Pre-construction land produces > 100% returns

Unlike many people, I have a very broad definition of pre-construction which can be summarized as follows:

Pre-construction is the pursuit of real estate projects that offer the opportunity to ride rapidly increasing prices over time without the need to put tenants in place to defray costs.  Since no tenants are involved, this opens the possibility to making investments in locales that are far removed from where you live.

If you adopt this point of view, then a whole world of “alternative” pre-construction investments opens up to you.   Today, we are going to look at one specific type of investment:  investing in developing land projects where baby boomers might want to retire or own a second home.

Before we get into the specifics, let’s talk about what all investors want:

·        Low risk

·        Good investment returns; and

·        Minimal use of their capital;

Quite frankly, these 3 reasons are what got me into preconstruction real estate investing in the first place.   Now let’s see how these might be achieved on a purchase of investment land that we believe to be VERY desirable to baby boomers.

Suppose we are considering the purchase of a piece of property for speculation of future returns.  If, like me, you believe in the impact of the baby boomers, then you will do 3 things to control your risk:

1.      Carefully select a land project where you are solidly convinced that baby boomers will want to possess it at any costs;

2.      Make sure that you believe that baby boomers will be AWARE of this project in the future do to somebody’s marketing; and

3.      Manage your finances and investment portfolio so that if you are wrong and you do take a loss, it is not catastrophic to you.

For the time being, let’s assume that you have met these conditions on a pre-construction project and now you are ready to analyze your returns and your use of capital.

Now we have to resort to hard analysis.  Let’s look at the following ASSUMPTIONS:

1.      The pre-construction land project is assumed to increase at least 25%/Yr in price;

2.      We plan on holding the land for 2 yrs and then resell.

3.      $200,000 purchase price with $5,000 in closing costs.

4.      Annual taxes/association fees of 1%.

Let’s take a look at three cases in a pre-construction spreadsheet format to how things might turn out under this scenario.

            Case 1:  10% down payment, interest only, all payments made by BUYER.

            Case 2:  10% down payment, interest only, all payments made by SELLER.

            Case 3:  5% down payment, interest only, all payments made by SELLER.

Cases 2 and 3 require a bit of explanation.  There are some early stage pre-construction land projects available where the developer will take a percentage of your purchase price and escrow an amount that will make your payments for a period of time---- typically 2 years.  This means that during your 2 year hold, you would only pay taxes and association fees.  To enter this in the spreadsheet, we just show a 0% rate during the holding period.

If you scroll down, you can review the performance of each case.  It may surprise you that even under Case 1, where you paid in a total of $48,600 out of pocket, you still see a return on investment of 127%!  That equates to 51% annual return on investment.   Compare that to what your friendly banker is giving you in your CD. 

For many investors, pre-construction or not, they would prefer not to have to put in that much money so let’s look at Case 2 where the developer has escrowed 2 years worth of payments.  In this case, we invest a total of $29,000 with a total, out the door profit before taxes of  $81,625 thus providing a total return of  281%.  If you then extend that to Case 3, where only 5% down is required, then the return goes off the charts. 

The biggest variable here is our assumed appreciation rate: we choose 25%.  Of course this depends on the general market, the local market, the project, etc. and NOBODY can predict this going forward.  So what happens as the assumed level goes from -5%/Yr to 50%/Yr which hopefully will be a good bracket.  The chart below shows the results. 

In the very near future, there will be some opportunities on pre-construction land similar to what is described here.  If this type of investment may be of interest to you, then your job becomes deciding these 3 factors:

·        Is it low risk for YOU?

·        Is it good investment returns for YOU?;

·        Is it an acceptable use of YOUR capital;

To assist, we will try to present enough information about the project/locale to for you to assess your own risk and projected growth rates: what you assume may be quite different from what I assume and that is ok.