Investors make money on real estate in multiple ways. Some love fix-and-flip deals on both residential and commercial properties. Others buy commercial real estate for long-term rentals. Still others prefer to develop empty parcels for commercial or industrial use. But then there is the practice of land banking.
Land banking is the practice of purchasing undeveloped property with the goal of holding it for future sale. Rather than immediately developing it, the investor lets it sit while he waits for its value to go up. When it does, he starts looking at a strategy for improving, developing, or selling it.
A good way to utilize the land banking strategy is to finance new acquisitions with hard money. You could even say that land banking and hard money are a dynamic tag team for driving profits in real estate. But you need to know what you are doing. You also need to have liquidity and equity in other assets.
Hard Money’s Role in Acquisition
Banks normally hesitate to fund the acquisition of unimproved land. They consider such deals too risky because the targeted properties are not generating cash. That makes them high-risk collateral. Hard money lenders are less concerned. They make approval decisions on the land as-is. If it’s a valuable enough asset, most hard money lenders can be convinced to move forward.
Hard money plays a key role in land banking, as manifested in these four ways:
1. Acquisition Speed
Land banking transactions move pretty quickly, especially in competitive markets. There are not a whole lot of contingencies in play because the land is raw and undeveloped. A successful buyer among multiple competitors is usually the one who gets to closing fastest. More often than not, that means the buyer with hard money behind him.
2. Financing Unimproved Land
Hard money lenders are not scared away by unimproved land. They focus on the loan-to-value (LTV) ratio and the investor’s exit strategy. On the other hand, banks almost always require that land be improved with at least utilities and road access before they will fund.
3. Funding Entitlements
Although not all hard money lenders are willing to fund entitlements, some are. This means an investor can get a single loan that covers both acquisition and land banking’s soft costs. These costs would include hiring engineers, surveyors, and legal representation in order to transform a parcel into plotted residential lots.
4. Bridging to Long-Term Finance
Lastly is hard money’s ability to bridge the gap between property acquisition and long-term funding. According to Salt Lake City-based Actium Lending, hard money is a short-term proposition. Loans are rarely carried beyond 24 months. However, an investor can utilize a hard money loan to bank land, then spend the next 24 months getting it ready as residential building lots. Selling the lots provides the money necessary to pay off the loan.
Thinking Things Through Is Important
By its nature, land banking is more risky than fix-and-flip and investing and long-term rentals. So thinking things through is important. Especially where the exit strategy is concerned, an investor needs to consider:
- How the banked land will eventually be sold.
- How the land will be refinanced, if necessary.
- The possibility of bringing in partners to keep the project alive after the loan is paid off.
Land banking is a great way to make money in real estate if you have the assets and the nerve. It can be very successful when used in concert with hard money. Together, land banking and hard money can turn a small portfolio into a revenue powerhouse.