Don’t be fooled into any investment without evaluating what a realistic return will be! Buying land can be a tricky investment however, I have found a simple strategy to keep myself in check when analyzing land for purchase.
If you have spent much time learning about investments you have probably heard of the Rule of 70. This rule is used to determine the number of years it will take for a certain investment to double based on a projected rate of return. While the Rule of 70 is very common among many investors in stocks, bonds, etc. I rarely hear of it being used in the real estate world.
Instead, I often hear investors boast about how a piece of land they own has doubled in value in 10 years. At first you are impressed, but when you truly analyze the investment you find that this was not a stellar return by any means. By using the Rule of 70 you can take the number of years your investment took to double and determine the ROI (return on investment) for this property.
You spend $100,000 for a land investment.
You have a 10 year hold time.
The land now has a $200,000 appreciated value.
The value of this land doubled in 10 years, so take 70 / 10 and this gives you a 7% ROI.
While initially the thought of doubling your money in 10 years sounds impressive, upon closer inspection you find it was actually only a 7% return.
You can also use this equation when analyzing a piece of land for purchase. For example, if you are buying an undervalued tract of land for $100,000 and you think it will be worth double what you paid in 5 years you can calculate your expected ROI in order to see if you are getting your desired rate of return.
The equation for this example would be:
70 / 5 years = 14% ROI
These are a couple of basic examples of how this equation will help you quickly analyze an opportunity to see if you want to proceed. However, before you take the next step you need to subtract any carrying cost such as taxes, insurance and maintenance for the equation to produce a true assessment.
You can also clearly see from these examples that buying land by utilizing debt is very difficult if you want a competitive return on your investment. In the first example, a loan with an interest rate of 7% would actually cause a breakeven or most likely a loss of income instead of a gain at all.
While raw land can be a great investment if you have excess cash, be careful. The returns often seem greater than they actually are! Use the Rule of 70 and you will make solid decisions while taking the emotion out of the game.
What techniques have you used to help analyze your purchases? Feel free to comment or ask any investment or real estate questions by clicking here to reply.