Pros of Buying Land
During a recent drive into the country, you noticed a few acres of land that immediately raised the light bulb that generates all the ideas in your brain. One of the biggest advantages of buying raw land is you enjoy the freedom to develop the land as you see fit, with of course abiding by zoning regulations concerning land development. For example, the few acres you see for sale might be exclusively for commercial development. You can push for zoning ordinance changes to give you even more freedom to do what you want with the land.
Low Maintenance Costs
Real estate investment involving residential and commercial properties require you to spend money to take care of maintenance issues. If you buy undeveloped land, your maintenance costs are much lower. Maintenance costs for properties include plumbing, electricity, heating and cooling, and materials to fix structural issues. You also do not deal with as much vandalism when you own a parcel of raw land.
Cheaper than Developed Land
Let’s assume you want to purchase land to build a place you can spend retirement. Instead of buying land and property, you pay much less for just the land. Then, you control how much you want to spend on construction of the new home. Buying undeveloped land is a much cheaper way to invest in the real estate market than spending money on acres of developed land.
Cons of Buying Land
The first con to consider for buying land involves the challenge of getting a lender to improve a land loan. It is much more challenging to get approved for financing the purchase of vacant land than it is to get approved for more conventional residential and commercial property loans. If you develop vacant land, you have to wait until you develop the entire property to receive a healthy return on your investment. Poor liquidity is especially a concern for lenders that review applications for land loans.
Fewer Tax Breaks
Federal tax law allows landowners to receive tax breaks for the depreciation of specified improvements, such as the construction of a home or the paving of a road leading to a business. However, raw vacant land offers few, if any tax breaks depending on the different tax laws enacted by each state. You also do not enjoy mortgage-related tax breaks, which includes a deduction for mortgage interest payments.
Waiting for the Cash to Flow
Although you do not have money going out to pay for a mortgage of a monthly payment on a commercial property loan, you still have to pay property taxes, land development expenses, and in some cases business or homeowners association fees. Without rental income or revenue generated from business sales, you end up at best looking at a neutral cash flow position. The more likely scenario is the purchase of vacant land will create a money drain until you develop the raw land. You can sell rights for mining resources or sell pieces of the land to generate cash.
Zoning Can Be a Problem
With less restrictive zoning ordinances, you enjoy more freedom to develop the land. However, especially in urban areas, many cities pass highly restrictive land zoning ordinances that tell land buyers what they can and cannot do with the land. You might also have to deal with a municipal government that drags its feet when approving your request for a project to develop the land. Many local governments limit how many lots a land buyer is allowed to develop and sell.
Market Timing a Risk for Vacant Land
If your goal is to buy land and wait for an uptick in the real estate market, you risk losing more by purchasing raw land than you risk by investing in a developed property. You can improve services such as sewer and transportation and become stuck with nothing to show for it. Timing the real estate market is difficult for savvy investors that put money into developed land. The risk is much higher for investors buying vacant land.
Types of Land Loans
As a broadly defined term, “Land Loans” encompass loans used by borrowers to purchase land. However, the primary difference between land loans are the four major providers that offer cash for the purchase of land. Another difference is whether a borrower funds a land acquisition for commercial, agricultural, or recreational purposes.
Let’s review the four main types of land loans.
Local Bank Loans
Most land loans originate locally from financial institutions that are familiar with the characteristics of the parcels of land borrowers consider for purchase. Local banks are often the only financing option for borrowers to acquire land in rural areas. Therefore, we encourage borrowers to inquire about land loans with local banks, credit unions, and savings and loans. Locally generated land loans are ideal for land buyers that prefer to deal with a finance professional who knows the area well.
Here are the terms generally applied to local land loans:
Interest rate: Around six percent in some cases
Length: From seven to 30 years
Down payment: Up to 30 percent of the land’s purchase price
Credit score required: At least 680
Time it takes to receive loan: Between five and nine weeks
USDA Rural Housing Site Land Loans
Sections 523 and 525 of the USDA code spell out the provisions of what the federal government calls Rural Housing Site Loans. These loans are targeted to low and middle-income buyers who want to purchase land for the construction of a home. Rural Housing Site Loans are perfect for rural land buyers that meet the income requirements. Remember the income requirements constantly change because of changes in the inflation rate, as well as changes in the definition of low and middle-income brackets.
Here are the terms generally applied to Rural Housing Site Loans:
Interest rate: Around five percent
Length: Two years
Down Payment: Up to one-and-a-half percent of the land’s purchase price
Credit score required: At least 640
Time it takes to receive loan: No more than 60 days
SBA 504 Land Loans
The Small Business Administration (SBA) helps small businesses acquire land loans to develop the land for commercial purposes. Under Section 504, the SBA has the power to lend money to small businesses to purchase land for building factories, restaurants, office buildings, and grocery stores. The SBA sometimes approves small business land loans for the construction of hotels and apartment buildings. SBA 504 combines two types of loans: one from a lender and one from a Certified Development Company (CDC).
Here are the terms generally applied to SBA 504 loans:
Interest Rate: Between four-and-a-half and eight percent
Length: From 10 to 20 years
Down payment: Starting at 10 percent up to 20 percent of the land’s purchase price
Credit score required: At least 680
Time it takes to receive loan: Between 45 and 90 days
Home Equity Loans
If you own a house or some form of another type of investment property and you have access to a home equity line of credit, you can borrow money from the equity in your home to purchase land. In most cases, it is easier to raise land investment funds from a home equity loan than from any of the types of land loans offered by financial institutions. Home equity loans are ideal for investors who have already established a line of credit.
Here are the terms generally applied to home equity loans:
Interest rate: More than four-and-a-half percent
Length: 10+ years
Down payment: Between 80 percent and 90 percent of the land’s purchase price
Credit score required: At least 620
Time it takes to receive loan: Between three and six weeks