MoneySense Magazine, December/January 2012
Paydirt: Investing in land
Canadian cities are growing fast. If you invest in the right land before the developers do, you could make millions.
This article was first published in the December/January 2012 issue of MoneySense.
Twenty years ago, Anne Schmidt thought the 50 acres of land she lived on wasn’t good for much. Her scrubby plot mainly served as a buffer between her quaint farmhouse and the rapidly-growing suburbs of nearby Barrie, Ont. Zoned for rural development, she and her then-husband knew the plot wasn’t even good farmland. But there was enough room for their two Ford pick-up trucks and plenty of time to consider how one day they might make the most of it by building their dream home.
So you can’t blame Anne for being caught off-guard when a housing developer came knocking 15 years ago offering her an astounding $600,000 for 40 acres of her land. Almost as suddenly as he appeared, the deal fell through. But Anne realized that her land wasn’t good for nothing after all: Barrie had become one of Canada’s fastest-growing cities and it was only a matter of time before the developers came knocking again. The only barrier? That her land wasn’t zoned for housing development.
Today, in her mid-50s, Anne has almost completed the long, complicated task of rezoning and selling off 40 acres of her land. She didn’t expect that it would take more than a decade to accomplish, but she has no regrets. After all, she’s right on the verge of every land investor’s dream payoff. When she completes the sale in a couple of years she expects to clear more than $3 million before costs.
For many people, land is the ultimate investment. As the saying goes, they’re not making any more of it. Even before the last spike was driven home in Canada’s transcontinental railroad in 1885, savvy speculators were trying to hit paydirt by purchasing cheap land with lots of potential, then selling it for a tidy profit when demand grew.
But investing in land isn’t always a walk in the park. As anyone who’s been tempted by swampland in Florida can tell you, for every legitimate potential investment, there are dozens of unwise gambles and outright scams. The key to making money is to know exactly what to look for when you’re choosing your investment, as well as the steps you need to take to turn a worthless piece of land into a gold mine (sometimes literally).
If you’ve ever wondered about whether you too could make money investing in land, read on. We’ll tell you about five key strategies for making it work: flipping land, developing it yourself, buying an infill property, renting it out, and exploiting its natural resources. Just as importantly, we’ll tell you everything you need to know to avoid getting suckered into a bad deal.
A plot gone wrong
In the late 1980s Toronto was in the midst of a housing boom and three local businessmen figured they had a surefire scheme to make millions. The trio of investors paid $2.2 million for a plot of land at 31A and 33 Parliament St., on the east side of the city’s downtown core. The property market was white-hot and their intention was to cash in by immediately flipping the land to a housing developer, who would then go through the process of rezoning the property from industrial to residential development.
But what Michael Kilbride, Norman Rothberg and Hollace Wong didn’t realize was that their plot was badly contaminated. An auto wrecker had once operated on the property and empty oil drums and other hazardous waste were still scattered about. Quickly, the syndicate of investors learned that the environmental hazards contained in their property made it virtually unsellable. Worse, as they considered their options, the local real estate market peaked and by 1992 it was in free fall. By that point, they couldn’t even give the land away. They spent the next eight years and tens of thousands of dollars in a legal battle. In the end each walked away with a massive loss.
The maneuver Kilbride, Rothberg and Wong attempted was the classic land flip. You buy up a piece of raw, undeveloped or under-developed land, then flip it fairly quickly to a developer for profit. But while it sounds simple, land flipping is fraught with risks and complications.
It’s all in the zoning
As Anne Schmidt found out, the key to flipping land is to buy cheap land that’s not zoned for development, and then get it rezoned yourself. Just changing the zoning can have a massive impact on the land’s value. For example, a few kilometres south of Barrie, a 100-acre cash crop farm, complete with a 3,400-sq-ft Victorian home, is currently selling for $1.7 million, or $17,000 per acre. But 15 minutes to the north, you’ll pay a whopping $433,000 per acre for a six-acre parcel of raw land—or $2.6 million for the lot. The reason for the steep jump in price? The second property is already zoned for residential use.
The hard part is predicting whether you’ll be allowed to rezone your land or not. That’s because provincial governments, which dictate land use, only commit to five-year development plans, and even then, those plans can suddenly change, sometimes dramatically. Take, for example, the Oak Ridges Moraine, a belt of rolling hills stretching between the Niagara Escarpment and Rice Lake in southern Ontario.
In the late 1980s, this land looked like a can’t-lose investment. Toronto, Mississauga, Oakville and other Golden Horseshoe cities were expanding rapidly northward towards the area, and it didn’t take a genius to see that soon that land would be worth billions. But in 1989 various groups petitioned to protect it. Twelve years later, in 2001, the Ontario government agreed. Some landowners benefited as the value of their land abutting the greenbelt went up in value, but many others lost out: their land was now protected by a conservation act and could never be developed.
To maximize the possibility of turning agricultural land into pricier commercial or residentially zoned land, you need to consider five major factors:
Proximity to urban infrastructure. The closer the land is to existing sewer, hydro and other services, the better the chance of future development. “Provincial and municipal authorities won’t allow development in the middle of nowhere,” explains Paul Rabinovitch, partner with HGR, Graham Partners in Barrie, and a certified specialist in real estate law. “Service and infrastructure are required in order to support any new development.”
Road access and allowances. Easily accessible land, or land close to major transportation routes, commands more interest and a higher price, since the commuter infrastructure is already in place.
Your timeline. Because it’s getting tougher and tougher to find land that has not already increased in value, you may have to prospect further and further away from major municipalities. This will also require a much longer holding time, and will probably mean a longer selling window.
Environmental issues. In addition to making sure that the land you’re interested in isn’t protected from development (or likely to be protected in the future) you need to gauge the possibility of contamination. “Only developers with deep pockets will get mixed up in contaminated land,” says Rabinovitch. To protect yourself, pay extra for a comprehensive title search to find out what developments were in the area over the last 50 years. As those three unlucky Toronto investors found out, “if there a was a gas station or auto-mechanic shop you should pretty much assume contamination.”
See it for yourself
Once you’ve found a good prospect, it’s time to conduct a visual inspection. With the advent of satellite imaging technology, such as that used by Google Maps, you may consider skipping this step, especially for remote land or foreign investments. “Don’t,” says software developer and land investor Robert Devenyi, 34. “Never buy a property sight unseen unless you have a very solid reason.”
Jeff Oberman, owner of OntarioTaxSales.org, a privately-owned corporation that facilitates tax sales, agrees with Devenyi. He says Google and other geo-mapping systems often average out house numbers or property coordinates, so their maps can be inaccurate. “We’ve seen maps that are three years out of date and we’ve seen maps where the wrong piece of property is shown.”
Assess the potential profits
Once you’ve identified potential land opportunities, you’ll need to assess what the land is worth now, and what it could be worth in the future. This calculation is always part math and part guesswork.
When Devenyi assesses the potential worth of an investment, he considers the current value, the annual property taxes and the future intent or use of each parcel of land. “The tax-assessed value gives me the cost to carry the land each year. All I need to do is multiply this value by the length of time I expect to hold the plot.” Then he’ll use publicly available real estate listings to compare his land to similar properties—this gives him an idea of what he could earn on the future sale of the land. Once he has these two numbers he’ll “discount” the asking price for the property. “If my numbers are positive, I’ll proceed with a bid or purchase. If the number is negative, I’ll keep reducing my purchase price until the numbers make sense.”
For land owners like Anne, the process was slightly different. She already owned the land and needed the zoning changed in order to make the sale of the land profitable. Don’t underestimate the amount of time and effort that’s involved: rezoning from agricultural to residential requires a significant amount of paperwork, including professional assessments, surveys and subdivision architectural plans. It can take many years. “Rezoning land for a subdivision can be very lucrative, but it’s also much more expensive and time consuming,” says Rabinovitch. “Municipalities require professional assessments and sign-off and that takes time and money—so much time and money that you could lose your shirt.”
Divide and conquer
One strategy that works well in urban areas is to buy a larger piece of land that currently has a single building and then go through the process of severing and rebuilding multiple dwellings on the land. Called “infill housing” by developers, this type of investment is common in cities where the infrastructure and amenities are already in place.
For example, a small 1,500-sq-ft bungalow in Toronto’s working-class West end recently sold for just under $360,000. The buyer went through the process of having the property severed, then tore down the bungalow and built two semi-detached homes, which he then sold. A few months later he walked away with a $160,000 in profit.
“Land severances are a much simpler process than speculating on future development,” says Rabinovitch, “but it still requires a lot of due diligence.”
Before you put in an offer to buy a property, call the municipality building department to see if severances are allowed in that particular residential area. While you’ll almost never get a firm “yes,” you could get a firm “no,” and you can find out what requirements you need to meet if you get a “maybe,” says Rabinovitch.
At this point, you can put in an offer on the property, but make sure to include a condition that will allow to you dig a bit deeper into the zoning and permit requirements before the sale is finalized. “This extra due diligence could cost you a few hundred dollars, but it could also save you a few hundred thousand dollars.”
You should also consider getting pre-approval on your financing. “Keep in mind that as soon as you demolish an existing building you demolish the security collateral for a typical mortgage,” explains Tammie McMullen, a Calgary-based mortgage specialist with ATB Financial. For that reason, most infill developers will seek out a land-value mortgage. “We can provide financing for up to 75% of the land value, but it does depend on where that land is located,” McMullen says.
While there are some significant benefits to infill development—information on zoning and permits is readily available—there are also pitfalls to consider.
First, you’ll be competing with other developers to cash in on the same opportunity. “The price of the land reflects the fact that there’s not a lot of uncertainty in this type of development,” says Rabinovitch. You’ll also need to factor in the price of development. Construction costs will range, but a good ballpark is $150 per square foot—so a 2,000-sq-ft home will cost you $300,000 to build. Plus you’ll need to obtain professional drawings, which cost between 10% to 20% of your total construction costs, and pay for municipal permits.
Develop it yourself
Like infill development, this strategy will see you adding to the value of raw land by building on it and then selling. Real estate investor Sean Ellis recently used this strategy with great success when he paid $80,000 for two acres of raw land near the North Halton Golf and Country Club, in the township of Halton Hills, Ont. There were no buildings on the property, but Ellis (we’ve changed his name to protect his privacy) knew that homes in the area usually sell for at least $800,000, with some of the larger new-builds fetching more than $1.2 million. Even after paying permit, construction and carrying costs—to the tune of approximately $550,000—Ellis easily made a profit of more than half a million dollars.
When considering this type of purchase, land investor Devenyi uses a rule of thumb: the further away from a major metropolis, the smaller the initial capital investment and the longer the timeline for growth. Of course, the opposite is true: the closer you buy property to a major urban centre, the more costly the land, the faster you can turn the property around for a profit. For Devenyi, closer properties require a five- to 10-year investment, while properties further away can take 20 years or more to achieve maximum value.
The key is finding property that’s undervalued because it’s underdeveloped. Realtors can be helpful: they know what’s formally and informally for sale, they can give you comparables for the area, and they can provide insight into potential obstacles, such as access issues.
Another popular resource for finding investment opportunities is the tax sale, a public auction that’s held on behalf of a municipality to collect property tax that’s gone into arrears. Since the current owners haven’t paid their taxes, the city will sell off their land, in “as-is” condition, to the highest bidder. While spectacular deals are possible—Sean Ellis’s Halton Hills purchase was a tax sale—there’s also a lot of risk involved with this type of investment.
“Tax sales are a bit like playing the lottery,” says Rabinovitch. “Most are dogs: back lots, or lots with complicated access issues, or land that’s so far north it will take decades to appreciate in value.”
Before making a bid, be sure to inspect the property to determine if there is year-round access by road. This is vital if you plan on financing the purchase, as most lenders won’t touch property that has only seasonal access. “If the land or cottage doesn’t have year-round access we simply cannot finance the purchase, because the risk of not being able to resell can be quite high,” says mortgage specialist McMullen.
If there is year-round access then you’ll want to consider one of two mortgage options: a “completion mortgage” means your builder covers the entire cost until the build is complete and you get funding at the end of the project. The more common option is a “draw mortgage” which provides your builder with financing throughout the build. Keep in mind that both mortgages are only amortized over a 25-year period and that you’re limited to a variable rate. “Borrowers with great credit will typically pay prime plus 1.25%. Those with low credit scores will start at prime plus 2%,” says McMullen.
Once your financing is secure, you’ll want to fork out between $100 and $300 for a basic title search (sometimes known as a sub-search). This will show you who owns the land, when it was bought, any liens or attachments registered against the property (such as mortgages), and any easements placed upon the property.
“You really only need to worry about federal liens,” explains Oberman. While all other debts are eventually wiped out once a tax sale is processed, federal liens remain on title until paid off, or the provincial government negotiates a settlement with the feds.
Still, the benefits of developing land for investment purposes are simple and straightforward: the cost to purchase raw land is significantly lower than purchasing property. And even if you sit on the land, untouched for years, your holding costs are relatively small.
Whichever strategy you decide to pursue—be it snapping up farmland with potential, investing in urban infills, or developing underused land yourself—keep in mind that while it can pay off handsomely, it’s not usually a get-rich-quick scheme. Just ask Ann Schmidt. She began the process of rezoning her farmland property for development more than 10 years ago, and she’s still a few years away from seeing that investment pay off. “It’s a tedious, tough process that can make or break you,” she says. Worth it though. When she finalizes the deal, she’ll clear more than $1 million in profit after covering her costs. Looks like she’s going to get her dream home after all.
MoneySense Magazine, December/January 2012