RealTMOR Asset Mgmt LLC and RealTMOR Apartment Mgmt LLP
Often, small investors confuse land purchases as “making real estate investments”. Further, abundant stories are narrated about land-owners “having made a killing”. In my opinion, finished real estate and land are two different asset classes. The risks are different and hence, logically, the returns will be different.
Undoubtedly, executing a land purchase is a genuine investment, even for small investors, and can provide lucrative results. But when one purchases land one should be clear with the risks associated with land ownership. It isn’t and shouldn’t be considered interchangeable with “owning a condominium in a prime city”. Land ownership is ideally for people who have the capability to reap financial benefits from the land by using it or making improvements to it. Agriculturalists would make use of agricultural land through cultivation thereby creating cash-flow. Regulatory experts would optimize land-use (owing to knowledge of zoning regulations) thus increasing/creating value. Developers would execute construction projects and market the finished product (residential or commercial complexes) to maximize value. Hence, one should be clear about “optimizing monetization potential of land”.
Land ownership entails issues/risks that should be considered. Some salient ones include:
- Risk of Encroachment: In developing countries with weak legal systems and poor quality of land records this is a real risk. Whether one owns large tracts of land or a small plot (rural or urban) there is danger of squatters and of “mysteriously moving boundaries”. This problem could be complicated by involvement of anti-social elements. Dealing with this is a problem and the solutions are expensive/cumbersome and could result in a partial or total loss. There are various solutions such as deploying security, fencing and marking the property etc. I have also read of ridiculous solutions such as spreading stories locally that one’s plot is haunted etc. Going the legal route to get your land back could potentially take years in India and prove costly.
- Risk of Zoning/Re-zoning: In urban and semi-urban areas there is “regulatory risk”. The local government could abruptly change zoning laws to suit a previously unknown agenda. This risk is more real than one would like to believe. Often one reads about arbitrary rulings regarding land use from various city governments. It is time-consuming and painful to deal with governments (whether local or regional). So, even with regulatory expertise and ability to navigate the minefield there is risk of “rules changing” during the process. Adverse rule changes midway during the “zoning-status” alteration process could result in losses for the buyer, if the price paid assumes alteration.
- Risk Associated with Land Development: Many investors believe their plot will be desirable to “any” developer and fit into developer plans. That could happen in some cases. But for that to happen, the plot should have certain development-related specifications and commercial stars need to align. Further, this is viable in urban and semi-urban areas but land-prices there are already high (due to the development potential). However, post-development, the purchase might not be as profitable, as initially estimated. Additionally, land development and commercialization risk is significant and the process is time-consuming. There are many instances where “promising areas” never got popular and the development never materialized. Driving between Las Vegas NV and Phoenix AZ one comes across Kingman AZ. Kingman AZ was this “promising town” between two significant and dynamic metro areas. During the US real estate bubble, land prices there were significantly high. But the market changed and realization dawned that it was not as attractive as originally thought. Today, there are gigantic plots for sale, at low prices, along the entire highway.
- Risk related to the Environment: In developed countries this is a significant risk. There are many instances where local governments find “valuable flora and fauna” on land parcels and then “protect the habitat”. In the US, endangered animal species have been found to use land as nesting grounds or connecting pathways between habitats. In such instances, the government would not allow land use that could damage the ecological balance.
- Risk of Eminent Domain: Most countries allow the government to forcibly “take/purchase” land from private owners for “public good”. So, if private land is needed to build a public highway, railway etc. the government can take it. The value that the government could ascribe to the land can be highly arbitrary. It would have massive power in determining fair compensation for owners. If the owners disagree, then they could fight the government through the courts. That is never easy.
- Other Legal Risks: Multiple legal and regulatory risks arise because the government can deem certain areas as critical to national security. In the essence of space, it’s hard to go through many of them in detail. Simple examples would be land that is close to airports, defense installations, strategic coastal areas etc. Any of these events/re-classifications can result in serious value destruction.
- Risk of Poor Land Records: In India, there is a serious risk of defective title and multiple ownership claims of land. If the buyer is a large entity with significant resources (legal and financial) then it can defend itself vigorously, should problems arise. The many changes in Indian land laws (Land Ceiling Act etc) and poor historic record keeping has to result in Land Title defects/disputes being a common feature.
- Risks Related to Upkeep and Maintenance: When one owns land which could be cultivated then generating value from it needs expertise. This value-creation refers to owning a sizeable plantation or orchard and not a plot with “ten mango trees”. Such land owning would be a business (with revenue and cost considerations) and not an investment and it’s not relevant for this discussion. But if one owns a “garden plot” or a small plot of “fruit trees” then keeping it in a desirable state is an expensive and high maintenance proposition. In many developed countries, maintenance of vacant land has to follow protocol and local regulations.
- Risk of Under-Developed Areas: In many rural areas large tracts of land could be available but may not be connected to local utilities. Getting that type of land connected to utilities and making it habitable or developable could be very costly and time-consuming.
So in summation, land purchase can be lucrative for small investors, if done right. But is riskier than buying finished condominium units in prime urban areas. Hence, the higher returns that could be achieved are due to the higher risk undertaken. If risks are acceptable, well documented and there is a value-creation pathway, then it could be lucrative.