Investing in Land for Development: Cardinal Rules

People who invest in land for a living, like builders and developers, know that following a couple of cardinal rules can mean the difference between having a deal that's potentially viable and one that is a disaster in the making. Here are the principles that influence their purchasing decisions.

Rule 1: Location
Location is the most important aspect of a property because it's the only thing that can not be changed. You can destroy or add onto a house or maybe even pick it up and move it, but you can not pick the land up and move it. Location determinates not only how the property can be used (zoning) and accessibility to public utilities, but also the parcel's value based on the surrounding properties. There is no substitute for a good location.

Rule 2: Value Is Always Related to Use
The value of land for development hinges on its ability to be used by buyers. A 10 acre parcel with substantial areas of floodplain, steep slopes or wetlands may produce only one building lot. Its value will absolutely be determined by what a buyer can do with it (ie, build one house) and not by the number of acres it has.

Rule 3: More Target Markets = Higher Value
Value increases if the parcel can be used by many potential buyers or categories of buyers. Several factors determine the market appeal of development land. These include uses permitted under current zoning, location, availability of public or on-site utilities, physical characteristics, and legal restrictions. Suppose you're thinking about buying a property that abuts a pig farm. It has everything you want, including a cheap price tag. But chances are, you will not find many buyers for it when you go to sell. Conversely, you will have to pay more for a parcel abutting parkland, but you'll have your choice of buyers willing to pay a premium price for it.

Rule 4: Value = Price + Terms
Ultimately, buyers determine what a property is worth, but an offer is much more than just price. It's a set of scales with price on one side and terms and conditions on the other. The real value of development land is the price a buyer is willing to pay in exchange for terms and conditions. For example, you want to buy a landlocked parcel. You need to know if the owner of the adjoining property will sell off some frontage. You do not want to purchase the frontage without the seller accepts your offer and you do not want to have to buy the property if you can not get the requisite amount of frontage. So you would give the seller an offer contingent on your being able to get the frontage and anything else you'd need to be able to sell the parcel to builders. You would offer the seller a higher price if the seller would agree to these conditions than if the seller wanted to sell "as is."

Rule 5: When Buying, Think Like a Seller
Before you decide to buy a land parcel, you should evaluate it as objectively as possible and try to identify objections that buyers might have when you go to sell. In short, when investing in land, think like a seller because your goal is to sell the parcel, not live on it. When builders purchase land for development, they evaluate it in the context of the property's appeal in the eyes of the end users (ie, home buyers or those leasing or purchasing office and retail space).

Rule 6: Do Your Due Diligence
Most of what you need to know about the land parcel can not be seen. So many issues need to be investigated, including zoning, utilities, surrounding property uses and values, deed and other title restrictions, and the site's physical features. It's absolutely critical that the due diligence be performed thoroughly, even if that means you have to hire somebody to do it for you. There are no short cuts here. Incorrect assumptions, bad information and what you do not know could come back to haunt you.