During the economic downturn, I have had many clients come to me with an interest in taking some of their money out of the securities markets and investing it in raw land. Their theory being that if economic troubles continue, at least they’ll have something they can see, touch, & smell.  These are typically individuals who do not own real estate besides their personal residence and often don’t feel like they can or want to understand the management associated with income-producing commercial real estate investments.  There are some merits to investing in raw land, but there there are also some challenges associated with it.  The intent of this discussion is to lay out the factors that an investor should consider when comparing raw land to income-producing commercial real estate or other financial markets.

POTENTIAL BENEFITS TO INVESTING IN RAW LAND

• Very Little Management – in most cases, the management will be no more than making sure the weeds are cut, maybe negotiating a lease with a local farmer, or paying the property taxes.
• You Own a Hard Asset – Even during difficult times the land can be of value.  It can be farmed or built on even if markets don’t allow for it to be sold at a good price. Unlike stocks or bonds, raw land will always be there even if its economic value is gone.
• Scarcity – The quantity of raw land is limited.  As land is developed it becomes more scarce.  Scarcity creates value.
• Appreciation – Raw land has the potential for huge appreciation if purchased in the path of growth or if zoning can be changed to allow other uses. Over time the value of raw land has historically appreciated.  Over shorter periods is has definitely lost value at times but the trend line is historically upward.
• Inflation Hedge – Raw land tends to be a pretty good hedge against inflation.

POTENTIAL CONCERNS TO INVESTING IN RAW LAND

• Illiquidity of Investment – This becomes a challenge if you have to sell at a particular point in time.  If you have flexibility you can sell during good times but very few people have that flexibility.
• Lack of Cash Flow – Appreciation is your only source of return.  There is generally no cash flow coming off of raw land.  In most cases the cash flow is negative once property taxes are taken into consideration.  With farm land you can often lease it  to a farmer but rarely does the amount that a farmer can pay cover the property taxes.
• Governmental Restrictions on Land Use – The use of the raw land and resultant value are heavily impacted by surrounding property owners and the cities the property is located in.
• Lack of Tax Advantages – Since there is no building there is no opportunity for depreciation.
• Financing Difficult – Financing raw land is difficult and therefore an investor is typically unable to leverage returns as it would on a traditional commercial real estate investment.

If the decision is made to invest in raw land then there are a number of factors affecting which property to buy.  For example, is it in the path of growth?  What is the condition of the soils?  Where are utilities and services for the property?  What will it cost to get them to this property?  Do I want agricultural, commercial, residential or other types of property?  When will the market allow the property to be developed?  Where does the property sit in the city’s master plan?  What will ultimately be built on this property?  Do I want to develop or sell the property when the time is right?  Are there any easements which would adversely affect the property value?  Does the property have enough water available for development?  These are just a handful of the questions that need to be asked.

Under the right scenario’s investing in raw land can be a great investment.  I have many clients who focus solely on this type of strategy.  I also have many clients who refuse to buy raw land for the reasons listed above but primarily it is because of a lack of cash flow.  I have found that as an investor’s net worth increases, his propensity for doing land deals increases.

I hope this is helpful as you assess the place of raw land in your commercial real estate portfolio. Contact me for more information.