As the housing market continues to boom, it can be tempting for investors to play the long game and look into purchasing land. The reality of real estate, however, is that this temptation is often misguided.
There are, of course, compelling reasons to consider owning undeveloped land. One is culture. For example, people who have emigrated from places like India, where land value has skyrocketed beyond 100x over the past two decades, may mistakenly believe they’ll find a similar scenario in the US.
Attractive, bold headlines announcing land sales can make for good PR at best, and some ego gratification at worst. There also tends to be a scarcity mentality with land; that there is only so much left to be purchased, which is just a false supply and demand narrative.
Regardless of the market trends, the reality is this: It is extremely rare for individual investors to make money on an undeveloped residential lot. The following are the five biggest reasons why owning land is not a good investment:
1. Land is not a producing asset
Unless the property contains a farm or livestock, residential land just sits there without generating income. There is no cash flow to speak of, and thus provide no investment assurances.
2. Vacant land is hard to finance
Since there is no guaranteed cash flow, there are just a handful of lenders who finance undeveloped residential land. And since the bank has no guarantees of an ROI, the rates are astronomically high (often starting at 12 percent), and the buyers need to put up to half down.
3. High cost of ownership
Between property taxes, insurance, and, in upscale communities, high HOA fees, the carrying cost of owning land is very high. Between all the aforementioned and the subsequent real estate fees, unless the property value goes up exponentially, it won’t be a good investment.
4. No guarantees of appreciation
While you can predict what the value of a property would be in a few years based on past data and current trends, that is not possible with land alone. It is illiquid, plus it takes a very long time to complete the sale. Thus, any resulting profits are primarily based on luck.
5. Too many unknown variables and legwork
Purchasing land requires a vast amount of expertise, as there are far too many variables and unknown external factors for the layman. Knowledge of local zoning (like flood zones), usage and environment guidelines (like native species in that location, or pollution regulations) are a must. Therefore, ample research and a very detailed understanding is required.
Most land sold at a large profit was held onto for many decades. It was either located in an area that grew over a long period of time, or it was purchased at a deep discount. Buying raw land is a very risky investment if it does not come with a built-in revenue generator of some sort.
An alternative for most small investors could be a REIT (Real Estate Investment Trust), a company that owns, operates or finances income-producing real estate. Another option is an ETF (Exchange Trade Fund), which can contain a variety of real estate investments within one portfolio. Both can be an ideal choice because they do not require direct management.