When analyzing any land transaction, all investors must start with the status of the land. There are six main types of land. Understanding its current use and the possibilities for the land will aid the investor to know the “real” future value of the land. Let’s begin this lesson with an overview of the seven types of land.
There are seven main types of land that we will review in this lesson. The first is raw, un-entitled land. This land is typically farmland or agricultural land and is considered the most basic form of land. To be developed, the land must be entitled for the intended use. This is a growing type of land available as we see many farms “closing” and the land being sold off. This is where a variety of real estate developments are derived from. These lands are sold as individual lots to the buyers for a variety of new real estate options.
The second land type is master-planned raw land. Municipalities generally have a master plan for their communities. These master plans state which type of development the municipality wants on certain parcels of land. The master plan is just a concept and does not provide the landowner with any rights.
The third type of land is zoned raw land. Zoning defines the types of use that might be permitted on the land. If investors want to build a project for which the land is zoned, they have a much better chance of getting the development plan approved. However, zoning by itself does not give the owner the right to develop the land.
The fourth type of land is preliminary-approved raw land. The land is zoned, has gone through the necessary public hearings for subdivision or a site plan, and is approved for the intended use. The subdivision or site plan goes through preliminary to final approval after the development details, (e.g., grading, improvements, fire and rescue, traffic, storm water management, etc.) are worked out with engineers and local land-planning staff. Agreements with neighboring property owners are often reached at this stage, to obtain their public support for proposed development.
The fifth type of land is fully approved raw land. Approved land, or “paper lots,” provides real value to the owners. The land has been taken through the local approval process, which might consist of public hearings and meetings with local municipal land planners and neighboring property owners. After the land is approved, development can begin.
The sixth land type is approved and finished “super pads.” These larger, finished tracts or pads are fully graded with all utilities functioning up to the site. There are no internal roads or improvements, but the pad is graded and ready for development.
The final land type is approved and finished lots. These are the ultimate land commodities. Finished lots mean that the land has been graded and public utilities and roads are in place. The land is a finished pad, parcel, or lot that is ready for construction, which is also known as “shovel ready” land. This is the most liquid form of land.
The following sample transaction is what an investor would consider for residential land. As you can see from the assumptions, the main costs associated with the land would be the purchase price and then the cost to develop the land. In the first section, we discussed the land types. This is when, as an investor, you need to know what type of land you are valuing because the development costs will be higher for the raw, and unentitled land versus the “shovel ready” land.
Another key point is the price per acre. When an investor compares land, you want to try to compare “apples to apples” as much as possible. This means finding land in similar condition and location and determining the actual cost per acre. As an investor, you want to obtain the “most bang for your buck” and not over pay for the land.
The following sample transaction is what an investor would consider for commercial land. Similar the residential land example, in this example, the greatest concerns are the purchase price and the development cost of the land. However, other considerations need to be evaluated as well. Unlike residential land that will likely be sold off to the individual consumers, commercial land will likely be leased to the tenants. You have likely seen the “build to suit” signs when commercial land is for sale. In many instances, the investor/developer will build for the potential tenant and then lease the property at a certain amount. This is usually determined in a lease rate of per square foot. Some of the considerations that are made for the pricing include location, competitors in the same area, and the need for the additional space.
Below is an illustration of the land continuum. When considering investment land, there are several factors that you need to consider. One area that is often overlooked is the zoning. Before you purchase land, make sure you have a clear idea of what you want to do with the land and then make sure that you have the correct zoning! As was mentioned earlier, you are much more likely to have your project approved if it falls in with the existing zoning of the property.
As was mentioned earlier in this lesson, there are seven main types of land. In this section, we will discuss the three broad types of land transactions. The first type is Residential. Residential land is approved for unit housing, including single family homes, townhomes, cooperatives, and condominiums. The common denominator among these various properties is that they are all “for sale” housing. In other words, this is land an investor would purchase and sell to individual buyers versus keeping and collecting rental income.
The second land transaction type is Commercial. Commercial land is approved for income-producing property, such as retail, hotel, office, industrial, or condominiums. As we have mentioned before, understand the zoning before you purchase the land and make sure that it “fits” with your plans for the property. The third land transaction is Mixed-Use. Mixed-use land is approved for both residential and commercial. This land is the most difficult to analyze since there is not one clear path that could be taken.
Regardless of the land type or land transaction, all land investments have similar investing characteristics. Let’s explore these characteristics. The first characteristic is Illiquid. Land is the most illiquid of all real estate investments and the market for land sales is significantly smaller when compared to retail, office, industrial, and multifamily investments. The second characteristic is No Cash Flow. Land investments provide little to no cash flow (e.g. parking lots, lots for temporary uses, such as Christmas tree sales).
The third characteristic is Cash Requirements. Land investments typically require cash during the land-holding period to be used for the following purposes:
- Property Taxes: The amount depends on zoning and the local tax authority.
- Insurance: This expense will be low if no improvements have been made on the property.
- Maintenance: Land must be kept free of weeds, debris, and dumped trash, per municipal ordinances.
- Approvals: These include legal costs and third-party costs during the holding period.
The fourth characteristic is Market-Dependent Value. Market conditions affect land values more than any other asset class. The final characteristic is Terminal Value Only. Unlike commercial real estate, land does not provide an income stream. The cash-on-cash return comes at the time of sale.
There are two main strategies for land investing. The first strategy is buy land and change the approved use. This approach generally has a large positive impact on the land values. However, as was stated before, changing the zoning or use of the land is not always easy! This does come with some risk that the zoning might not be changed.
The second strategy is acquire and subdivide large parcels. Subdivide larger parcels into smaller parcels. This strategy creates a zero basis in the remaining land and provides for instant equity in the remaining parcels. One of the most common forms of this is farmland that is purchased in bulk and then divided into individual lots for consumers to purchase.
As in any real investment opportunity, it is important to understand the numbers and what to look at before making the decision to buy or pass. Land is financed, sold, and traded using many metrics. The first metric is Per Acre. There are 43,560 dirt square feet in each acre. The second metric is Dirt Square Feet. To determine this value, multiply 43,560 by the number of acres to calculate the dirt square feet (e.g., 5 acres * 43,560 – 217,800 dirt square feet).
The third metric is Buildable Square Feet. This calculation pertains to the amount of dirt on a site where one can actually build. For example, a 1-acre site might have only 20,000 buildable square feet, also known as the buildable parcel or the building envelope. The fourth metric is Floor Area Ratio (FAR) Square Feet. The FAR pertains to the number of square feet to which a site can be built out (based on approvals), including the stories of a building. For example, a 600,000 dirt square feet with a FAR of .25 equals a building of 150,000 square feet. The higher the FAR, the more dense the project. The more density, the greater the potential value. In some cases, land trades on per-FAR square footage.
The fifth metric is Lots. Residential land typically trades on a per-lot basis. Lots vary in size:
- Common lot sizes include ¼ acre, 1/3 acre, and ½ acre.
- Lots can also be described by width or linear feet (e.g., a standard suburban lot is 50 ft. * 200 ft. = 10,000-square feet lot, or approximately a ¼ acre.
- Lot width is important because it dictates the street density. The smaller the width, the denser the product. The wider the width, the more “estate” the product has.
The sixth metric is Land Conversion. In many cases, the investor will need to convert land from square feet, to acreage, to FAR square feet. The formula below is your tool for performing such conversions:
Below are two examples using this formula:
FAR to Buildable Square Feet
Back to Dirt Square Feet
There are seven main types of land that we will review in this lesson. For this assignment, list each of these seven types and provide an example of each. In addition, state which land types are considered the “better investment” and why.