building you can have. Other considerations include:
- Setback requirements: There is usually a code that will require your property to be built a certain distance from the neighboring property lines. This includes the front, which is likely the street, the two sides, and the back. Permanent structures, such as a home, garage or deck, must be built a certain distance away from the property lines. Depending on the size of the lot you are looking at, this could greatly affect the size of the structure that can be built, potentially making it not worth the investment.
- Lot coverage: This code is in place to prevent flooding issues. There must be a certain percentage of the lot that is not covered, where rain has the ability to seep into the soil so that it does not flood neighboring properties.
- Floor area ratio: The square footage of each floor of the property (certain towns include basements, others do not) will be added together and then divided by the size of the lot. The total floor area can only be a certain percentage of the lot size, which each town will determine.
- Height: You need to know the height of the structure you can build. If you were planning on a three-family building, but the town will not allow more than two stories at that location, the investment will not make monetary sense for you.
- Accessory buildings: There will be code restrictions on the size and placement of structures such as garages and sheds. There may be a requirement as to how many parking spaces are required for the property's size. Some towns may even require these spaces to be covered.
A third risk of buying raw land is you do not know what lies beneath the soil. You could encounter high levels of radon or asbestos. The soil could be unstable and unfit to build on. If you build on soil that is not stable, it could cause the foundation of your property to crack.
The land could be located in a flood zone. This will not be the end of the world if you can raise the property up or change the grading of the soil to prevent flooding. Flood insurance is very expensive and can be a deal-breaker for potential buyers.
There are exceptions, however. Much of Hoboken, New Jersey, is located in a flood zone, but because of its proximity to New York City, the land in that area is considered very valuable.
Access to Utilities
How easy is it to get utilities at the location? This includes sewer, running water, electricity, gas, telephone, cable, and Internet. Do neighboring properties have these services, or is your plot of land in the middle of nowhere.
If your property is in the middle of nowhere and does not have access to a sewer line, you can have a percolation test done on the soil to determine if a septic system can be installed on the property. This test determines how quickly water drains through the soil. Assuming the land passes the percolation test, you will also have to dig a well for drinking water, which will easily cost five figures.
Getting these utilities onto your property can be a significant expense. If you are unable to gain access to necessary utilities, it is a disaster for any potential development you were considering.
No Income, but Expenses
When you buy raw land, there is nothing on the land, so it is not generating income. It is very difficult to get a loan on vacant land, so you likely have to pay cash for the land, leaving a lot of money tied up in the investment.
There is no income being generated, but you will still be responsible for the expenses on the land. The main expense will be taxes. You may also have to pay to maintain the land, such as mowing the grass regularly.