One of the ways to minimize risk when you are pursuing a development or adaptive reuse project is pursuing covered land deals. These investments can come in a variety of forms, but the basic premise is that you buy a property for the potential value of the “land”, while the existing buildings, whether or not you intend to keep them in the long run, generate income that “covers” your carrying costs as you pursue your long term strategy.
The period in which the existing asset covers your costs can vary depending on what you goals are for the property. This produces an asymmetric risk profile by ensuring the worst case scenario is not a losing one, while providing potentially tremendous upside potential through the future value of the land.
While inherently a speculative investment to some degree, the covered land play is a responsible form than simply purchasing raw land with no improvements and hoping for growth to occur. Covered land plays give you the assurance that no matter what happens, you’re starting off on the right foot by covering the cost of operation.
Here are a few examples of covered land plays that help illustrate the concept:
1. Zoning Code Overhaul
An experienced developer is aware that his city will soon by overhauling their zoning code and will allow greater density in some neighborhoods. This is often a very slow moving process that takes years to eventually be codified into law. The developer, having foresight, can leverage his relationships with local decision makers, as well as his own knowledge of the politics of development in his city to anticipate which of these proposed higher density areas are likely to be approved in the end. The developer could then purchase several abutting two or three family properties over the course of a few years negotiating with the current owners. While waiting for the political process to work itself out, the valuable “land” is “covered” by the rental income from the existing lower density multi-family properties. When the area is upzoned, the developer could then raze the existing structures, combine the parcels into a larger single parcel, and erect a much denser apartment building.
2. Buying a single story commercial structure
(or just a lower-density structure in general) with retail or office in an area undergoing population growth and economic development. A nice tip we’ve found for these deals is to target single story commercial structures. The existing asset can bring in some nice income while you entitle the land for greater density, and the building footprint of single story commercial structures usually leaves some nice meat on the bone for future development. Often times these structures will be located in zones that allow 4 or more stories by-right, giving you a pretty good idea that you’ll have some options to work with when you go to redevelop.
3. Special Permits
Similar to the first point, if you envision a higher and better use for a parcel, but it would require special permission from your municipality (zoning relief, special permits, etc), then you can mitigate your risk by making sure the existing asset is still capable of covering the cost of ownership. This is critical because when you are relying on special government permission there is always some degree of uncertainty. Politics can shift with the wind and be unpredictable sometimes. That’s why it’s imperative you have a plan B and plan C just in case things don’t fall your way.
4. Subdivisions
Subdivisions and large planned development areas are another example where covered land plays are nice for minimizing risk. Developers may purchase comparatively larger parcels with existing income-generating assets that have the potential to be subdivided. They can then develop in phases additional buildings on the new parcels, all the while offsetting carrying costs during the entitlement process. As a bonus in this scenario where you have one or few existing buildings on an oversized, you could keep the existing building(s) to generate income all throughout the construction and stabilization of your new building.
5. Long Term Plays
Longer term covered holds in areas with steady growth may last 10 or more years, depending on the investor’s strategy. An example of this might be a parking lot in an urban infill area. Local investment groups with confidence in the long term growth of a particular neighborhood can reap huge rewards from their patience. The parking lot is a low maintenance asset that can be held for longer periods and then, once the time is right and gentrification and economic development come to the area, it also present a simple and clean development site. This strategy is perhaps the most speculative, but the risk has been mitigated by the income of the parking lot while you wait to see if your assumptions about your market’s growth bear out.
Where should you look for covered land deals?
If you are holding out for increased value to your property, whether it be from the ability to entitle new development at a higher density level or any other reason, you need to have some solid reasons for believing your assumptions about the potential value are true. This can be done by attending political hearings and events, as well as events where you can meet and interface directly with political and community leaders in your area.
If you’re trying to invest in areas undergoing growth and generate income for a few years as your parcel becomes more valuable, then the classic indicators of a robust and growing economy are the best things to analyze. Population growth, the state of the local economy, average income levels, planned future development and investment, year over year rent growth, and major employers in the area are all good things to pay attention to.
This type of strategy is dependent on robust knowledge localized to the area you’re investing in. As a result, local developers and investors who have connections and keep a pulse on their market have an advantage over long distance operators. If you’re looking to invest in covered land plays in a market you are not intimately familiar with, consider partnering with a local operator who has that boots on the ground knowledge you need.
