At its best, land speculation is a high-risk, high-return investment with no tax advantages. At its worst, it is the playground of scam artists and rife with high-level collusion.
The purpose of land speculation is to buy undeveloped areas that are expected to see a building boom. Then you have the option of selling this land as developers move in or developing it yourself. Carrying out this simple plan, however, is often harder than people expect. In this article, we will look at the issues involved with land speculation, and show you how to work with and around them. (To read more real estate basics, see Investing In Real Estate, Smart Real Estate Transactions and Exploring Real Estate Investments.)
Undeveloped land is cheap compared to buying land with property on it. If you can buy sections of land near an expanding population base, you can turn around and sell it during a building boom for a tidy profit, with no toilets to fix or roofs to re-shingle. (To learn more about flipping houses, read Fix It And Flip It: The Value of Remodeling.)
Professional speculators probably do realize double-digit profits, but they often neglect to include the expense of holding the land while they wait for the economic growth. In fact, areas that are seen as "hot spots" generally sell land at a premium long before the developers will ever set foot on it. Therefore, effective land speculators have to buy very early and hold on (sometimes for years) to see the double-digit returns.
If the expected growth doesn't boom like the speculator hoped or doesn't happen at all, profit may completely disappear. To hedge against this risk, successful speculators buy land in multiple locations that meet a certain profile. This approach requires a lot of capital and research. Even so, if enough speculators are watching for the same profile, they will inadvertently drive prices up to a premium and shrink each other's gains.
From the perspective of a small-scale real estate investor, land speculation is an expensive and risky investment. Here are a few of the reasons investors should ask questions first and buy later.
- There is the money required to purchase the land, and the investor's mortgage will be at a higher interest rate as lenders consider land bought for speculative purposes to be at a higher risk of default.
- There are property taxes to pay on top of the mortgage, and if you aren't getting any regular income from the land to pay them (for example, from renters), then the money will come right out of your pockets.
- If your land depreciates in value (for example, all the building permits in the area are canceled), you can't write off the depreciation because there is no allowance in the tax code for the depreciation of undeveloped land.
- And, the final blow, if you decide to develop the land yourself, getting financing is harder and more expensive than financing traditional properties. In short, you have to consider the ongoing price with holding the land as well as the purchase price. Can you afford to have a chunk of undeveloped land eating away at your cash and still meet your other financial obligations? (To keep reading about owning property, see Downsize Your Home To Downsize Expenses and Profit As Your Home's Price Changes.)
The most significant factor that land speculators watch is the health of local economies. Although many outside factors can ignite a building boom in an area, such as the building of an auto plant or submitting the winning bid for the world cup of soccer, a strong local economy makes its own luck in attracting these outside factors - or failing that, it provides incentive for more people to move there. (To read more, see Consumer Confidence: A Killer Statistic.)
There is still a significant amount of undeveloped land in the U.S. and abroad, but not all land is created equal. When you are looking for land you need to picture it not by the scenic beauty, but by the cost of development versus the purchase price. Assuming that a developer is looking for land to put a gated community on, he or she will likely aim for a balance of location and cost of improvement - i.e. the cost of building roads from existing highways and bringing in power, water and sewage lines.
Once you have found a piece of property that lays directly in the path of a future building boom, you have to check its zoning status. Land just outside developed areas tends to come with quite a few strings attached. There are many communities that are not ready to give up an unobstructed view of the countryside so someone can put another row of houses in front of theirs. The only recourse these homeowners have is to restrict the use of the land by influencing the zoning status.
The zoning status not only affects what type of buildings can be built, for example a single-family dwelling or a mall, but whether or not you will be able to bring services, such as roads and power lines, to the land once you build on it. You have to find out the attitudes of the community and the planning department toward development - if they are hostile, don't buy. Even if the zoning status is favorable at the time of purchase, zoning alterations can take place at any time.
Not to put too fine a point on it, never buy land you haven't personally researched yourself. The idea that you should buy land from someone whose only proven skill is the ability to use a phone book or email to contact you is ridiculous. These land speculation scams probably hit their height in the late '70s, but they still surface from time to time. (To read more about scams, see our Online Investment Scams Tutorial.)
Speculating in land requires large amounts of capital and research. The more property that an investor is able to control, the better the chances of seeing good returns - but the holding costs continue to tally on inactive land. If you have the knowledge, or the money to hire people who have the knowledge, then land speculation may be for you. If you don't, there are far more accessible forms of real estate investment that also give you the thrill of holding a physical asset.