Land banking: What does it involve and how good an investment vehicle is it?
In a land banking scheme, property developers usually buy a piece of land, divide it into smaller blocks and offer it for sale to investors.
What you need to know:
- In a land banking scheme, property developers usually buy a piece of land, divide it into smaller blocks and offer it for sale to investors.
- Each land-banking scheme will usually have its own investment rules elaborating on the rights of the buyers and the sellers, the contract periods of the options, as well as exit clauses to protect the rights of both parties.
- As with any investment in real estate, due diligence to establish ownership and avoid future legal complications is important.
It is often said that money is always ready and eager to work for anyone willing to employ it.
For those seeking to create wealth and make their money work for them, this saying summarises what investment is all about.
If you are like most real estate investors, you are probably pursuing this business with one or two primary goals in mind - to either buy a property and flip it for profit as soon as possible, or to buy a property and create a dependable source of passive income.
Both strategies are legitimate time-tested methods that can create wealth for you in real estate.
Due to time and resource constraints, sources of passive income provide an ideal investment portfolio for most investors.
Unlike active income which requires the investment of time and resources, passive income is generated with minimal input from the investor.
One such investment vehicle that is often overlooked in the real estate market is a buy-and-hold technique called land banking.
What is land banking?
The term implies almost exactly that. Rather than putting money in a savings account or investing in the stock market or other similar investments, some entrepreneurs have taken an alternative approach, which involves acquiring land, and in doing so, parking their cash in a tangible, fixed asset.
In a land banking scheme, property developers usually buy a piece of land, divide it into smaller blocks and offer it for sale to investors.
As an investor, you either buy a plot of land or buy an option to purchase a plot of land.
These are known as option agreements. An option agreement for a land purchase option is a legal arrangement between a landowner and a prospective buyer of a site.
In essence, the option holder has the right to acquire the site from the landowner at an agreed-upon price and within a specified time period, assuming the option’s terms are met.
During the holding period, the investor can generate cash flow by leasing the land or putting up short-term agricultural projects, for instance, horticultural farming or beekeeping.
Land banking schemes vary in terms of tenure of contract, price, and the rights of the seller and the buyer.
Investing in a land-buying scheme should be done after conducting research and ensuring that the scheme is keen on following due process.
Before investing, one should consider the appreciation value of the land. Appreciation of land is often subject to the availability of amenities, institutional and commercial development in the vicinity and development of residential premises among others.
In most cases, land banks buy vacant residential land in close proximity to major cities or developing towns.
Each land-banking scheme will usually have its own investment rules elaborating on the rights of the buyers and the sellers, the contract periods of the options, as well as exit clauses to protect the rights of both parties.
Even though sometimes overshadowed by other investments in real estate such as houses, homes, apartments and commercial properties, land banking is not a new investment portfolio.
The first known investment in a land bank took place over 500 years ago when the first American multi-millionaire John Jacob Astor bought a huge piece of undeveloped land in New York and later sold it for huge profits.
What are the investment rules for land banking?
Each land-banking scheme will usually have its own investment rules elaborating on the rights of the buyers and the sellers, the contract periods of the options, as well as exit clauses to protect the rights of both parties.
The general idea with these schemes is very similar to off-plan investing – buy today at an understated or undervalued price with the prospect of making significant returns at the maturity of the project.
Similar to off-plan schemes, they are often sold on the concept, unlike actual subdivision schemes so that the investor is basically pooling their funds with other investors to acquire a larger parcel, as if on the basis of shares, not necessarily with the rights that attach to actually owning the property.
Before investing in land banking
James Ngane is a financial consultant at Cymes Consultants Limited. He says while land banking can be a lucrative investment in the long run, it was important to be properly informed beforehand and to be prepared for any eventuality, be it positive or negative.
Legal issues and zoning laws
As with any investment in real estate, due diligence to establish ownership and avoid future legal complications is important.
However, when it comes to a land bank, you also need to understand various legal matters relating to development.
If, for instance, you plan to subdivide the land and sell plots apiece, or you hope to develop a gated community, it is important to plan ahead and have an understanding of the legal processes involved in each.
In subdivisions, you also need to consult a surveyor to establish the minimum size of a plot as stated by local laws.
Financing
Land banking is a long-term investment, therefore it may take a long time to realise profits.
This can be critical, especially if servicing a loan, therefore proper financial planning is critical. Should the market collapse and you cannot make projected returns, it also helps to have alternative uses for land identified.
When this is done before investing, these alternatives will help you make an informed decision depending on where the land is.
As with any investment in real estate, due diligence to establish ownership and avoid future legal complications is important.
A good example is someone who invested in Konza City when it was approved, with the hope of making good resell profits.
Alternatives such as commercial farming, or the development of holiday homes for instance, if your plans do not come to fruition as intended, are some of the ways you can counter and mitigate negative impacts in the future should they happen, and protect your investment.
Benefits of land banking
Requires lesser financial input
Compared to other investments in real estate, land banking is the cheapest investment portfolio. Unlike an apartment or home for instance, where you require millions to acquire property, you can invest in a land bank with as low as Sh100, 000.
This makes it ideal for people looking to invest in real estate and may lack the financial muscle to invest in more costly ventures. You can begin investing in this category, then move your way up.
Low maintenance
This investment has little or no maintenance, no imposed taxes or insurance.
This is unlike other investments where you have to pay land rates, repair and maintenance costs for apartments or houses, as well as taxes and other charges that may be applicable.
High profits
Proper profits in land banking are all about location and appreciation.
If you do due diligence before investing and carry out proper market research, you will be one step closer to realising your wealth creation goals. Further, you can earn profit through short-term leases or projects of your own.
Risks of land banking
As is with any form of investment in real estate or other investment opportunities, land banking has its fair share of risks. It is especially important for one to take note of these, before investing money in a land bank scheme.
Financing
If you do not have enough capital to invest in land purchases, securing financing from a bank may be quite a challenge. Financial institutions see it as a risky venture, as returns are pegged on futuristic appreciation of the land, which is not always guaranteed.
Planning and ecological factors
As land banks are mostly on undeveloped land, when and if you want to develop the land, the responsibility to get approvals falls squarely on you.
This will be affected by many factors such as zoning laws. Environmental factors such as reducing productivity, siltation, deforestation or pollution will also have a negative effect on the profitability of your investment.
Real estate crash
A real estate bubble is also known as a housing bubble or a real estate market crash. This is where there is an increase in the prices of real estate as a result of demand and speculation.
However, it causes high-spirited purchases of real estate products, leading to a market collapse. When this happens to land banking investors, they suffer losses because the housing and land prices reduce significantly.
Long waiting periods
Another setback in land banking is the amount of time required for the investment to mature.
This, added to other factors such as approval failures can lead to you losing your money, or waiting for very long periods to rake in profit.
For instance, some properties will require changing the use of land, for example from agricultural to residential property or residential to commercial land.
All these largely depend on approvals by the government, and lack of it means that as the land owner, you will not get the profits you planned for.
Is land banking a good investment?
For the savvy investor, this form of investment can be highly profitable and create wealth for you in the long term.
If backed by research on trends in the real estate market and development in emerging towns, land banking can offer good returns to investors.
It is essential for each investor to also determine if a land banking scheme under consideration comports with their individual appetite for risk.
To gain a clearer understanding of the opportunity, be sure to understand what disclosures you must have in order to make an informed choice by consulting with independent, competent financial and legal advisors.
