The joker in the paper deck of cards is the land note.
A house is a house. The houses in any one area are more or less alike, and they sell in a narrow range. A commercial property is valued on its income: if the income won’t make the payment on the loan, don’t buy the loan. But there are no such guidelines for a land loan.
An appraiser can make mistakes, but it’s very rare for one to estimate a property at double, triple or even five times its real value. On a land loan, it can happen.
Why land value is so hard to pin down
Land has one feature that sets its value: nothing is built on it. So you have to research what, if anything, can be built there. If it’s possible and legal to build a house on the land, it’s worth a lot more than if it isn’t. Land can be worthless.
Questions to ask before you broker or buy a land note
- Does the land have water, power or sewer available? What does it cost to hook up, and is it practical to do so?
- Does it have legal access? A road that doesn’t show on public records may not be legal. It may take court action or negotiation with other owners to make it legal.
- Does the land qualify for construction under the local building rules? See the examples below.
- Is the zoning settled and correct? Some large tracts are under building moratoriums where local governments want to discourage growth.
- Are there special environmental concerns? You may need an environmental impact study, a geology report, a percolation test, a confirmation of zoning and, on the California coast, Coastal Commission approval just to learn whether building is legal and practical. In other cases, a lot of money must be spent meeting the requirements of governing bodies before construction can begin.
Common reasons a lot can’t be built on
- It doesn’t meet the minimum lot size.
- It doesn’t perk for a septic system.
- It isn’t geologically stable for construction.
- Other requirements make building impractical, such as a street-widening plan that would shrink the lot, or a large assessment that must be paid before construction can begin.
Location rules matter too. Land within five miles of the Pacific coast of California falls under the California Coastal Commission, a body that has historically been unwilling to approve construction.
Why land notes can still be good buys
None of this means I’m shy about land notes. They can be excellent. Interest rates are higher, the notes are usually first liens and loan-to-value ratios are lower. It may also be possible to see that a parcel is buildable and valuable because of building around it or a history of approvals in the area.
But land should be appraised by someone competent in that area. Brokers and investors should be wary of “lizards and cactus” parcels, and of parcels in areas where development has run into problems in the past.
