Got Dirt? Land as Investment – Part II

Got Dirt? Land as Investment – Part II

In Part I we discussed the three main categories of land available now. In Part II we review the reasons land is attractive to investors and how you can estimate potential profit:
o Land that is purchased raw and then entitled has good potential for appreciation. Vocal environmental groups have made development more difficult and there are more costly hurdles in place to develop a parcel. The NIMBYs (not in my back yard) dominate development hearings. The end result of this is a diminished supply of entitled development land. When the construction industry resumes activity, demand for entitled land will resume with it.
o Land is simple to own. You don’t need leasing brokers, property managers, tenants, or a maintenance staff.
o The secret for buying land is relatively simple – follow the roads, airports and commuter rails. Roads are extended, widened, and new roads are built for a reason. With transportation an essential part of what makes land valuable, chances are that property located on or very near major transportation routes will be a good investment.
o Compared to developing buildings on land parcels (horizontal development), developing the land itself (called vertical development) is relatively inexpensive and less risky.
Land value is determined primarily by property zoning, the location of the property, and the condition of the land itself. Typically, land suitable for dense development (apartments, hotels, high-rise offices, etc) will command the highest prices. That is followed by retail, office and industrial zoning, with single family and agricultural at the lower end of the pricing range.

When estimating future value of the land, because there is a dearth of recent comparable land sales on which to base your estimate, you can use the “back door” approach to valuation often used by the developers who will be the buyers for vacant land. A pro forma is developed as though the planned development was already completed, and a projected net operating income (NOI) is estimated. By then applying an estimated market capitalization rate for that kind of building to the NOI, a value for the completely developed project is estimated. All hard and soft construction costs and the developer’s profit margin are deducted from this estimated value to arrive at the land value. Another way to estimate values is to go back and look at 2003-2005 closed transactions for similar land parcels. Those sales, because they are “pre-hyped up real estate market” pricing, are indicative of conservative estimates for future value.
Susan Lawrence is president of Real Estate Strategies, Inc. based in Winter Park, Florida. The company’s experts assist commercial real estate owners, trusts, lenders, private equity companies and foundations in evaluating and developing strategies for commercial real estate investments. Additional information on qualifications and services may be found by visiting www.restrategies.net.

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