Buying Land at Below Market PricesMarch 23, 2018 / Blog / 0 Comments
You’ve probably heard that successful real estate investing is all about “buying right”. Buying right in a land investment comes down to two different considerations of a purchase:
- The characteristics of the parcel, that is, how attractive that particular piece is for current or future development, and,
- Its price.
A land investment might be successful strictly because of only one of these characteristics, or because of some mixture of each. This post is going to focus primarily on the 2nd characteristic, the price paid. Specifically, I want to answer the question:
“Is it realistic to expect to find land at prices that are truly below market value?”
What is “market value”?
A market can be understood as the activity that arises when there are multiple buyers and multiple sellers making informed transactional decisions. The options and decisions of the market actors affects the options and decisions of all the other actors. Each new piece that is available for purchase changes the purchase options for buyers, and each sale increases the competition among buyers for remaining pieces. Knowledge of the terms of recent sales and active listings affects the expectations of both buyers and sellers. Those dynamics affect all markets: Your local grocer, the stock market, and, of course, all forms of real estate including land sales.
Market value is simply the price that something sells for when fully exposed to its market.
What is “market efficiency”?
A market is considered efficient when the information about available properties and closed transactions spreads efficiently to other buyers and sellers. A market is considered inefficient when that information is not available to market actors.
Here is the important point: The more efficient a market is, the more difficult it becomes to find a below-market deal. When efficiency is high and information is readily circulated, buyers and sellers negotiate prices within a much more consistent and predictable range. When efficiency is low, the negotiated price of each transaction can vary tremendously—a dedicated shopper can find a great deal. The stock market is a highly efficient market. The single family home market is less efficient, and commercial and land markets are less efficient still. An extremely inefficient market would be used furniture, musical instruments, or glassware at garage and estate sales, which is why dealers can find some of their best deals there.
Sophisticated investors are drawn to market inefficiencies. That’s because the likely way to buy something below market is to buy it when it isn’t fully exposed to lots of other knowledgeable buyers and sellers. Only inefficient markets produce below market prices.
Consider the seller of a home who recently inherited it from the passing of his out-of-state uncle. Perhaps he’s never been to the home and has no intention of flying out to examine it. Instead, he pulls some tax records to find its size and assumes the house is in average condition. To avoid some headache, he calls a couple investors from the letters he’s recently received in the mail offering to buy his house for cash. Will he sell at a below-market price? All those people mailing letters to inherited properties owners believe he will. They come to the table with much deeper knowledge of local values, a clear understanding of how to put that home in top-of-market condition cost effectively, and, perhaps, a realization that the home is actually 300 sf larger than the tax records indicate. They’re hoping for an inefficient sale.
At the complete opposite end of the scale, here’s a conversation that never takes place:
Customer: What is the stock worth today?
Broker: It looks like it’s currently trading at $375
Customer: OK. I’d like to buy 100 shares. But see if you can find someone willing to sell at $325.
The stock market is so efficient that it would be ludicrous to hope to find someone selling stock for $325 while the market is valuing it at $375. In efficient markets, buyers and sellers don’t expect to negotiate a price that is very different from what everyone knows everyone else bought or sold for.
Land investments and market inefficiencies
A land investment can turn out to be outstanding even if it’s purchased at market prices. If it’s a strategic piece, well located in a growth corridor, and is purchased at the right phase of the development cycle its market value will appreciate and likely provide anywhere from a good to great return for an investor.
But when you exploit the less efficient nature of the land market by buying below market the returns can become radical. The most exciting examples of land investment returns are from buyers who bought strategically in terms of both location and timing, but also found a “deal”, a property they could purchase at a below-market price.
How do you find below-market deals?
Below market deals are, by definition, rarities. But they can be consistently, though not easily, found. Here’s what it takes:
1. Deep market knowledge. This is a critical component and new investors often don’t realize how necessary it is in order to buy a property at a great price. Without deep market knowledge, a buyer wouldn’t even know that the offering in front of him was below market.
Let me illustrate. If some stranger were to randomly offer to sell me a painting for $100,000 dollars, I would decline the purchase because I know nothing about art. If he told me it was painted by a famous artist from the Renaissance I would at best be skeptical. If he then told me a convincing story of how his family has been the documented owners of it for centuries, that it was well known by the art world, that it was worth many times what he was asking, that he had to sell it quietly and immediately due to unrelated legal pressure, and then he produced articles from prestigious art journals that included photographs of him standing next to the very piece of art, I would become quite intrigued. But it’s simply unlikely, bringing so little knowledge of such things to the table, that I could bring myself to actually give him $100,000 to buy it in any reasonable time frame. Long before I could overcome all my skepticisms and concerns he would find someone else that would quickly snap it up, someone who knew a lot more about such things than me.
It might be a deal, but it’s not your deal if you don’t come to the market with deep knowledge.
2. Look at hundreds of deals to buy one. This speaks to the tedious work of the professional investor. It’s a numbers game. If you are looking for a one-in-a-hundred deal, you are going to have to look at a hundred deals. And diamonds in the rough don’t look like diamonds, they look like stones. Each requires a thoughtful and time-consuming examination and you’ll be passing on the vast majority of them. Once you’ve got deep market knowledge, the thing that will usually determine how many great deals you find is how much time you spend looking at not-so-great deals.
3. Develop market credibility. By developing and maintaining a good reputation you’ll put yourself at a significant advantage. Specifically, when land agents come across a particularly good opportunity, they will frequently call only their most trusted contacts. The agents often don’t have complete control of the deal and are afraid to widely share information. If you have a reputation as a credible and trustworthy buyer, you get that call.
In the case of dealing directly with an owner, you’ll find they are justifiably skeptical of people who are offering to buy their property. Your negotiations won’t proceed very far if they don’t find you credible. You can establish credibility as you interact and present your interest, demonstrating your experience and market knowledge.
4. Come prepared to pull the trigger. The great deals almost always present themselves with a short window of opportunity. When they show up, a buyer has to act fast.
Sellers don’t like selling properties for a low price or without exposing them to the greater market. They are typically forced to by some unfortunate circumstance that is imposing a significant and impending deadline. The buyer is solving a difficult problem for the seller, but to ensure the deal closes that seller will often want a much shorter due-diligence period, no financing contingency, and a quick close requirement. Buyers that can jump through those hoops reap the reward.
Naturally, every investor would like to pay below market prices. The formula for success is the same in this endeavor as in most: It takes a lot of work and a fair amount of skill and preparation. We wish you best of luck in your hunt!