The fact of the matter remains: undeveloped real estate has the ability to deliver the same consistent cash flow as any other type of investment opportunity.
Fortunately for investors, raw land is a limited resource, making it extremely valuable. If you purchase land in an area that is headed towards development and growth, there’s a chance your land can become worth even more.
Investors looking to develop raw land should mind their due diligence and thoroughly educate themselves on the market where they plan to invest. The best way to do so is to pay attention to market trends.
If you can track the market’s cyclical movement, you will have a better understanding of when to buy. It would be best if you first examined the recent developments in your selected market. If there has been a recent surge in development projects in the area, buyers will likely be looking for land. It is also smart to look at the growth in surrounding markets.
There’s something about standing on your private acreage and letting that soil sift through your fingers; a feeling of pride, independence and security as you survey your personal property. You’re a landowner!
But besides pride, there are plenty of good reasons to buy raw land. Price is one of them. You can find reasonably priced raw land parcels across the country. This is particularly true in rural, less populated areas. And while financing for raw land purchase is harder to obtain from your bank, you can often get it through the seller at below-market rates.
Tips for Developing Raw Land
Plan for your land
You’ve decided that you want to buy some raw land, but what will you do with it once it’s yours? Do you want to raise cattle? Build your dream home? Use it for retirement investment? Or develop it so you can quit your day job?
Before you start the buying process, it’s best to determine exactly how you want to use the raw land and when you want to buy it. A little planning will help you choose the parcel that’s right for your stated purpose. For example, land purchased for hunting would require enough wildlife in the area. If purchased for fishing, you need to locate streams and lakes. If you want to use your raw land purchase for investment, at what point will you consider your investment success?
Planning isn’t just for your benefit. It’s also important if you intend to apply for financing through your bank. The lender will want to know this information before granting loan approval. A development plan with blueprints can help to justify the loan. Check out our range of dual occupancy builder for your dream house.
Understand the drawbacks
Although investing in raw land can be lucrative, there can also be a downside. Raw land cannot be depreciated, and there are few tax advantages associated with it.
Purchasing raw land is considered a long-term, illiquid investment. Even if you begin developing it immediately, it may take a long time before you reap any profits. Selling it fast is usually not an option.
There is also a risk of losing money on the resale of raw land. This is particularly true if you choose poorly or fail to evaluate the parcel fully. Unforeseen events such as a slowing economy can also affect your sales price and how fast you can sell it.
Negative cash flow can be a problem. Investors sometimes find that they owe more for the land than they are able to generate as income. Others plunge in headfirst, spending more than they can get in the resale.
Banks consider raw land purchases to be speculative investments. They often generate little income, and the cost of development can be high if it is often better to see if you can get financing through the property seller. Typically they will accept a lower down payment and provide financing at a lower interest rate.
Consider the factors that affect the value
Value is sometimes hard to determine, although some sure factors affect it. For example, an oddly shaped parcel that makes development challenges can be a detriment. So be careful to review the exact size, shape, width and depth of the property you are considering.
Location is a top factor. Corner lots with easy access to roads and parking are prime candidates for development. Easy access to sewers, drinking water, natural gas, electricity and telephone service should also be considered when selecting the location of your raw land purchase.
Trees add value to your land, as do streams. A stream on your property can increase its value by as much as 100 per cent in some cases.
Good drainage is important, as well as contour and grading. A good view, however, can be a double-edged sword. It can add value, but also be costly when you develop the land. You could pay up to 30 per cent more for roads, utilities, water, sewer and building foundations when you develop land high up on a hill.
And of course, the environment affects value. Climate, air quality, water supply and the presence of hazardous materials can help determine the worth of your raw land.
Be prepared for potential problems
The raw land may look beautiful, but be sure to search for problems hidden beneath the surface, literally. Buried toxic waste in leaking underground storage tanks, old wells and septic systems, underground pipes and cemeteries are all potential problems. And while you might see the rocks above-ground that need to be removed, you might not see the huge boulders lurking below that could prevent you from digging a basement for your new home.
If your land parcel is close to a river or stream, do your homework to make sure it isn’t part of a flood plain. You’ll also want to check with the area government to ensure there aren’t any unknown moratoriums on the books that prevent the development of your land at all.
What’s the environment like?
No matter how you intend to develop your raw land, you’ll want to know it has the necessities and a comfortable environment. Smells from landfills or other industry could dampen the fun at your water park. Noise from airports or traffic might compromise a gated subdivision. And trash cluttering the land would ruin the ambience of your weekend getaway.
If there isn’t a power plant within a reasonable distance, you will have to pay the cost of running cables across public lands to get hooked up. Depending on your financial resources, this could be a deal-breaker. Be sure to call the utilities and find out before you buy.
You’ll also want to know if there is sewage disposal or if a septic tank is required, and whether there is trash pick-up or must other arrangements be made. Other important services include police and fire protection, hospitals, schools, churches and mail delivery.
Calculate the total cost of your purchase
The cost of your raw land purchase isn’t the same as the sales price you pay. The sales price is only part of it.
You’ll want to determine the yield, or what you can get from the developed property. That will require additional outlays of money for property surveys, environmental impact studies, fees, permits, engineering services and soil tests. Planning for a new look for your house? Look no further! MJS Construction Group is here to help in your dual occupancy builder Melbourne.
And once you’ve determined that your property has potential worth, you’ll also have the actual development costs. These can include tree removal, grading and clearing, the building of access roads, payments to bring utilities to your land and expenses involved with drilling a well or installing a septic tank.
Before you buy, make sure you have the financing to cover the sales price and beyond. Lenders usually won’t lend you more than 50 per cent of the land’s purchase price. So, you might consider part-seller and part-bank financing.
Know the right time to develop
Timing can be everything when developing raw land. Changing demographics, a shaky economy or other uncontrollable factors must be weighed. Building a new apartment complex when there is a housing surplus doesn’t make sense. Nor does spending money to develop your parcel when already-developed land is easily available at a lower price.
If you already own the land, it might be best to wait until there are changes in the market or the economy picks up before developing. If you haven’t yet made your raw land purchase, be willing to walk away if the time isn’t right. Don’t get so attached to your land parcel that you make the wrong move. There will be other days — and other parcels — available.
Match talent to the task and be clear of your roles and responsibilities.
People. People. People. They can make or break a successful land development. Put the right people in the right role on the right projects, and you’re virtually guaranteed to succeed. Be careful, and even the best people are not enough without clearly defined roles and integrated communication. Also, pay attention to the market – even the best talent can’t change market conditions. Please make sure the developer, contractor, and city officials are in sync, as they all have different priorities. Gaining an understanding of where the other parties are coming from enables a more seamless project. Developing a relationship, asking the right questions, being professional – it all helps in executing the project.
Design from the outside in.
This is the low hanging fruit! The two largest areas to influence development costs are earthwork (grading) and stormwater management. For single-family and multi-family developments, start with the homes first. From here, design back yards to the property boundaries and front yards to the street. This reduces the need to move dirt and efficiently manages stormwater. Earthwork/grading is an iterative process. We typically have several iterations included in a design. This also balances and reduces grading, each time reducing costs by as much as 20 per cent.
Save streets for last.
Beginning with the street design is an easy mistake to make. Municipal engineers often design the street layout, then fit the houses around it. But people don’t live in the streets, and they live in homes on lots. “Happy end-users” hinges on designing the homes and the lots first, while saving the streets for last – this is how successful land development engineers work. This way, you’re keeping the focus on the people who will be most impacted by your design. Often, we can increase the lots per acre while also increasing the green space, creating a more livable neighbourhood. It may seem counterintuitive, but it’s true. Challenge yourself to reduce street length while increasing density and green space.
Don’t ignore topography.
There’s an old saying among engineers, “stuff doesn’t run uphill.” What appears to be an efficient design for the first phase of a multi-phase project may not suit future phases. Topographic maps are essential for learning the geologic and hydrologic characteristics of a property. Combine them with assessment photos, and it can help you determine how the property has changed over time. Don’t be afraid to incorporate new technologies to make the best use of your space. Drones can help you see and understand every inch of your property. Three-dimensional mapping technology shows you the property from a completely different perspective – and helps you guarantee you’re putting your buildings in the right place. Besides, nothing beats drone photography for marketing the amenities a neighbourhood has to offer. Looking for home builders? Look no further! MJS Construction Group has you covered.
Steps to Find Out How Much to Offer on Land You Plan on Developing
Figure out your development costs.
Development costs can vary wildly from state to state and city to city, depending on things like the amount of work in the area and the cost to deliver materials to your site. When estimating development costs, I counsel investors to research their market by calling local developers. Find out what they paid. Talk to contractors, and find out what the going rate for material and labour is. Talk to local builders’ associations. They often keep data on home building costs in the area.
There are two ways to estimate costs. You can use a price per square foot method or go line item by line item. The second method can only be done if you have a list of all the line items required to build your home. The price per square foot method is easier to do but not as accurate. Your goal is to determine the total soft and hard development costs.
If your local contractor tells you the average hard and soft cost to build your home would be $100/square foot, then you know your total development cost would be $150,000 ($100/SF x 1,500 SF = $150,000).
Do the math.
Now it’s time to resolve your numbers. The value of the completed home is estimated at $500,000, which is hopefully the amount it will fetch when you’re ready to sell. Your development costs are $150,000. The residual land value is the difference between finished value and development costs. In our example, the residual land value of the proposed property is $350,000 ($500,000 – $150,000 = $350,000).
What this means is that for you to build a home that would cost $150,000 and have a value of $500,000 in the open market, you could pay up to $350,000 for that piece of land. This is the break-even point. If you pay more for the land, there is great potential for you to lose money. If you pay less for the land, you’re potentially building in profit. And that’s exactly how a professional developer would do it.
But they don’t stop at the residual land value. They go one step further by working in their profit.
Work in your profit.
As a developer/investor, you’re here to make a profit. You want to work that into the equation before you price your land and make your offer. Most developers of residential property like to make 20-30%. Anything below that will be hard to finance through a conventional lender and would also be a risk on your part.
Markets move up and down, sometimes as much as 10% in a few months. If your profit margin was only 15% and the market drops 10%, you’re left with a 5% profit. For that kind of money, you don’t need the risk of development—you can go out, buy a T-Bill, and sip iced tea on your front porch until retirement.
If your cost to develop was estimated at $150,000 and you’d like to make a 30% profit on costs, your profit margin would be $45,000 ($150,000 x 30% = $45,000). This number is then subtracted from the residual land value of $350,000 for a maximum offer price of $305,000 ($350,000 – $45,000 = $305,000). That means, to make a 30% profit on your development costs, you wouldn’t pay more than $305,000 for the land.
Well, that’s fine and good, but most developers want to profit on their entire project, not just the costs. Thus, we do this calculation one more time—this time on the land purchase portion, as well. Assuming you’d want to make 30% on the land portion, too, how much would you have to back out? You’d back out approximately $90,000 ($305,000 x 30% = $91,500).
Establish your max offer price.
Take your residual land value minus your profit on cost and your estimated profit on the land cost, and you can determine your maximum land offer price. For our example, the final land value and max offer price would be $215,000 ($305,000 – 90,000 = $215,000).
For the property cited in the example, I would offer the seller no more than $215,000 to purchase their piece of land. This ensures I can get the development done and make a nice profit for myself. To check my numbers, I run the math one more time.
Check the math.
To check your final expected profit, run the numbers forward from the start.
Keep in mind, and we have not accounted for taxes of any kind. That will, of course, reduce your profit margin—but still, this is not bad for a development that probably took less than a year from start to finish.
For even higher returns, your land offer would be made at an even lower number than your max offer price, just in case you end up negotiating the price higher with your seller. As you can see, the residual land value technique of obtaining land value is an easy and efficient way to make sure you’re paying the true market value of the land, while working in a profit for your potential development.
There are many more things to consider for your site selection, so it’s important you do your due diligence. In the development game, time is money. So you will need to learn to assess a potential site very quickly.
One way to fast track the analysis process is to engage other professionals to do this important work for you. If it is your first development, then work with an experienced project manager so you can learn from them as you progress through the complicated and challenging journey of your property development.
The market, housing trends, interest rates and consumer preferences – among other things, are often out of our control in the world of land development. Suppose we remember the fundamentals and stick to the rules. In that case, we can positively impact what we do control, give ourselves the best chance for success, increase ROI, and achieve happiness for everyone involved.