Today I Had my Eleventeenth Call Of The Week About Land — Let’s Take A Look

What’s not good about land? Bottom line, without it we’re either sportin’ gills or flappin’ wings. Most investors simply don’t do well with land, as the use of leverage with land automatically means moderate to massive negative cash flow from Day 1 99% of the time. Sound alluring?

Is land a vehicle equipped to provide a smooth ride for real estate investors on their way to Retirement Land? Not in my humble opinion, and for several concrete reasons.

1. When capital growth is needed most, the first dollars of any real appreciation are soaked up by the cost of simply holding the land — and that’s free and clear land.

2. To the extent you took on debt in the acquisition of the land, your negative cash flow is now approaching scary territory. And don’t say, “I put 50% down’ ‘cuz that means you’re now servicing debt at a rate of at least 5-8% a year. To have your capital grow one itty bitty drop, the appreciation must exceed all your holding costs by the same little drop. Not freakin’ likely, mate.

3. In times like these your options menu doesn’t include ‘Hold until this blows over’. Why? Oh, I dunno. Maybe ‘cuz now, instead of the dirt not increasing in value, it’s losing value, while you continue to add to your losses by making your loan payments and staying current with the taxes.

4. Oh, did I mention taxes? If ya bought this pile of dirt during more or less good times, tax assessors love to reflect that by raising taxes. Duh. Ever notice they don’t use the same logic as it’s losing value?

Let’s create an example.

You bought a couple acres of land for $100,000 back in 2003, using 50% down. Your annual debt service, based on 6.5% interest only, is costing you $6,500 — year in and year out. It appreciated at a relatively fast pace the first couple years or so, around 15% a year.

2½ years at that rate puts its value at around $142,000 or so. Problem is, it’s over three years into this correction, and you’re lucky if it’s worth what you paid for it. Really lucky. Let’s see where you are now.

5 years of debt service — $32,500 out the door.

5 years of real estate taxes — $7,500 you’ll never get back.

We won’t even talk about the little surprise local cities/counties spring on vacant land owners. Ever got that warning in the mail? You know the one — you clean up the brush or we will, then charge ya for it? I have — think 30 acres of cleanup. It’s what Grandma called a learning experience. Why are they almost always painful?

So to review, you now own land worth about what you paid for it. It’s cost you $40,000 for the privilege. It’s saved you $2-3,000 a year in income taxes. How exciting for you.

Shall we stop the math here so as not to heap insult on top of injury?

If you were to list it with a land specialist and sell it today for 150% of what you paid for it, a fantasy if there ever was one, your net proceeds would be, um, enlightening.

After costs of sale, say 8% including everything, you’d net around $85,000 or so after paying off the loan. Sounds pretty good doesn’t it? You put $50,000 plus some closing costs into it at purchase, and got $85,000 back. Oh, wait a sec. You also poured around $40,000 or so into that money sucking black hole during the holding period, which again, you’ll never get back. That means you had over $90,000 into it — cash taken directly from your Levi’s and turned into steam which immediately did, well, what steam usually does. Disappear.

Here’s the cherry on this dirt cake — your CPA will be tellin’ you to write a check to the IRS. Seems you made a capital gain when it sold.

Isn’t land grand?

To be honest, yes, sometimes it’s pretty cool. Mostly though? Not much. It’s a whole lotta buy low and sell high, with time being of the essence, usually in a big way. That’s real estate talk for it better happen soon, ‘cuz with land time ain’t yer friend more times than not.

Leverage actually works against you, ‘cuz debt with no income ain’t recommended.

Even buying without debt guarantees negative cash flow.

No leverage means you might as well buy stock — at least there’s no negative cash flow.

It’s possible to owe capital gains taxes even though you lost money. Go figure.

What we haven’t discussed here is your opportunity cost. Oh yeah, that.

If you’d bought income property instead, it would be worth more or less what you paid for it about now. You would’ve put 10-25% down when you bought it, pretty nice leverage, relatively speaking. Let’s say you used 20% down. It’s been 5 years now, and the property has paid for its own operation. It’s given you the same tax shelter as the land would have, but with one little exception. It didn’t cost you a dime. It was based on a ‘paper loss, for which you lost not dime #1 from your Levi’s. Those tax savings are what we in the business call positive cash flow. Also, while your debt service was static, your net income probably (not for sure) rose due to rent increases. It could’ve dropped, but probably not if you bought in a solid growth region.

Since it held its own the last 5 years, you kept roughly $40,000 or so in your own Levi’s — a good thing. Furthermore, you can relax and wait for this correction to run its course. Every 1% of appreciation means your original capital investment of down and closing costs, (maybe $55,000) grows by over 4.5% as a result of your new best friend — income supported leverage.

Including my own sad story of woe, many clients have told me how they’ve been holding a piece of dirt for sometimes longer than 20 years — not only resulting in no real gains to speak of, but in San Diego, the literal loss of hundreds of thousands of dollars in gains not realized. A sobering thought for anyone.

BawldGuy Axiom: Most of the losses incurred from land investments aren’t from the land, which often rises in value. It comes from holding costs, lack of leverage, and gains not realized from better, more prudent investment vehicles.

If in 2000, in San Diego, you had taken $100,000 and bought a piece of free and clear land, by 2004 you might’ve made $75,000 before costs of sale. If instead you’d acquired small income properties for $500,000? That same $100,000 woulda turned into a whole buncha $500,000. Which scenario would you prefer? Go ahead, take yer time, no rush. Even if I tripled the gain on the land? It still wouldn’t amount to half of the gain on the income property. Oh, now yer payin’ attention.

OK, enough about land. Bottom line is, you can make a boatload of money investing in land. Problem is, your timing must be impeccable, and your pockets should be pretty deep. When investing for retirement, sorry, but land probably isn’t the way to go.

Here’s something you can do. Call me at 619 889-7100. Why? I need a fix, plain and simple. ‘Course I always need a fix — I always need to be creating new plans, solving new problems. It’s what I do. If you’d rather email me, just click Contact BawldGuy and you’ll be on your way. Have a good one.

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