By James J. Prescott, Braver PC
In the current skittish lending climate, obtaining a loan to invest in land can be a challenge. Far fewer lenders are willing to finance land purchases because of the inherent risk of funding a non-income-producing asset. And those that do fund land deals generally apply more stringent lending standards than on other types of property. If you or your client is looking to buy some land, here are some insights into what lenders are looking for.
The challenge of raw land
The requirements and prospects for a land loan depend on the type of property you’re investing in. If you want to purchase raw land — land without services, such as sewer, water, access roads or power in place — and have no immediate plans to develop it into an income-producing asset, it may be difficult to find willing lenders.
Lenders value land based on its development potential. Prior to development, land holdings are financial liabilities because owners still must pay property taxes and sometimes provide maintenance. What’s more, investors can’t depreciate land on their taxes. The services to make raw land ready for development can cost tens of thousands of dollars.
Lenders who consider such deals often require a hefty down payment of 50% or more and charge higher interest rates. You may have more luck with a local lender who knows the area. But be prepared to tell the story of the property and why you want to invest in it. You can also pursue seller financing or use home equity loan funds, depending on the size of the purchase.
Whatever type of loan you end up with, you’ll need to provide the lender with a detailed budget plan, past financial statements and tax returns. In fact, your credit history and financial statements will be particularly important to land lenders, who have learned that borrowers are more inclined to walk away from relatively low-cost, undeveloped land than from more costly, developed property.
Lenders tend to be more amenable to financing vacant land — property with development services in place — when there is a proposed development accompanying the request. When deciding whether to offer you financing, they’ll consider whether the property is zoned for the use intended, the attitude of the community toward potential development, the site’s location and the demographics of the area in which it’s located.
Most lenders will want you to have a plan to develop the site, or an “exit strategy,” because, once you get a mortgage on the proposed structure, the land loan will be paid off.
You’re apt to find that lenders are much more willing to step up to the plate if you’re buying land with a specific development plan in place, depending, of course, on the merits of the plan and the track record of the developer. This type of funding — called an acquisition and development (A&D) loan — incorporates the price of the land, along with its development and delivery-to-market costs. Lenders also like the fact that your development plan establishes the market value of the site, rather than forcing them to rely on a speculative appraisal.
If the development plan passes muster, the down payment on an A&D loan will likely range from 25% to 30% of the project costs.
A good time to buy
While financing land investments can be difficult, this could be a good time to consider such purchases because land prices for residential development have been declining. Undeniable challenges exist but land can still be a profitable investment.
James J. Prescott, is a shareholder and real estate specialist at Braver PC, an accounting firm with offices in Massachusetts and Rhode Island.