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 Returns from investing in land Investing in land offers the possibility of impressive financial returns for the shrewd investor, but the key to this is information, its accurate analysis and experienced interpretation ! The specifics of investing in landBefore investing it is prudent to recognise certain issues particular to this form of investment and acknowledge the risks associated with the level of reward. The return is not guarranteed by anyone, ever !
This is a medium/long term investment.
It can take considerable amounts of time to achieve a return; think in terms of years, not months.
Land is a capital illiquid asset and it is difficult to realise cash from it in a hurry, unlike stocks and shares.
Promoting land for future development is often complicated and not cheap.
Money spent on planning promotion is all completely speculative and you can't get it back.
The strategic land market is fragmented and diverse and information can be incomplete and misleading.
This investment generally suits the sophisticated investor best.
Some examples of possible returns
The following are some simple worked examples of how investments in land and property are appraised with estimated costs and values. They are not predicted or fixed returns but demonstrate how investments could perform, the levels of speculative costs involved, the variability of returns and the returns that could be achieved.
The examples are also to illustrate the differing level of returns from different methods of purchase, promotion and investment.
Case study No.1; a freehold unconditional purchase
(A) The background to the investment
A 10 acre parcel of land is purchased outright by an investor for £500,000, which is 10 times the normal agricultural value for the area in which it is located. Having received many times it's agricultural value, thus reflecting it's hope value, the landowner includes no uplift or clawback provisions in the transfer to the investor.
The land is succesfully promoted and allocated for development. The cost in fees and expenditure of this exercise is £100,000. An outline planning consent is granted, the cost in fees and consultant's expenditure is £125,000.Consent is granted within 10 years of purchase. The open market value of the land, which is realised on disposal, with a residential consent is £1,000,000 per net developeable acre. Only 60% of the gross area of the site is developable with the consent requiring that 20% of the housing is affordable. The RSL purchasing the affordable homes acquires the land at Nil cost.
Planning agreement (S.106) and planning conditions attached to the consent require expenditure of £250,000 to be spent to lawfully implement the permission.
(B) The gross return (before tax) achieved from the investment
Sale proceeds
Gross area 10 acres; net area 6 acres
6 x 80% private sector = 4.8 acres @ £1,000,000/acre = £4,800,000
6 x 20% affordable housing = 1.2 acres - Nil
less; agents disposal fees - 2% of proceeds = £120,000
less; solicitors conveyancing fees, say £10,000
less: original land purchase price, £500,000
less; purchase costs - legal £5,000
less; stamp duty (SDLT) - 1% £5,000
less; planning promotion costs - £100,000
less; planning consent costs - £125,000
less; S106 & planning condition implementation costs - £250,000
Net realisable proceeds from disposal £3,685,000
Total investment costs (land & planning expenditure) - £1,115,000
Gross Development Profit (Proceeds less investment costs)
before tax and excluding any interest charges £3,685,000
Gross return to investor - 330 %
(C) Comments and analysis
The investor has paid a 900% uplift, or special premium of £450,000 over market value to acquire this asset. If let it will bring in a very limited income of perhaps £1,500 pa. as grazing or pony paddocks provided it is suitable for this use which is a very poor annual return of 0.3% before tax.
However if neccesary, the original outlay could probably be realised by a sale always assuming the hope value prospects remains stable. If the property was sold with an allocation it's value could have crept up to say 60-70% of the Open Market Value with a consent. At that stage it's value could be between £3,360,000 and £2,880,000. Without the expense of securing a consent the total expenditure would have been around £678,000 thus generating a profit of between £2.2m and £2.68m and a gross return of 324% and 395%.
At this point it is worth comparing this with a return of less than 0.25% if the promotion exercise is ultimately unsuccesful.
This shows that the returns that can be achieved from securing an allocation can be comparable with those of continuing to the final conclusion of obtaining a consent and then selling. It also shows the flexibility of being able to realise a profit from a sale at an earlier stage provided the market will support the disposal. As recompense for the initial high capital investment, the investor has the benefit of a freehold interest and so the flexibity of choosing the precise time of the property cycle to maximise the sales proceeds.
Case study No.2, a freehold purchase subject to an uplift provison
(A) The background to the investment
A 10 acre parcel of land is purchased outright by an investor for £250,000, which is about 5 times the normal agricultural value of the land. The vendor and purchaser accept that the property has some hope potential and agree a claw back provision in the sale contract that returns to the vendor of 25% of the increase in value if consent is achieved within 10 years of purchase.
The land is succesfully promoted and allocated for development. The cost in fees and expenditure of this exercise is £75,000. An outline planning consent is granted, the cost in fees and consultant's expenditure is £125,000. Consent is granted within 10 years of purchase. The open market value of the land, which is realised on disposal, with a residential consent is £1,000,000 per net developeable acre. Only 70% of the gross area of the site is developable with the consent requiring that 25% of the housing is affordable. The RSL purchasing the affordable homes acquires the land at £50,000 per net acre.
Planning agreement (S.106) and planning conditions attached to the consent require expenditure of £200,000 to be spent to lawfully implement the permission.
(B) The gross return (before tax) achieved from the investment
Sale proceeds
Gross area 10 acres; net area 7 acres
7 x 75% private sector = 5.25 acres @ £1,000,000/acre = £5,250,000
7 x 25% affordable housing = 1.75 acres @ £50,000/acre = £87,500
Total proceeds = £5,337,500
Original purchase price - £250,000
Increase in value - £5,087,500
less; agents disposal fees - 2% of proceeds = £106,750
less; solicitors conveyancing fees, say £10,000
less: original land purchase price, £250,000
less; purchase costs - legal £5,000
less; stamp duty (SDLT) on purchase - 1% £2,500
less; clawback - 25% of increase in value = £1,271,875
less; planning promotion costs - £75,000
less; planning consent costs - £125,000
less; S106 & planning condition implementation costs - £200,000
Net realisable proceeds from disposal £3,291,375
Total investment costs (land & planning expenditure) - £2,046,125
Gross Development Profit (Proceeds less investment costs)
before tax and excluding any interest charges £3,291,375
Gross return to investor - 160 %
(C) Comments and analysis
The investor has paid a 400% premium of over market value to purchase this asset. If let for grazing or pony paddocks provided it will bring in a very poor annual return of 0.6% before tax.
As before the original outlay could probably be realised by a sale always assuming the hope value prospects remains stable and the sale is conducted in a reasonably steady land market. If the property was sold with an allocation it's value could have crept up to say 60-70% of the Open Market Value with a consent. At that stage it's value could be between £2,067,000 and £2,457,000 after reflecting the vendors clawback sum. Without the expense of securing a consent the total expenditure would still have been between £1,385,000 and £1,529,000. A sale at this stage would generate a profit of between £682,000 and £982,000 and a gross return of between 49% and 64%.
This again illustrates the returns that can be achieved from securing an allocation as compared with a sale at the consent stage and the long term impact of an uplift clause. There is the flexibility of being able to realise a profit from a sale at an earlier stage provided the market will support the disposal and provided the investor is willing to accept a major reduction in the return.
Despite the lower initial high capital investment, the investor has the benefit of a freehold interest and with it the flexibity of choosing the precise time of the property cycle to optimmise the profit from sale.
Case study No.3, a purchase by means of a promotional option
(A) The background to the investment
A 10 acre parcel of land is optioned to an investor for a premium of £20,000 for a period of 15 years. If the investor is succesful in obtaining planning consent he can acquire the land at 80% of the open market value with all planning promotion and planning costs being deductable.
The land is succesfully promoted and allocated for development. The cost in fees and expenditure of this exercise is £100,000. An outline planning consent is granted, the cost in fees and consultant's expenditure is £100,000. Consent is granted within 10 years of purchase. The open market value of the land, which is realised on disposal, with a residential consent is £1,000,000 per net developeable acre. Only 65% of the gross area of the site is developable with the consent requiring that 30% of the housing is affordable. The RSL purchasing the affordable homes acquires the land at £100,000 per net acre.
Planning agreement (S.106) and planning conditions attached to the consent require expenditure of £200,000 to be spent to lawfully implement the permission.
As soon as the investor exercises the option he sells the consented land on to a housebuilder.
(B) The gross return (before tax) achieved from the investment
Sale proceeds & Open Market Value
Gross area 10 acres; net area 6.5 acres
6.5 x 70% private sector = 4.55 acres @ £1,000,000/acre = £4,550,000
6.5 x 30% affordable housing = 1.95 acres @ £100,000/acre = £195,000
Gross Value = £4,745,000
less; planning promotion costs - £100,000
less; planning consent costs - £100,000
less; S 106 planning costs - £200,000
less; option premium - £20,000
Net Value on exercise of option = £4,325,000
Proportion to landowner - 80% = £3,460,000
Proportion to investor - 20% = £865,000
Costs to investor, not already deducted from Open Market Value or paid by purchaser.
less; purchaser's legal costs of preparing option,say, £10,000
less; agents introduction fees,say, £10,000
less; contribution towards vendor's legal & agents fees,say, £10,000
less; stamp duty on purchase (SDLT) 4%, £173,000
less; agent's fees on disposal 2 % £86,500
less; legal costs of disposal, say £20,000
Investor's total investment costs - £309,500
Investor's Gross Development Profit (Proceeds less investment costs)
before tax and excluding any interest charges £555,500
Gross return to investor - 179 %
(C) Comments and analysis
The fundamental difference between this option example and the two above is that the option is a diminishing interest. It's duration is the period of its contractual life and although it may be capable of extensions it is simply a limited right to purchase, generally when certain planning conditions have been satisfied. It only becomes certain when it has been exercised. The option holder usually has obligations to promote the property on the owners behalf and ultimately the option can be terminated if he does not perform.
In recognition of this and the fact that the landowner has given away a proportion of the uplift in value the option holder has not invested it's capital in purchasing the land and has the right not to purchase if it so chooses and stop promoting the land at the end of the option, or break clause.
Thus it is a balance of risk speculatively promoting the property for a lower return versus the reduced amount of capital invested in the option rather than an outright purchase. Options rarely have much intrinsic value themselves unless the planning prospects are good so the scope to assign them and recoup the costs expended are usually very low. |
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