Supply and Demand Are Key Drivers When It Comes to Valuation
“Buy land, they’re not making it anymore.”
We’ve all heard Mark Twain’s famous quip, and it’s as true today as it has ever been. Investors searching for growth potential are finding that the right land investment can pay handsome dividends, especially as interest rates remain at historic lows.
However, investing in land is speculative and can be risky. In fact, overall land prices in the United States increased by just 2% in 2018, a percentage point lower than the previous year’s gain, according to the 2018 Land Market Survey conducted by the Realtors Land Institute (RLI) and the National Association of Realtors.
The RLI report underscores the fact that development land prices, in particular, can be volatile. Understanding land values in the context of specific market conditions is essential for investors, who should consider key factors like location, zoning regulations, appraised values, interest rates, cap fees, and tariffs.
Choose the Right Location
Location has historically been one of the most important factors in determining land value. “The location of the property is the benchmark and starting point for all land valuations,” says Seth Hayden, a broker with Hayden Outdoors Real Estate in Windsor, Colo. “If it is commercial, it is about traffic count and foot traffic. If it is residential development ground, it is about [proximity to] city services, privacy, beauty, and a location close to amenities and schools.”
Vinny Delgado, a broker with Fay Ranches in Bozeman, Mont., agrees. “For example, a ranch near Bozeman is going to be worth more than a ranch in eastern Montana simply because Bozeman is a booming community with an ever-expanding airport, offering easy access for absentee owners to get in and out,” he says.
Of course, location is just one layer of consideration for land investors. Hayden also recommends carefully evaluating ease of access, soil makeup, proximity to city services, annexation possibilities, topography, and access to paved roads and utilities, such as sewer, water, and electricity.
Understand Local Regulations and Fees
Zoning laws and requirements vary from city to city, notes Hayden, so it’s important to research the zoning process in a particular area as it can have a significant impact on land value.
“If a town takes three years to go from raw ground to a shovel-ready development, for instance, it is worth much less to a developer than a higher functioning town where it can be done in 18 months,” he explains.
Though, Delgado says that zoning laws are not a big factor in some places, like Montana, because ranch land zoned for agricultural or rural residential purposes will generally allow most uses. But what can make a difference, he says, are over-restrictive conservation easements and mining activity. Both can lower the value of ranch land.
In addition to zoning, the costs to connect a property to the utility grid vary from town to town. Tap fees and other costs related to utilities, excavation, and paving can significantly impact a property’s value. For example, says Hayden, one city in Colorado charges $23,000 per housing type in fees, while a town five miles away assesses a $50,000 fee. “Obviously, the price of the land is hurt by the higher tap fees,” he says.
Delgado says costs related to infrastructure that is in place at the time of a valuation can vary depending on what is needed and where the land is located. “We have equations that help us valuate what it took for someone to bring power into a ranch or specific build site,” he adds.
Consider Interest Rates and Market Trends
Land values rise and fall in tandem with the economy. A strong economy and low-interest rate environment helps drive development, which is the demand-side driver for land values.
Both local and national economic factors can push land valuations up and down. “In strong economies, you have low unemployment and higher wages, and you will see a boom like the past three years,” says Hayden. “But if the economy crashes and unemployment rises, real estate markets fall across the board.”
Delgado agrees that land valuation is heavily influenced by economic factors. “Land is an appreciable asset,” he says. “We use extensive data tracking tools that give us the ability to determine what a ranch is worth, and why.”
While the national economy can have an impact on buyer confidence and sales, Delgado says that comp sales are key to valuation when it comes to the price of ranch land. Prices are determined by what other ranch land sells for, and what characteristics those properties have or don’t have compared to the one being valued.
Conduct Due Diligence
Land investors should conduct due diligence in order to identify hidden costs, ranging from potential changes in zoning to the fine print related to mineral rights. In some cases, for example, public infrastructure projects can boost a property’s value. However, public projects also can subject private land to eminent domain, which allows a government entity to take private property for public use—with compensation that may be below market value.
It’s also important to pay attention to macro-economic trends driving the overall economy. “Factors that increase demand and drive commercial real estate prices higher include a growing U.S. economy, higher corporate profits, and low unemployment,” notes a report by the National Association of Insurance Commissioners (NAIC).
Of course, the fundamental rules of supply and demand apply when it comes to land valuation. According to the NAIC report, prices tend to increase or remain stable when inventory change (supply) and net absorption levels of available square footage (demand) are being absorbed by existing demand.
Moreover, the report adds, investors should closely monitor data points that could indicate a commercial real estate pricing bubble, including supply and demand, vacancy rates, leverage, sales volume, and the cap rate spread over 10-year Treasury yields.
Ultimately, understanding land valuation requires investors to pay attention to both the local details and macro-economic trends.