Here is a simple guide to help potential investors distinguish between land banking schemes and secure land investment opportunities.
What is land banking?
Land banking is an investment method that involves the purchase of raw land, holding on to it in order to sell it at a future date to turn a profit. However, the flaw with land banking is that more often than not, the land purchased in these schemes is of low value, a greenfield site, not classified for development or agricultural use (un-zoned) and is likely never to be developed. The probability is it will never receive any form of planning permission.
Frequently there is no development company taking responsibility for the future development of the site. The landowner could be any third party, tax haven country, real estate agency or sales company with no or little interest beyond selling the initial investments.
Because 75%-90% of the land is normally sold to individual investors, there is no majority shareholder committed to the future progress of the land (obtaining re-classification etc.). Therefore it is a highly risky investment option.
What is land investment?
In contrast to the low-value land offered in land banking schemes, land investment concerns prime land with a clear path to real estate development. The site offered under this type of investment is zoned (classified) by the local government to allow development for a specific purpose, or already has planning permission in place.
The site is owned by a development company that has a vested interest in its development and has a specific development plan.
If full planning permission is not already in place, the developer works closely with the local municipality to ensure the proposal is approved and the site can be developed.
Additional development capital is raised through private investment in the land, but the majority share of the site is retained by the developer ensuring their vested interest in the future success of the development. As infrastructure is put in place, investors benefit from the development’s increase in value, taking a share in the profits. Unlike land banking, capital appreciation is assured.
How do the sales objectives differ?
With land banking, the main aim for the landowner is simply to sell the land at a higher value than it was purchased for. Once they have sold the plots, their objective has been achieved.
On the other hand, developers are selling land because they wish to raise capital to fund their planned developments. The finance model is an alternative to traditional borrowing.
Ordinarily a development company would raise finance from a financial institution using the land and other assets owned as security. However, almost immediately interest would accrue and very significant payments would be required once the development is realised. By raising capital via private investors they do not have to pay this interest. In exchange the development company shares part of the profit with its investors.
How do the timescales and exit options differ?
With land banking, exit is reliant upon selling the land to a third party. This may be relatively easy if zoning or full planning permission for development has been granted, but this can take a long time – especially with no development company overseeing the process.
It’s worth remembering, if the land is not zoned for any form of development at the outset, it is highly unlikely it will be rezoned, unless in an area where urban expansion may be necessary at some future date. And if the land is not reclassified, it could be extremely difficult to resell.
To realise an investment from this type of land can take between 5 to 10 years – if all goes well. If it doesn’t, exit may be impossible. And because the future of the land is so unpredictable, it is also impossible to estimate what sort of returns will be achievable.
The timescale for realising an investment in development land depends on what stage the development is in. If it is in the beginning stages – pre-planning permission – it could be as long as 5 to 7 years. For developments that already have full planning permission and have started instating infrastructure, you should expect to realise your investment in between 3 to 5 years
However, the length of time is not the most critical part here; it’s the appreciation over the term if you invest. If the annual appreciation meets your expectations then this is the most important thing.
Once the development has been completed, you can either exit with your profits (many developers offer guaranteed buy-back), or swap your investment for a building plot. If you choose to build a piece of property the length of your investment could be longer, but you will still maintain a healthy gain year–on-year.
The developer will be able to provide a realistic projection of the returns by using comparables i.e if they have planning permission to build a beachfront leisure and residential resort, what is the value of a similar existing development in the area? This will give you a good idea of what your investment is likely to be worth in the future.
Conclusion
A well-known adage in property is that ‘land is bought by the acre, but sold by the square foot’. The disparity between entry level and retail exit prices is phenomenal. However, it takes a great deal of expertise to judge which land is most likely to receive planning permission, so buying cheap un-zoned land is extremely risky. Investing in pre-development land, while not without risk, is a far more secure investment option.
