A new term has emerged in popularity over the past couple of years called "land banking". Perhaps you've heard the term and wonder what it is or maybe you've never heard of land banking at all but are intrigued.
Basically, land banking is the process of buying a piece of land solely as a long term investment with no plans to develop it or do anything special with it in the future. The investment pays off when markets go up and there is equity in the value of the land.
In this article I'll discuss 7 benefits of land banking and also how to be sure you hedge your investment in a way that limits your financial risk.
We will discuss these 7 Incredible Reasons to start Land Banking:
1) Supply and Demand
2) Compound Interest Aint What it Used to Be Brotha'
3) Low Initial Investment
4) Low Holding Costs
5) Low Maintenance
6) Subjective Prices
7) Instant Equity
The 1 Most Powerful Way to Limit Your Financial Risk
Why would somebody invest in raw land?
Buying vacant land for holding is an out of the box strategy that most people don't think of because quite frankly, people don't have a lot of patience.
Also, it's a bit un-conventional and boring sounding, so most people don't even think of it as an option. However, it can be a lucrative move for a variety of reasons that I analyze in more detail below.
Just remember that in business and investing, it's about the numbers, not about the sexy. The only thing sexy about raw land is the word raw, until you make a better than average return. That's always sexy.
So here we go, 7 remarkable reasons to invest in land...
1) Supply and Demand - There is an old saying that investing in land is a great investment because they're not making any more of it.... with the exception of Dubai, I think the statement still holds true. That doesn't mean that every piece of land is a sound investment though.
Be wary of land that has no legal access, is underwater, or is in an unbuildable area, such as some parts of the green swamp area. It all comes down to doing your due diligence. If a property is inaccessible but close enough to a road to get access, it may be perfect for you depending on what you want to do with it.
2) Compound Interest Aint What it Used to Be Brotha' - If you managed to stock pile some capital for investing or retirement, you aren't going to get the same returns as you used to by parking your money somewhere and relying on compound interest. Even in a bank or CD, you'll be lucky to make money after inflation.
There's a lot of talk by certain types of financial salespeople about the power of compound interest and how you can double your money in "x" number of years. So let's take a closer look at this.
This can be figured out using the rule of 72. The rules of 72 basically states that if you divide 72 by your interest rate you will know how long it takes to double your money.
For example, let's say you have $20,000 to invest and you want to double it. If you get an 8% annual return on your money, it would take 9 years for your $20,000 to get to $40,000 (72÷8=9) according to the rule of 72.
In my opinion, to get 8% every year in today's economy would be great, but waiting 9 years is not so great. That's if everything goes perfect. What if you only get 6%? That would take 12 years. A 3% return would take a whooping 24 years (72÷3=24).
I don't know about you, but if I had $20,000 and my only option was to invest it at 3%, then what's the point? I might was well spend it and live large. It would take me less than 24 years to save up another $20,000.
3) Low initial investment - Investing in dirt doesn't cost a lot upfront. It can, but it doesn't have to. One of the drawbacks of investing in traditional real estate is upfront money. Land can be bought with a relatively low budget.
$10K or more can get a person a great piece of land. To get an average house that doesn't need improvements and isn't in a war zone is going to probably cost $100,000 or more in most strong markets.
Land banking allows small time investors to get started and investors with deep pockets can spread the wealth over smaller deals (or just invest in more expensive pieces of land or large acreages).
4) Low Holding Costs - This is one reason I think the concept of land investing is starting to gain popularity. Once you buy a piece of raw dirt (assuming you paid cash) there is very little maintenance. The only thing you need to pay are yearly taxes.
This changes if you buy a vacant parcel in a subdivision with a homeowners association because you'll have HOA fees and maybe maintenance fees. But if you want to avoid that... then just avoid it.
There can also be some advantages to owning in a homeowner association neighborhood though. Typically they are more desirable lots so as there become fewer and fewer lots, your parcel may go up faster in value. But again, this is something you can decide when shopping for your land.
Taxes on land are much cheaper than taxes on a home as well since the values are lower. So when I talk about holding costs the range I've seen on average for property taxes is from $50-$500 a year.
This all depends on the value of the land. So if your taxes start to climb, it usually means the value of your land is going up. Since vacant land tax is a pretty small percentage of total value, I see it as a very nominal risk.
In addition, property taxes only need paid once a year in many places.This gives the average person plenty of time to plan for and pay their property taxes.
Also, in most states, if you don't pay the taxes, the process of taking the ownership back from you is a long and tedious process. Sometimes it doesn't even start until 3-5 years of non-payment. This gives plenty of time for you to make things right if you had financial issues during tax season.
5) Low Maintenance - When it comes to maintenance, raw land wins hands down compared to other forms of real estate. Again, this depends some on the neighborhood.
If the HOA requires you to maintain the grounds you may need regular lawn care for it but again, you can avoid this by not purchasing in those areas.
I had 2 pieces of land recently that were heavily wooded and in an area where wildfires broke out. In the end, over 2000 acres burned and my parcels did not.
I wasn't too worried though when the area was being evacuated because I didn't have a house or anything else that could burn. Just trees. When somebody buys land they typically clear much of it. When they build the lay down sod anyway, so I don't think I would have taken much of a hit on value if they did burn.
6) Subjective Prices - One of my favorite things about land is that it's hard to price because there aren't comparables like there are in single family residences (SFR's).
So while it's relatively easy to see what a 3 bedroom 2 bathroom 1500 sq. ft. house sells for in the area, it is not so easy to see what 2.43 acres should sell for.
Often times the price is very subjective. Buyers and sellers make decisions just like in the home market based on emotion. Do they like the location, the shape, the size, the trees, the lack of trees, etc.
This can work for or against you as you invest.Sometimes a person wants way more than the land is worth because of their belief that it should be worth that much.
Tony Robbins says the problem with people is they should all over themselves. So this thinking is the same thinking you'd run into in the housing market or any other market in which people buy and sell.
Where land differs though, is that to some people their land is worthless. To these people, they are happy to get out of it and sell it for under market value because they hate paying taxes on what they think is a worthless piece of real estate.
Now let me be clear here. Some land (in my opinion) is worthless. Don't invest in worthless land. However, again that is subjective and some people would argue that all land is worth something or eventually will be because of supply and demand.
The green swamp area mentioned before is a great example. Will that area be developed in 50 years? How about 350 years when my great, great, great grandchildren are alive and kickin? Now we're in a legacy discussion and investment, which is an entirely different animal.
7) Instant equity - Land banking beats traditional investing because if you become an expert in land, you'll recognize a good deal when you see it. I believe people discount land more often than houses because of the perception that it's less valuable and thus, harder to sell.
While there are substantially less people in a market buying and selling land, it can make for a great opportunity for the person who seizes a great deal and then has the patience to wait for a buyer.
For example, let's say Joe lives in Massachusetts. He owns 5 acres in Florida and he needs cash. He has a rental he could sell quickly but he doesn't want to because he sees it as part of his retirement.
But he hasn't seen his 5 acres in Florida in 10 years. He would like to get $25,000 for his land but he actually is in real need of $15,000. What do you think the chances are that he'd sell for $15,000 instead of waiting for a year or two (or more) to get his $25,000 asking price?
I would say those chances are pretty high if he really needs the cash. It may not be so high with a home because you can always refinance or get a home equity line of credit if you've got some equity. That's not really on option with land, so it shifts the advantage from the seller to the buyer.
Let's say you stumble across this deal and you go ahead and buy the land for $15,000. Now you have $10,000 equity immediately in the land. Those returns are far greater than the law of 72.
I can hear some saying, "hold on, wait a minute. I can do the same thing buying houses. You make money when you buy, not when you sell, so if I find good deals why not do it with houses?"
My answer would be that the equity position is not as great nor as easy to find. You may find a $100,000 for sale for $80,000 and be lucky enough to get there first, but you've created only a 20% equity position.
In my example, you created a 40% equity position using only $15,000. If you spent $75,000 on 5 similar deals, your net worth on the total investment would be $125,000. In the house deal it was only $100,000.
Additionally, you've diversified with 5 different parcels of land. On top of that, it's much easier to find land with good equity positions than it is to find houses because everybody and their mother thinks they're a flipper (Way to go HGTV).
Lands not as easy to liquidate and you can't get to your money as easy as selling out of a home... But IF you buy in the right area at the right price, it wouldn't be hard to get out of if you need to.
Besides, if you've read this far and you're still with me reading about land banking, you probably don't need to get to the cash right away anyway. You have cash, what you need is a great investment vehicle to grow your net worth as fast as possible without unnecessary risk to your capital.
If that sounds like you, keep reading (almost finished)...
The 1 Most Powerful Way to Limit Your Financial Risk
If you're involved or thinking about getting involved in land investing for the long term, below is the the most powerful way I've found to limit your financial risk.
1) Don't buy from the MLS (multiple listing service) - This sounds counter-intuitive but the fact is you will pay more for MLS properties. Much of the reason for this is because they've been marked up.
Regardless of what anybody tells you or what they believe to be true, properties (especially vacant land) on the MLS will be marked up significantly higher than what the owner would take for the property.
Most people won't admit that it happens and may not even realize they are doing it if they're involved. But the fact is that it's done, sometimes underneath the surface of the subconscious because the conscious mind doesn't want to admit it's happening. So here's a story....
Example: Joe has a property. He wants 20K for it but he plans to tell his realtor he wants 30K because Joe knows there's going to be some fees and commissions involved. He wants to walk away with 20K.
Joe calls realtor#1 and asks what he thinks he could get for it and tells realtor#1 he wants 30K. Realtor#1 looks at the land and does the math... Listing this property would take roughly the same amount of paperwork, time, and effort as as a single family residence that is priced at $100,000.
Since realtor#1 will likely only get half of commission because he'll be splitting it with whomever brings a buyer he is looking at a 3% commission, which is $900.
As an experienced realtor, he realizes it's not worth his time because he could spend the same time finding and listing a $150,000 property which would net him $4,500 and maybe even $9,000 if he gets a full commission. So he declines.
Joe then talks to Realtor#2. Realtor#2 is new to real estate and eager to make new clients happy. He sees the same problem with the numbers. But he is building his network and sees Joe as a potential future client so he agrees to list it. However, he suggests they start at $39,900 and slowly drop the price to maximize Joe's sell price (and thus realtor#2's commission).
Eventually the property sells after some negotiating for #33,500. The buyers are happy they got a great day. The realtor is happy he got commissions and they seller is happy because he got more than he needed (he only needed $20,000).
Would the buyers be happy if they knew they could have gotten it for $20,000? I doubt it. Does this really happen?.... what do you think?... I'll leave that for you to decide.
The question then becomes, how do you find deals if you can't look on the MLS?
There are a couple ways to do this. One way is to browse sites like Craigslist or For Sale By Owner and look for good deals. You'll occasionally find good deals or be able to negotiate average deals to good deals by dealing directly with the seller and agreeing on a price.
Another way is to post to sites like Craigslist or Facebook that you are in the market for land and want to buy some. This can flush people out who have been thinking about selling but haven't talked to anybody yet. The key is to get there first.
Thirdly, you can market directly to people who own land and look for those who want to sell. This costs more money and is more time consuming but if you plan to buy a lot or have a lot to invest, it is the most scalable way to do it.
Lastly, you can let somebody else do the work by joining preferred buyers lists and then pick and choose the deals you want. If you've read this far I"m assuming you're pretty serious about land banking and land investing.
This last buying method looks like this. If you join our buyers email list (at the top of our pages), you'll get an email every time we have a property available and in that email you will see a discounted price for being on the list.
These are our properties, we are NOT wholesalers, we are re-sellers. We flip dirt. We buy the deals cash and then resell them.
Our business model is to buy and sell in volume. We like getting market value but we like selling fast to fund our other deals and build out pipeline even more. So many of our deals never make it to Zillow or online because we sell them quickly to our cash buyer list.
In return for being on the list, you get the first opportunity to buy our land also a discount rate that is good for as long as we have the property available. This allows you the chance to do your own due diligence and see if there is enough equity in the deal to make it worth it for you.
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