Hello C

Generally, raw land is considered to be a high-risk investment. Ultimately, when you buy an investment — especially one that is illiquid — it is important to consider your ultimate goal for the investment. In this case — how are you going to make money on it?

Typically, land makes money in 1 of 2 ways. Either it appreciates — and you sell it for a profit — or it generates income (such as timberland — or land which is already developed, like a strip mall or office building).

Based upon it being residential raw land and your comments about capital gains exclusion, I’ll assume your purpose for considering its purshase would be price appreciation. Price appreciation can occur naturally over time, or can be caused by something you do to the land — such as developing it.

If you intend to increase its value by developing the land — (horizontal development, such as cutting down and selling the trees, putting in water lines, septic or sewer, etc) and then selling it to a developer — you may be in for lots of unexpected costs such as engineer’s reports, zoning permits, etc. All of that comes before vertical development — such as building a house on it. I would check these costs, and your tax strategy with a tax professional before assuming that any capital gain on this type of appreciation can be excluded; the tax calculations may be a bit more complex than you are assuming.

If your intent is merely to hold the land and assume that it will appreciate over time, I would first check out the historical appreciation of property in your area BEFORE 1995 or so. The reason that I say this is because about 1995, real estate values entered into the Real Estate Bubble that we are all so familiar with. All the Real Estate Crash really did was bring these values back to where they WOULD HAVE BEEN — IF that bubble never existed in the first place. This is called reversion to the mean. It is highly unlikely that we will see price appreciation in residential real estate anywhere near what we saw after 1995 because the market dynamics have changed significantly. A realistic expectation for raw land appreciation would likely be somewhere in the 3-4% range — unless a local market dynamic — such as a new plant opening — were to change that.

So many people are assuming that since prices have fallen — they are likely to rise again back to where they were. Unfortunately, the data does not support that assumption. The price appreciation of real estate from 1995 to 2006 was fueled by unsustainable lending practices and massive fraud on the part of investment banks. We are not likely to see that particular mix again any time soon.

So. in short. I would consider this to be a high risk investment — a risk made much, much higher if you are considering financing it.

1 Comment | Flag | Mar 28, 2012 from Jacksonville, FL