Buying land for development in 2012

I was going over some Commercial Real Estate market reports the other day. My Department gets them from different firms on a quarterly basis, and they are an excellent source of information to see trends in different real estate sectors as well as the specifics in a particular market.

In addition to the reports, my employer has the benefit of dozens of new appraisals on a monthly basis. Based on the data provided by the appraisals and the market reports, It is clear that in the part of the state where I live there are some noticeable signs of improvement in commercial real estate. However, the improvement is not across the board with some asset types doing better, and others still lagging.

As far as I can tell:

Multifamily is hot. The time to get a bargain in multi-family was two years ago. Cap rates are back to pre-boom years (around 6.5%). I do not think we will see boom cap rates anytime soon because there are not going to be any condo conversions for a while, which means valuations will be based on cash flow.

Retail and Office are slowly coming back, but it is still spotty in some areas. My employer lends mostly in two large metropolitan areas, and their downtown office markets are still around 20% vacancy. On the other hand some retail and niche office markets such as medical offices are under 10%.

Industrial is weak. Double digit vacancies are still the norm, and low rents per Sq. Ft. are all over the place.

Land is still dead. All the investors are still worried about the holding period before construction is feasible, and are pricing land accordingly. Infill land zoned for multi-family is the only place where a seller can get good prices, and only if the location is right. Nobody is buying multi-family land in the outskirts.

Taking into consideration my assessment of the different markets above, I was wondering what would be the best area to put some money to work. My preference would be multi-family because of the cash flow, but maybe there is something to be said about being a bit of a contrarian right now. Since land is still a laggard, maybe this will be a good opportunity to acquire some.

I see this as a long to medium term investment. If you buy land, you will need to hold it until building something becomes feasible. This could be one year, but it could also mean twenty years. It is a bit of a gamble, but there are certain things that you can do to minimize the gamble.

First, when buying land location is important. A lot of agricultural land got purchased prior to the recession with the intention of changing the zoning. Now that the projects are no longer feasible, that land is again being valued as agricultural land. If the growth fundamentals are still there, additional residential property will eventually be needed. If your municipality has an “urban development plan” reviewing it is a must before bidding on any of that land. It could very well be that this agricultural land is already planned to become something else in the future.

Density is just as important. I know of a 15,000 square feet property that is under foreclosure. Current zoning allows for two residences (duplex) to be built on it. The owner purchased it for about $200,000 in 2005. I am not sure what the plans were, but it is possible the owner was thinking of building two nice townhomes. However similar townhomes are now being sold for $250,000 if the seller is lucky. It is no longer feasible to spend around $150,000 to build each townhome just to sell them at cost. I expect that the lot will go for $100,000 or so at the foreclosure sale. However, there is another factor to consider. The lot does have potential to be changed to a higher density district as it meets the requirement of size and is right next to an existing higher density district boundary. If an investor could get the zoning changed to multi-family allowing the construction of 6 units, buying the land for $100,000 would result in a land cost per unit of less than $20,000. The new density might be enough to make construction a financially feasible proposition again.

Don’t buy more than you can carry. Remember that you are buying a non-income asset. If you are thinking of getting a loan with a commercial bank, you will not find them very receptive. Land loans are limited to certain regulatory loan to values with raw land limited to 65%. On top of that most bank lenders are actually more conservative than the regulators requiring a 50% loan-to-value. There are some better options with credit unions or residential lenders. Higher loan to value land loans are available for the purchase of a lot for to eventually build the borrower’s primary residence.

Buying land is a long-term play that is not without risks. However, the old axiom of “buying low” has not changed. If you do decide to look for opportunities, do not forget to do your due diligence. For more information about investing in land, you can read this book Investing in Vacant Land: It’s Not What You Think

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