Starting in Land Investment
Starting in Land Investment
“Buy land, they’re not making it anymore” - Mark Twain
Land investment is one of most lucrative ways of investing in real estate. Saying that, however, I must give a word of warning that this area requires an investor to approach land project carefully. A lot of due diligence must be done prior to securing a land project. A land investor needs to know far more than simply his exit strategy, potential growth rate in the area etc. Professional team is required to approach almost any land investment project.
Most popular ways of investing in land are Land Banking, Lot Severance, Single Home Construction and Subdivision Development.
Land Banking is usually associated with a Long-term investment with a main goal of waiting for the property to increase in price due to municipal changes or area development. The biggest challenges are the lack of available financing, high sensitivity to the investor’s knowledge of the area and underlying economic factors.
Land Severance is a process of creating several land parcels by dividing an existing parcel. It is a complex process, sometimes involving public input. Probability of success depends on neighbouring lot sizes and town’s planning department agenda. If successful, ROI (Return of Investment) of such projects can easily reach 25-30% (ROI = Net Profit / Total Investment * 100%). In some rare cases, the sale of one of the parcels allows investors to cover the initial costs of purchase and severance process.
Single Home Construction is a complex process that can be divided into the pre-construction period and construction. Time and complexity of the pre-construction process depends on the lot, plan and municipality; cost of the process may vary from $50,000 to $200,000+. Cost of construction will vary depending on the complexity of the build, materials selected and the crew. Current costs may vary from $150 to $500+ per SF. If successful, ROI of such projects can easily reach 30-50%
Subdivision Development Project is the most complex, requiring previous experience from at least one of the participants and a team of professionals. Time and complexity of the pre-construction process depends on the land, plan and municipality. In Toronto, the time expectancy of the project from the starting stage to the building permit is in the range of 3 to 5 years, while the soft cost of the process may exceed $1M. Cost of construction will depend on the complexity of the project, builder’s experience and materials selected. Current costs vary from $120 to $350+ per SF. If successful, ROI of such projects can exceed 50%, as higher risk may lead to a higher return.
As a steppingstone into the land development play, the investment into the small lots construction could be the best opportunity. Given the complexity of the process, it is important to start on a smaller scale.
For the purpose of this article we will consider a small, 0.3 Ac land lot purchase in a municipality 2 Hours drive away from Toronto, ON, located within 10 minutes of walking distance to the lake. Three simple exit strategies for this investment property that we will consider: (1)Recreational rental, (2)Residential rental and (3)Build and sell. Usually, the lot’s location and zoning will determine the best use and potential exit strategies. In our case, the zoning will allow for 1 single family home or a cottage and, given the location, the best use would be to build at regular 3-bedroom house that can be used as a recreational rental.
To successfully transition from ideas to blueprints to finished product, beginner investor would require a professional help of an architect, engineer and a construction (project) manager. Sometimes the latter can provide their clients with the “full package” turnkey solution including assistance on the drawing and permit stages as well as construction.
The drawing and permit stage in our case will take around 4 months, with the site preparation. Followed by the pouring of the concrete slab foundation and another 3 months of construction, the full process should take under a year (depending of the complexity, of course). Not to get sidetracked but worth a mention, there are several methods of construction (i.e. modular, panel etc.) that can reduce the construction time (and sometimes the price) significantly.
To be able to calculate the profitability of the project, we need to carefully consider all the costs involved at different stages:
Land Purchase: usually an outright purchase, with a chance of a Vendor Take-Back mortgage (VTB). In our case - $125,000 including closing costs. Where we will finance $62,500 - 50%LTV(Loan-to-Value) at a rate of 4% per year (Cost of financing – $2,500).
Soft cost: drawings, permits, deposits, charges etc. - usually outright payments, not part of the construction mortgage. In our case - $75,000.
Hard cost: construction cost – most of the times can be financed up to 70% LTV. In our case, the construction cost will average at $175 per square foot, and given a 1,500 SF house, the cost will be $262,500, where we will finance $183,750 at a rate of 6% per year (Cost of financing – $11,025).
A simple proforma for this project would look as follows:
Even though the third exit strategy does seem more profitable, any of the strategies are plausible, depending on the long-term goal of the investor.
In conclusion, being somewhat biased as land development is one of my favorite ways of investment, I would like to add, that there are usually many more potential exit strategies that are presented for the purpose of this article, and all pros and cons need to be carefully weighed before making a land buying decision. To summarize – work with an experienced team of professionals and never cut corners on your due diligence! Every case is different and if you need help figuring out a better strategy for you, I will be glad to help.
Additional Cost To Keep In Mind:
Building permit fees
Lot levies/ development charges
Septic permit/Sever Hookup fee
Septic Installation/Sewer Hookup
Well/Municipal Water Connection
Landfill and landscaping
Professional fees: Architects, Engineers, Lawyers, Surveyors, Planners
Contingency (10-15% of the cost)