Pros & Cons of Vacant Land

Commercial vs. Residential Real Estate

Part IV - Lots and Land


This is the fourth of a series of five articles comparing the merits and drawbacks of different real estate investments. The next article will offer concrete data, which should assist you in determining the type of real estate investment best suited to your needs, to your personality and to your pocketbook.

For the purpose of this article, lots and land will be taken to be for residential purposes. It will therefore exclude:

- Farm land, which can be considered a commercial venture, with a valuation equal to the residual left after the expected expenses from the cultivation or farming of the land;
- Vacant land zoned commercial or industrial, which also carries a valuation which is a function of the cash flow anticipated from the tracts' highest and best use.


Factors affecting land valuation

The first obvious element is that land very seldom yields a positive cash-flow. The land owner must pay at the very minimum the yearly real estate taxes (often equal to approximately one percent of the land value). If the lot is located in a subdivision subject to homeowners' association dues, these can add to the holding cost, anywhere from a few hundred dollars to a few million (yes, you read well - as is the case for a very exclusive community in Jupiter, FL). If the purchase was made with borrowed money, the yearly debt service must be factored. Other expenses may include a liability insurance policy and accounting fees. Some lot owners - very few however - can enjoy the cash flow procured by road side billboard rentals (if located alongside a major highway), parking fees (if near a stadium or resort where parking is in demand), or any other benefits derived from vending machines, street vendors or other revenue sources.

The second element to consider is the risk associated with possible zoning changes. Such risks would include restrictions on size or style of houses; neighborhood effects such as allowing condominiums next to a single family residence. This would also include eminent domain, when the state forces a sale for the common good - such as the construction of a new highway.

The third element pertains to changes in property rights. If you are not clear about those, ask most land owners on Cape San Blas; they will promptly tell you that the state and Federal governments may "take away" their rights to build on beachfront lots, which had been hitherto buildable.

The fourth element is variation of construction costs. If costs to build increase exponentially between the purchase time and the construction time, you may find out that buying a home would have been a better (and definitely cheaper) way to go. This would bring lot prices down. Reversely, buying discounted lots when construction costs are high, and waiting until they go down to begin construction is an opportunistic way to make money.


Land's main tangible benefits

In the residential market, it makes good sense to buy a house if you need a home. Yet, acquiring a lot might make better sense if:

- You cannot find the house of your dreams and are willing to cope with the hassles of construction, or
- You do not need a house now, but wish to secure a location. This is valid for residents of Atlanta wishing to relocate to Apalachicola upon their retirement in twenty years, or
- You cannot afford your dream house now, but you feel that you will in a few years. This applies to professionals or hard working people starting their career, and who have enough confidence in their ability to earn more down the road.


The vacant lots market

Lots are a perfect example of a market economy. Offer and demand fix the price. Desirability and scarcity are the two key words. All of these factors can be summarized in the well known saying: "location-location-location".


Lots amplify the market trends

One of the most interesting facts concerning lot valuation, is that it tends to register price increases higher than houses' in an up market...And, as a matter of symmetry, lot values go down quicker than that of houses in a down market. In short, lots amplify the existing trend.

The above remark explains why an investor can make a lot of money speculating on lots in a healthy market - but beware, sell out before the end of the up cycle.

How can you foresee the end of an up cycle? This is not an easy task, but it is not impossible either. This is why you should hire a competent and honest Realtor to guide you. I remember very well when Harry Plumblee, Realtor based at our St. George Island office, advised his clients not to buy in an overheated market, as early as the second quarter of 2005 - which was one full year before the "real estate crash".


In conclusion...

Lots are a smart way to make a lot of money, when speculating in an up market.

Lots are also a cheap(er) way to set aside a location or a community life style before you need it or before you can afford to have a house on it.

Posted by: Olivier Monod
Posted: 6/26/2008