If you bought land in California in the 1970s, you’d probably opine that land is a good investment. If you bought it in 2006, and now it’s worth a fraction of what you paid, your opinion would probably differ. Most knowledgeable real estate investors will agree that buying land is not a good idea, and this includes buying small parcels of land and/or potentially investing in a large land deal. There’s just way too much risk.
Land is speculative
Here is the issue with land: It’s a 100 percent speculative investment. You are 100 percent hoping that the value will go up to provide you a fair rate of return. And it might. But will it go up enough to provide you a fair rate of return for the extreme risk that you are taking holding that land?
Here’s the risk
Let’s say you buy $100,000 worth of land, and you pay cash. It’s still going to cost you money each month to cover property taxes and insurance. And, here’s the kicker: It’s also costing you the opportunity cost of capital.
You probably took $100,000 out of your mutual fund account, or other financial asset, to buy the land. And when that money was in the financial account, it was probably earning interest — let’s say 5 percent — but now it’s not earning anything because you took it out of your account to buy some dirt. So you’re really effectively losing 5 percent in wealth each year because you’re not earning that return. Unless, of course, the land goes up that much in value plus compensating for property taxes, insurance and other annual costs.
As an example, if you have $100,000 and put it into a mutual fund, you’d earn 5 percent, or $5,000, per year. That’s cash in the bank that you can reinvest to earn even more money. After 10 years you’d have your original $100,000, plus $50,000 to $70,000 additional cash/financial asset earnings.
On the other hand, if you bought land, you’d earn no interest or dividends, and after 10 years you’d have a piece of dirt that you’ve been paying taxes on. Will your land have gone up enough in value to match the returns you would have earned on a financial asset?
In addition to those significant financial issues, land also can be contaminated, undevelopable or have significant development restrictions, among other issues.
Who might consider land?
Land may be a good investment for home building companies and long-term corporate land investors with extensive development and entitlement skills and experience, and significantly diversified portfolios of land to reduce their overall risk. But for small investors, it’s a high-risk gamble with little chance of earning a fair rate of return. There are much better investment opportunities, such as stocks, bonds, mutual funds, rental properties or, quite frankly, heading to Las Vegas for the weekend (where, by the way, many an investor has learned some tough land investment lessons in the past decade!).
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Leonard Baron is America’s Real Estate Professor® – his unbiased, neutral and inexpensive “Real Estate Ownership, Investment and Due Diligence 101” textbook teaches potential real estate buyers how to make smart and safe purchase decisions. He is a San Diego State University Lecturer, blogs at Zillow.com, and loves kicking the tires of a good piece of dirt! More at ProfessorBaron.com.
Note: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinion or position of Zillow.