Tuesday, April 4, 2017

Should You Buy Land As An Investment?

A reader writes asking whether it is a good investment to buy land as opposed to buying an investment rental property with a house on it.  Good Question.  The answer is generally "No".

This is a good question.  Most of my knowledge in real estate is based on the "Ask Bob" column in the Washington post as well as the real estate column published by Edith Lank in Rochester New York, the latter of whom has achieved deity status.  Both columns offer wise and what sometimes is brutal advice to people looking to buy and sell houses or invest in real estate.

The rest of what little I know is based on my experience is buying and selling a few properties over the years, which I managed to make some money because I bought while everybody was running away from real estate and sold when everybody was going crazy over it.

In the Ask Bob column in the Washington Post, he never recommended buying empty land as an investment as he said it was usually a lousy investment.  And if you do the math, it's not hard to figure out why.  This is not to say you can't make a lot of money buying empty land, only that as a whole, improved real estate (with some sort of building or something on it) is usually a better deal.

That is may be confusing to some, as I have noted the past when I sold my house in Washington, they drove a bulldozer right through the center of it and leveled the place. The land was worth far more than the house ever was.  So why wouldn't it have been a good idea just to buy empty lots and then wait for some developer to want to buy them?

In a way it is just like the difference between income stocks and speculative stocks.  Some folks like to buy stocks and speculate that the price will go up over time.  The company might not be making a profit or paying any dividends, but the stock buyer is convinced that down the road somebody else will pay even more for the stock and they will make a lot of money.  And about half the time they're right and half the time they are wrong.   This is little more than gambling on the stock price than it is investing per se.

Income stock, whose company produces profits and then pays dividends to shareholders, is an entirely different deal.  You make money on dividends from such a stock and then hope the price goes up as well.  Even if the price goes down, you still have those dividend checks to comfort yourself with.  Over time, the combination of dividends and price increase generally results in a bigger profit than merely speculating on stock price.

Some folks might argue that over time, the stock market and particularly the Dow Jones Industrial Average goes up almost universally, even if it dips in price on occasion such as in 2009.  And it is true, that over time, stocks go up in price as a general rule.  However not all stocks go up in price, and sometimes they go up and then back down again and if you buy when they go up and sell when they go down, you can lose your shirt.   In addition, a company that goes bankrupt also winds up being a bad investment. Never confuse general trends with specific outcomes. You are not a statistic, but an individual.

Now let's take these stock concepts and apply them to raw land.  A piece of land with nothing on it that cannot be rented out for any particular use is sort of like one of these speculative stocks.  You hang onto it and hope that it appreciates in value because somebody else will pay more for it down the road. However, unlike a stock, you will have to pay property tax on the land which in some jurisdictions could be quite steep.  So there is a carrying cost for holding empty land. You have to hope that the value of this empty land goes up at a rate higher then the cost of the property taxes.  And you have to hope that the time you choose to sell, the value of the property is higher than when you bought it.  In other words, you are speculating.

Now, a piece of real estate with "improvements" on it is something different entirely.  If you have a piece of land with a house on it, and you can rent that house, and the rent can offset not only the taxes and insurance and other fees, it may actually pay for the property itself by paying down the mortgage on the property. The income from the improvements on the property will exceed the value of the property over time.  It is like getting dividends on your stock in addition to the stock improving in value and the dividends paying for the stock itself.  Not only is this a much better deal, but down the road, the real estate may have cost you nothing.

For example, I bought an investment duplex. I paid $99,000 for the duplex, although in reality, I only put about 10% down, or about $10,000.  But that $10,000 was taken out of equity I had in my office building, so in theory, I paid nothing for the property.  But even assuming I put down $10,000, that is not the same as putting down $99,000.  I financed the rest with a mortgage.

The rent for the duplex paid not only the property taxes and insurance but also that mortgage.  I actually ended up with $100 every month left over.  So it addition to not having to put any money down (or little down), I ended up with a positive cash flow meaning that the property literally cost me nothing.  And in fact they generated a small dividend.  Over time, the property appreciated in value and I sold it for a profit.

What was that profit?  The sales price minus the $99,000 I paid for the duplex?  If you think about it, since I put it really none of my own money into the deal, it was all pure profit. And since I did in fact depreciate the property on my taxes, I did have to pay capital gains tax on the whole amount. But that's another story. The main thing is it didn't cost me a penny to purchase these properties or hold these properties.  Even if I had to put down the down payment in cash, the carrying cost was zilch, and in fact, generated a profit.  And over the time I held the property, the profits paid for the down payment.   Net cost, nothing.

Now look at a piece of vacant land.  If I wanted to buy a piece of vacant land, I would have to come up with the cash or finance it.  Guess what? Banks don't like to loan money on vacant land, as it is pure speculation.  So even if I could get a mortgage to buy vacant land, the bank would want a larger down payment and charge a lot higher interest.  So either that or I would have to pay cash for it, which would tie up a lot of money in something that's not generating any income.  Now, in addition to this, I would have to pay property taxes on this vacant land.  And that would depend on your jurisdiction as to how much the property taxes were. Some jurisdictions actually penalize people with vacant land by charging them as much and property taxes as somebody with improvements on their land.  The idea behind this is to encourage people to improve their properties and not punish people who have.  But check your local jurisdiction to determine your own situation.

So, say I bought a $99,000 piece of vacant land. I would have to make mortgage payments on that piece of land, which would not be offset by the any rent collected from tenants. Not only that, I would have to pay property taxes on the vacant land, and possibly even insurance in case some kid walking across it fell into a hole.  I would have to hope that that piece of vacant land appreciated in a rate far higher than the duplex did.  I would have to hope that some developer desperately wanted that piece of land down the road to build a high-rise or something.  I would be basically gambling that the land would be worth a whole lot more.  And gambling is not investing.

Note that when I say improvements on the property, this could mean a number of things.  If the piece of vacant land is paved over and is used as a parking lot and you're renting out parking spaces every month, then those are improvements and they generate income. Similarly, if the land is farmland and arable, you can lease it to a farmer who plant crops and pay you lease payments which generate income.

However, these sources of income are often not as great as other improvements such as buildings and structures either for housing or office space.  The income derived from running a parking lot or leasing out farmland usually will not cover the carrying costs on the property.

But as in everything else, you have to "do the math" and figure out what's going on.  However unless you can be one hundred percent sure that someone will pay you for the empty lot later on, it really amounts to no more than gambling.

In a typical scenario, a small investor is snookered into buying vacant land as an "investment".   Since he has to pay a mortgage and taxes on this "investment" it is a drain on his finances.  Eventually he is forced to sell due to some minor personal financial difficulty - and he sells at a time not of his own choosing, at fire-sale prices.  He buys high, sells low, and pays taxes and mortgage interest the whole time he holds it.   This is not investing!

Right now I am holding on to piece of real estate because it developer wants to bulldoze it yet again and build on it. We have a condominium in Alexandria that is on 22 acres near the Washington Metro rail system. The condominium owners paid to have surveys done, including traffic studies, and paid to have the property rezoned for medium-rise development. We've then presented this is a package deal to a number of developers, three of whom made offers.  It appears that all this work may pay off and that we may be bought out in the near future, although the buyout isn't as lucrative as many it had hoped. However in the interim the rent received from the condominium more than covers the operating cost of owning it, including taxes, insurance, condo fee, and repairs.

So you see it costs nothing to hold the property as a speculative investment.  If I had to pay the roughly $8,000 a year that it costs to hold this property without any rental income to offset it, I would have sold it long ago. And in fact people would not have paid me very much for the property since it wasn't capable of generating income and since the buyout from the developer was not all that lucrative.

Thus, I tend to agree with the "Ask Bob" column in the Washington Post with regard to empty land. Empty land is really more of a speculation than an investment.  Unless you can be assured the property will skyrocket in value, the carrying costs will offset any profit you make from the property.

Bear in mind that real estate investment is not for everyone.  If you're not comfortable being a landlord or not comfortable with least a modicum of risk-taking, it probably isn't for you. If you can't add up a column of figures and "do the math" you will have your ass handed to you on a platter, many times.  If you're not willing to visit the property and at least paint the bathroom or something, it probably isn't for you.

And bear in mind that real estate can be a really really lousy investment at times, particulate during the bubbles which regularly occur in many markets.  When the carrying costs of the property far exceed the rental income, you are back in the situation where you're buying vacant land.  You're paying money for the privilege of holding onto a piece of real estate and hoping that it increases in value.  It makes no sense whatsoever, yet people do it all the time and as a result lose their shirt when the real estate values fail to appreciate as they hoped they would.

This, and this alone, is why the real estate market collapsed in 2008.  People were bidding the prices of real estate through the ceiling beyond the point which they could recoup their overhead costs. At that point no person in their right might wanted to pay those prices although a lot of people not in their right mind did. Prices eventually fell back down to the point where not only would rental income cover the overhead carrying cost, but that would generate tidy profits as well.  At that point, many real real estate investors jumped in and snapped up these properties, much as I did in 1994 after the 1989 collapse.

Making money is never easy.  There is no simple way to wealth.  You cannot just throw your money at something and become fantastically rich overnight.  Sure, this happens occasionally to people, just as at the casino, occasionally somebody would hit the jackpot.  But the key word here is Casino.  Gambling is not investing and speculating is not investing.  And as a small investor, we can ill afford to gamble or speculate, even though the media encourages us to do both.

A far better option is to invest in sound things, which may not be sexy or see huge gains in a short period of time.  However over a lifetime, they could generate a small fortune if you are astute and a little lucky.

NOTE:   I am not addressing here the obvious fraudulent "land sales" schemes that appear in the local paper, on billboards, or in flyers mailed to your home.  These schemes have been going on for decades.  Watch Glengarry, Glen Ross which describes such scams and how they are sold.   In the old days it was Florida land, which was under water most of the year.   Lately, it has been lots in the mountains that are sold to suckers who never can build on them because they lack sewer, water, or electricity - and won't perk for a septic system.   It is worthless land, bought by con artists, divided up into lots and then sold using high-pressure sales tactics such as seminars or the like.   Just say no to vacant land!   And timeshares, while you're at it.

NOTE ALSO:   The plebes love a good rags-to-riches story about some yahoo who had some piece of worthless land that he was sitting on and then Wal-Mart offers him a gazillion billion trillion dollars for it to build a distribution center.  Ol' Jimmy was smart to hang on to that land, and ol' Bob doesn't know shit, does he?

Well, the deal is this:  These are the sort of poverty stories that poor people like to tell each other, and rarely are they true.  These are usually "Friend of a Friend" (FoF) stories, and ol' Jimmy is my second cousin's sister mother's husband twice removed.   In other words, he doesn't exist.   

Also, Wal-Mart didn't get rich by overpaying for land.  They intentionally locate their stores in places where the land is cheap, outside of town, and use nominal buyers to purchase these properties so as to not arouse suspicion.   They aren't about to dump money in ol' Jimmy's lap when Fred across the street will sell for less.  In fact, they often pit one seller or two against the other to get the lowest prices and tax concessions.

Yes, there are people who sell vacant land at a profit.  Usually these are people who have inside knowledge that the land will be worth more in short order.  They buy a property from some unsuspecting yahoo (ol' Jimmy, in reality) and then quickly flip it for a huge profit.

For example, the fellow who helped found the Jekyll  Island Club bought the island at a fire-sale price from the heirs of the original owners, and then immediately doubled or tripled his money by selling it to the nascent Jekyll Island Club.   He knew in advance the land would be worth more.

And like with stocks, it is damn hard (and in that case, illegal) to get such insider information.   Stop believing in poverty stories!   They will drive you broke!   You don't need to be "lucky" or clever or know someone to get wealthy - you need to be persistent and work hard.