I’ve recently become very interested in trying to value vacant land. This is primarily because Kate and I have decided that building a house is in our future. However, after some initial research I’m beginning to find that vacant land can also prove to be a good investment.
We’re going to look at vacant land value from two perspectives. First is the perspective of a home builder and second is the perspective of an investor. But first, let’s talk about what we should be looking at when valuing land.
The general pattern I’ve seen is that the value of land depends on what can be built upon it.
Features That Add Value
When you go to purchase a home, you’ll probably be looking for certain things. Features like a pool or a newly updated kitchen can add significant value to a home.
Land isn’t as complex as a home, but there are absolutely qualities in land that can increase its value.
The importance of being able to access the land cannot be overstated. I mean, if you can’t actually reach your plot, then what good is it to you or anyone else? If there is a gravel or dirt road leading to the location, that’s good. If there’s a paved road leading there then it will be valued even higher.
Road access is even more valuable than it seems at first glance. If you have any intention of building on the land, you’ll need construction crews to drive there. And if this is an investment, then you’ll have a very hard time cash flowing if nothing can actually happen on the plot.
Access to utilities
Some uses for your acreage may not require access to utilities, so this isn’t quite as important as road access. Some do.
A personal residence can require electric, water, gas and sewer. Farmland will require water at least. Running utilities to a parcel of land can cost at least $30,000.
You should know what your purpose is for the land before you buy, and whatever the purpose is, make sure you know the utility landscape and any associated costs.
Zoning laws dictate how your land can be used. Examples of zoning classifications are residential, commercial, agricultural, industrial and hotel/hospitality.
Zoning also affects the highest and best use of a parcel of land. The highest and best use is basically just the thing you can put on the land that makes it the most valuable. The more valuable you can make the land after building on it, the more valuable the vacant land will be.
Clearly, your land is only going to hold value to you if it’s zoning classification allows you to do what you’re intending to do with that land.
Location is important even for vacant land. Generally, land will be more valuable the closer it is to civilization. Your most valuable land will be smack dab in the middle of downtown. And that fact is in line with our highest and best use valuation (downtown land is typically zoned for commercial).
The ideal location depends also on the intended use. The best location for farmland is not going to be the best location for a home.
This one is pretty obvious. More land is more valuable.
That’s not to say that 10 acres is always more valuable than 2 acres. In fact, that’s definitely not always true. 100 acres of unreachable land is probably less valuable than 1 acre of land with road and utility access, but it’s still more valuable than 50 acres of unreachable land.
Buildings already existing on the land can add value. Obviously, a lot of land already has a home built on it. This adds quite a bit of value.
A lot of the vacant land I’ve seen will have barns or shelters build already. These things can add some value if they’re in good condition.
Cash flow opportunity
As an investor, I think of every purchase differently. Every time I spend money I am asking whether this purchase makes me richer or poorer. That’s why my interest in building a house has created articles on this blog.
I have a friend whose grandfather purchased farm land and is paid to NOT grow crops on it. Getting paid to do nothing is a pretty sweet deal if you ask me. If you have a phone tower or some other service provided on your land, it will increase the value as well, because you get paid for those things. Purchasing land like this will not come cheap.
There are holding costs associated with owning land. The inescapable cost is property tax. If your land can cover the holding costs through cash flow, then this will of course increase its value.
Characteristics That Lower Value
Most of the opposites of what we just covered will lower the value of vacant land. And there are a few extra items to watch out for as well.
When there is a lot of rain, the water will pool up in localized areas of the lowest altitude. This can cause serious problems for whatever is built on that land. There’s a few sports fields in my city that get totally flooded when there’s a big rain. Nobody is going to be playing football in 8 inches of standing water.
So on the one hand a flood plain can completely ruin the use of the land for a period of time, or it can also cause damage to anything built there. But on the other hand you may have to pay expensive flood insurance. Both of these are reason enough to significantly devalue the land.
We’ve already talked about this one. If the only way to actually get yourself there is to take a plane, off road vehicle or to hike for several miles, then the land will hold significantly less value. You’ll just find a very hard time creating a meaningful or profitable use for land that is difficult to reach.
Again, certain types of uses are less valuable. Commercially zoned land has a higher potential than residential zoned land. And each of the different zones has further break down.
For example my town has Residential 1 (R1), Residential 2 (R2) and Residential 3 (R3). Each of these has different allowed building types. R1 is OK for single family homes only. And R2 and R3 can house single family and multi-family homes.
For an investor, R2 and R3 zoned land will hold more value than R1. Sometimes what surrounds your land matters. If you are looking at small R1 lot to build on and its surrounded by R3 lots, then you might lower the value of that land. Who wants to live in a single family home surrounded by apartment complexes?
Bad location can come in many forms. We just mentioned one (R1 lot surrounded by R3 lots). In fact, most of the things on our list come back to location. No access to the lot is a form of bad location, and land in a flood plain is also poorly located.
In general, land that is further from civilization or that comes with a major expense is less valuable.
Flat land is more valuable. Building is more expensive on ground with major topographical features.
If you have slopes or rock faces, then you’ll be spending a lot of money to excavate when you build on the land.
Buildings on the land can also lower the value of the land, particularly if they are in bad condition.
When a building becomes trash and must be torn down and hauled away, it’s going to devalue the land it sits on.
Assessed Value vs. Investment Value
We’ve got most of the data points listed now. We know what we’re looking for, now it’s time to start bringing it together and creating actual values for our land.
When a professional values a plot of land, they are going to reference recent sales numbers. They’ll look at similar vacant lots that were sold recently.
Assessors of homes have an easier job because there are almost always recent sales of comparable homes in the area. This means they can find homes of similar size and quality sold nearby in the past year. Land assessors rarely have that luxury. So they must use more tools to properly value land.
They will use a handful of data points:
- Any available comparable sales in are used to help gauge value
- An inspection of the land which identifies access, terrain, and other relevant characteristics
- Determine highest and best use of the land, this will depend on zoning designation and location
From this information the appraiser will arrive at a per acre price point and multiply this value by the total acreage of the lot.
This is a bit of a simplification, but it holds pretty true. The assessed price is going to be anchored off the most recent comparable sales and adjusted based on the findings of the inspection and highest and best use investigation.
As an investor there’s no way I can value a parcel of land based on comparable sales. I only create valuations based on expected returns on investment.
It is possible to obtain a loan to buy land, but this will usually require the use of that land to already be decided upon. The loan to purchase the land would be bundled with the loan to build on that land.
There are two big questions for determining an investment value.
- How much revenue will the land bring in?
- What will the expenses be?
If you can answer these two questions, finding a proper value becomes much easier.
There are a lot of ways to create revenue through land ownership. The most obvious one is to build something on it and charge rent to use or live in that building.
However, that’s far from the only way. You can charge rent for energy companies to put windmills or solar panels on the land. You can rent farmland to farmers. I’m not an expert on cash flowing land (yet), but I’ve heard of at least a half dozen creative ways that investors have created revenue from their land.
When it comes to valuing land as an investor, you’ll need to know how your land will make money and be able to estimate the monthly or yearly revenue based on past experience or research.
Just like revenue, expenses come in many forms.
You’ll always have to pay taxes on your land, but you may also have insurance costs and any costs associated with the buildings on your land. This can include utilities, repairs and maintenance among other things.
I’m a huge advocate of an intensive due diligence process before the purchase of any investment and determining expenses is probably the most important part of that process. When revenue underperforms your expectations it hurts, but when you’re hit with big unexpected expenses it can be soul crushing.
Using revenue/expenses to value
Remember, an investor never uses comps (unless they plan to eventually sell the asset) to determine the value of a property. Don’t anchor your value off other sales.
Use a cash flow valuation.
My go to calculation is cash on cash return. I want to know how quickly the money I’m putting into the investment will return to my bank account. On more active investments like real estate, I expect my initial investment back in 4-5 years. On more passive investments, like stocks, I can live with 10-15 years.
Depending on your personal investment standards, you may also be fine factoring property appreciation into your return on investment. Regardless of whether you use cash on cash or another measurement, the value of the land should be whatever you would have to buy it for to reach your return on investment standard.
I’ll do a quick example to show what I mean.
Let’s say I’ve found a vacant lot and it’s 12 acres. I have a relationship with a company that wants to put solar panels on 4 acres of the land and they will pay a total of $900 per month. I don’t have a plan for the other 8 acres, but to keep it simple, let’s say it would just sit.
The only expense for this deal would be the property tax, which is $1,200 per year or $100 per month.
Using these numbers I would expect a cash flow of $800 per month or $9,600 per year.
Since this is a passive investment, I’ll be OK with a 7% cash on cash return. That would have me getting my initial investment back in a little under 15 years.
With this, my maximum purchase price would be $137,000 ($9,600 ÷ 0.07) for the land. I’m not sure how realistic this example is, but the point is we should use our cash flow numbers as opposed to the comparable sales to determine the value of land as an investment. If we found a good use for the remaining 8 acres, I’m sure our maximum offer would increase significantly.
Note: Before moving forward with a sale I would have the land inspected and appraised.
Remember that a good investor will pass on most investment opportunities because most opportunities will not have good returns. This is as true when investing in land as any other investment.
Valuing vacant land is typically done in the same way as a home is appraised. Value is anchored off comparable sales of similar land and then that price is adjusted based off size, access, highest and best use, terrain and other factors.
As investors, it is our job to ignore the traditional valuation methodologies and arrive at a value that would make us profitable using expected revenue and expenses.
As with other forms of investing, the investment land value is often lower than the traditional valuation. This can make finding deals difficult, but it’s always worth it when you finally find a good one.