The Drawbacks of Buying Land: What Investors Should Consider

As a real estate investor, you’ll hear about the importance of diversification on an almost daily basis. Instead of purchasing a single-family residential property (SFR) or long-term rental, you might be considering making land your next investment. But is it a smart choice? 

Buying land is complicated and not suitable for all real estate investors, especially if you’re not an established developer. While buying land comes with benefits like lower maintenance and low-term value appreciation, there are significant risks and drawbacks involved. By comparison, buying an investment property in a big town or small city offers more predictable returns than buying land. 

Ultimately, land doesn’t generate revenue by itself, and its value can be stagnant for years unless you invest in developing it. Many investors find themselves stuck with land, unable to sell it and struggling to raise the capital necessary to make meaningful improvements to boost its value. 

In this article, we’re exploring the drawbacks of buying land and why real estate investors should approach a potential land purchase with caution. 

The Illiquidity of Land Investments

Land is what’s known as an “illiquid asset”, meaning it takes significant time and effort to convert it into cash. By comparison, stocks are a liquid asset as they can quickly sold for cash. As an illiquid asset, it’s normal for the holder to take a financial hit as they may need to reduce the price below market value for a quick sale. 

Compared to selling other real estate, like condos and built-to-rent properties, it’s challenging to sell land. There are fewer buyers for land, and many will want to negotiate. There’s also a more prolonged legal and approval process when selling land, compared to selling traditional real estate. 

The land type, location, and market demand will determine the land’s individual illiquidity, but all land will generally be unsuitable for investors seeking short-term gains or a fast exit option. 

Limited Cash Flow Potential

Cash flow is what attracts entrepreneurs and investors to real estate, enabling them to generate passive income and even become full-time investors. However, land has limited cash flow potential as it doesn’t generate regular income in the way rental properties do. Instead, investors must focus on value appreciation, rather than ongoing cash flow. 

There are ways to generate cash flow from land, but these are limited and come with their own drawbacks. Solar energy contracts are a popular way to utilize land that isn’t in use, but not all land will be suitable, and these contracts don’t have ideal exit strategies, tying into a long-term deal. It’s also possible to lease the land for farming, but significant changes may need to be made to make it suitable.

In general, land investment is best suited for those who are comfortable waiting an extended period of time to maximize the return on their investment (ROI). While buying land can help diversify your portfolio, it likely won’t generate any active income for your portfolio. 

Zoning and Land Use Restrictions

Bureaucracies can make investing in land a headache. Zoning laws can place restrictions on the way land can be used, directly impacting investors who want to develop the land and the potential to sell the land in the future. It may be necessary to obtain permits to make changes to the land and you’ll have to comply with local laws and regulations, especially if there are environmental concerns.

Always do your research and check if there are any local regulations that will impact your land ownership. You may need to make a rezoning application, which can increase the upfront costs of owning your land and result in time delays if you’re planning to develop or sell the land in the immediate future. 

Depending on where your land is located – and its size – you may have unclear zoning regulations, especially if it spreads across more than one district area. You might need to consult a local expert to understand local government regulations, including those applicable to your intended use of the land. 

Environmental Concerns and Land Development Costs

Don’t overlook environmental concerns when buying land as these can be just as significant as the cost of land development. Protected areas, flood zones, and wetlands can make land development complicated or almost impossible, delaying projects and making developments financially unfeasible. 

As a landowner, you can expect to pay a high upfront cost to address these environmental concerns or they’re likely to negatively impact any future sales. These changes will also form part of your land development costs, alongside other hidden costs such as infrastructure, road access, and utility installation. 

If the land has previously been used for agricultural or industrial activities, there may be hazardous substances or contamination concerns, requiring remediation, which can be costly. Natural hazards, including coastal erosion and landslides, may negatively impact development plans and lead to higher costs.

It’s important to determine if the land is near wildlife habitats or a protective area as they may be required to have an environmental impact assessment with mitigation measures put in place. Similarly, water and air quality can also be a concern, especially if industrial activity has previously been carried out. You may also need to pay for professional checks for radon gas emissions from the soil, which can pose significant health concerns. 

Potential Land Development Costs

If you’re investing in land for the purpose of development, you can expect to face an avalanche of development costs, including:

• Acquisition cost: the price of the land itself, which is usually determined by its size, location, and development potential.
• Infrastructure costs: the price of connecting the land to necessary utilities, including sewage systems and water. This cost can be particularly high in remote areas.
• Legal and surveying costs: most investors can expect to pay a fee to hire a lawyer or professional surveyor to carry out due diligence checks of the land prior to purchasing. 
• Remediation costs: it may be necessary to pay for the land to be cleaned and remediated if the land has been contaminated because of its previous use.
• Regulatory fees: local regulations may require permits or approvals from local authorities, which can come with high fees and delay your development.
• Planning permission costs: acquiring planning permission from local authorities can be time-consuming and expensive, particularly if revisions are requested. 
• Financing costs: often overlooked, you may need to pay interest rates and other fees on your chosen financing option for purchasing the land. 
• Engineering and design costs: before you can start developing the land, you can expect to pay for engineering work, including site preparation and land grading. 

While you might not be planning to develop the land, it’s important to consider these costs as they may be a reason why potential buyers might seek to heavily negotiate the purchase price.  

High Upfront Costs and Ongoing Expenses

What makes land purchases unattractive to most real estate investors are the high upfront costs and ongoing expenses. It’s not just the purchase price you’ll need to consider as part of the initial cost of acquiring land. Other expenses like title insurance, survey fees, and closing costs can quickly add up. 

Land investment requires a larger upfront payment with most financing options having a higher interest rate than a traditional mortgage. Traditional financial and lending institutions are less optimistic about land investments due to potential environmental issues and the illiquidity of land. 

If you’re able to secure a loan, you may need to make a larger initial payment as a result. If you don’t have significant financial resources or the liquidity to secure a loan, it may be completely unfeasible to invest in land. 

Ongoing expenses will continue to rack up, even if you’re not actively developing or using the land. Upkeep, fencing, land clearing, and property taxes will usually result in negative cash flow, unless you’re leasing the land for agriculture or industrial use. In most scenarios, including rural areas, you can expect these ongoing expenses to quickly eat into any profit you’re generating. 

Unlike other forms of real estate investing, there are usually no tax benefits to buying land. You won’t be able to deduct the purchase price against your income and any profits will be taxed at your ordinary income rate.

Market Volatility and Risk of Depreciation

Real estate takes a hit when markets fluctuate, and this is even truer for land purchases. Land values take the full impact of any negative trends in housing prices, while higher interest rates will also typically reduce land value. 

There’s a higher risk of depreciation on your investment with land purchases than other forms of real estate investment, particularly due to the limited availability of exit strategies. Your only way out of a land purchase may be to sell it at a loss. 

Economic conditions, the local market, and buyer demand can also negatively impact land prices. If the area where your land is located undergoes an economic downturn or has slow growth, it may be difficult to maintain its value. Similarly, areas that are overdeveloped can also pose challenges when choosing to sell or repurpose your land.

Land is a Passive Investment

There’s no immediate upside to buying land as a real estate investment. You’ll almost always make an initial loss. Land investments are typically more passive in nature. While they don’t require active management immediately, they also won’t have the immediate income potential of a single-family residential property or long-term rental.

You can also expect a faster return on your investment – and more to do – when making renovations. As a passive investment, you won’t have the same property management needs with land as you will with traditional real estate. While this might sound like a positive, it can leave investors feeling like they’re twiddling their thumbs with their cash locked into a land deal.

Most investors ultimately choose land for its long-term appreciation. However, value growth isn’t always guaranteed, and you may need to wait a significant period to see appreciation and be able to sell the land in the right market climate. 

In this context, it’s easy to see why most investors opt for dynamic investments, whether it’s flipping properties or building a rental portfolio. Even if you’re spending money upfront on renovations, you’re seeing the positive impact of your investment, which isn’t always apparent with land.

Difficulty in Property Valuation and Appraisal

One of the most overlooked drawbacks of buying land is the difficulty in obtaining a property valuation or appraisal. It’s difficult to accurately assess the value of land compared to other real estate investments as these are largely subjective with more factors to consider than when appraising a condo or home. 

There are limited comparative sales data for land transactions, making it harder for investors to adjust comps for differences in land features to estimate its value. The factors that impact the valuation of land, including access, location, and its future development potential are all subjective, making it almost impossible to accurately appraise it.

Without the ability to accurately estimate the value of a land parcel, investors are at risk of overpaying for land. If you’re not familiar with the area or working with a developer with local knowledge, purchasing land could be a financial mistake if you’re unable to absorb the upfront cost or wait for the land value to rise significantly enough.

It’s possible for market volatility, regulatory changes, and data inaccuracies to make the accuracy of land appraisals difficult to judge. It’s necessary to use both real-time and comprehensive data when appraising a land parcel.