“Buy land. They ain’t making any more of the stuff.” – Will Rogers
One of the great things about rental property of any kind – apartments, office, industrial, or retail – is that, after you’ve built up your portfolio, there comes a point where you have thousands of dollars pouring into your mailbox each month. And it’s truly passive income. Management takes care of your properties and the net income takes care of you.
But the fact is, you can also generate real estate income without being a landlord. In fact, you can do it without owning a single building. You can do it with raw land.
I was first introduced to this idea on an investment tour in South America seven years ago. While touring vineyards, oceanfront condos, and cranberry bogs (yes, cranberry bogs… in Patagonia!), I met Hal, an 80-year-old Californian who had made a fortune subdividing timberland.
It was from Hal that I first learned the “pizza principle” of real estate.
A pizza generates more money when sold by the slice. Bubble markets notwithstanding, the same usually goes for selling individual condos as compared to selling an entire apartment building. And the same goes for subdividing land.
So how do you generate ongoing income from this? You sell on “terms” (meaning you provide the financing and hold the mortgages).
Let me explain…
Land by itself usually can’t generate enough rental income to pay for any significant mortgage – so you don’t get the benefit of leverage, the key wealth builder in real estate. Even if you have 100 acres of prime corn-growing land in Nebraska, you probably can’t rent it for more than a couple percent of what you’d pay for it – even in today’s corn-craving, ethanol-delirious market.
But when you buy right in the first place, then subdivide and sell your land with owner financing, you can create a big profit margin and a steady stream of income that lasts for decades. To see what I mean, consider the case of my friend Richard.
Richard is from New Jersey. About 20 years ago, he decided to try sunny Florida. So he moved there, and proceeded to build a successful business and a portfolio of investment properties. After a time, his properties were worth a lot more than he ever dreamed they would be. Meanwhile, he noticed that South Florida had become as crowded and expensive as the Northeast he’d left behind.
So he became a “halfback.”
Halfbacks are people who moved from the Northeast to Florida 10, 20, or 30 years ago… and are now moving “halfway back” to the mid-Atlantic states. Once again, they’re finding places to live that are far less crowded and a lot less expensive, and where the pace is less hectic.
Richard sold a few of his properties in South Florida for a nice profit, and began to buy properties in an area of Tennessee he fell in love with. He also began to move his business there.
About three years ago, he bought a five-story 10,000-square-foot 1920s bank building on the main street of a small post-bellum city rife with neoclassical architecture. The building is large enough to house his business, and there is room left over for him to collect some rental income to boot. (He already has tenants.)
He bought the building for just $120,000. It’s worth at least three times that much today, though it’s become nearly impossible to find anything of that character and quality at any price.
And yet, perhaps his best buy was 85 acres of pastureland a few miles outside of town, which cost him just $2,000 an acre. These days, land like that is selling for $11,000 to $15,000 an acre – and the market is rising steadily as more halfbacks flee high-priced, high-tax, high-insurance Florida, California, and other pricey parts of the U.S.
If he so chooses, Richard can now turn his one-time investment into a steady stream of purely passive income of $8,700 a month for the next 20 years. And he can do it without dealing with toilets, trash, and tenants… or even taxes, for that matter.
If Richard sells on terms, it’s likely he can get the higher range of the market, since, when you offer terms, you are usually able to command a higher price. That’s especially the case with raw land, because financing is not as readily available for raw land as it is for income-producing property.
What’s more, he could subdivide the land into smaller parcels of a half-acre, maybe even a quarter-acre. That could result in a higher average sales price per square foot and a greater sales price overall than even $15,000 an acre.
But let’s suppose he subdivides his 85 acres into 85 one-acre parcels at an average sales price of $14,000 apiece.
And let’s say he takes just $2,000 as a deposit from each buyer. With 85 acres, that’s $170,000 he gets upfront. That covers the initial investment he made in the land. And since Richard happens to have used an equity line of credit from another property to buy this land, he can now pay off that line in full. But he now also has 85 people who each owe him $12,000. That works out to $1,020,000. That’s his gross profit. And he’s going to take it – with a hefty interest rate – over the next 20 years.
Let’s say Richard lends the money to his buyers on a 20-year amortization schedule at an average rate of 8.25 percent. In today’s market, that rate would be quite reasonable for land. For each $12,000 borrowed, that works out to a monthly payment to Richard of $102.36. Multiply that by 85, and you have gross monthly inflow of $8,700!
And from that money, does he have to pay insurance? No…
Does he have to pay property tax? No…
Does he have to pay a property manager? No…
Does he have to repair roofs or sinks or toilets or windows? No, no, no, no…
It’s all his. What’s more, a portion of each monthly payment he receives qualifies as long-term capital gains. So, for someone in his income bracket, it will be taxed at a much lower rate. Only the interest portion would be taxed at his regular income tax rate.
Now, before you run out and buy your swath of paradise, a few points to keep in mind…
You always have to buy right first. You can overpay for raw land, just as you can overpay for any other kind of property. It’s even more of a concern with land, since your purchase price isn’t supported by rental income. And especially if you’re a lazy outsider, you’ll end up paying far more than the locals if you don’t do your research first.
You can also buy at the wrong part of a market cycle. What you want to look for is an area with growing jobs and employment, and where the fundamentals of the other local real estate sectors (single-family homes, apartments, offices, etc.) still make sense on a price-to-rent and price-to-household-income basis.
And remember that while this is a great strategy, the mortgages are wasting assets once you’ve sold the land. Richard might create over a million dollars in extremely passive income over the next 20 years – and with favorable tax treatment. But at the end of that 20 years, the party’s over.
With rental property, on the other hand, your income tends to grow over time. And so does your equity. Your tenants pay down your mortgage and give you net income each month, and every dollar of appreciation in the building and land is yours for as long as you own it.
Nonetheless, both of these strategies can fit into your real estate portfolio. The key is to learn the fundamentals of creative real estate investing – and to always apply them with a sharp eye toward value.[Ed. Note: Justin Ford is an active investor in real estate and global stock markets and the author of Main Street Millionaire, a value-focused real estate investment program.]