Key Elements Of Land Financing
While real estate is always the most
secure type of asset to lend against, land financing
can be extremely varied from situation to situation.
When I speak of land financing, I’m
referring to bare land that currently does not have any
erected structures attached to it.
Once again, the lending market has some very broad
variability when it comes to financing land, due in
large part to inherent risk. The primary risk to be
considered is the true fair market value of a parcel of
land and the likelihood of timely liquidation if
required.
Said another way, if the borrower
doesn’t make his payments, what does the lender do with
the property?
Bare land can have a very active or inactive market,
depending on where it’s located and its potential use. A
tract of land that is revenue generating is infinitely
easier to secure financing for that a non revenue
generating property.
Other market valuation and market ability factors
include the historical use of the property as well as
the current and historical use of neighbouring
properties. Existing environmental law can place
environmental cleanup bills squarely on the shoulders of
the owner, regardless of whether or not they
contaminated the property during the time the land was
under their control. Environmental cleanup bills can
destroy the security margin in a property and put the
lender in a loss position.
Bare land can also hold a high potential future value
due to near buy development, unique property features
(access, mineral deposits, water supply), or even
government appropriations for roads, parks, and so on.
The problem lenders have with depending on future value
when considering financing scenarios is predicting when
the future value may materialize. If it takes 20 years,
the lender could have to hold on to the property and pay
taxes and up keep costs for that period of time in the
event of default in order to get their money back.
Assuming there is an interested lender for your land
financing situation, a general rule of thumb for
financing ratios would be from 35% to 75% of the
appraised value of the land. That is, if the subject
property was appraised at $100,000, the maximum
available financing would likely be between $35,000 and
$75,000.
Properties that are currently earning income and have an
established market will receive the highest percentage
of financing. Non income earning properties with less
established markets are at the other end of the
spectrum.
Today, its pretty much a standard practice for any
financing involving real estate to have an environmental
assessment, a commercial property assessment, and a
regulatory clearance from all relevant government
agencies as to the buyer’s or owner’s intended use. On
top of these up front costs, bare land financing sources
tend to have higher interest rates to match the higher
risk of loss in the event of default.
Therefore, it’s pretty important to do your homework on
a subject property before you start looking for
financing, even before you place an offer, otherwise how
do you begin to determine what the purchase price should
be?
When you do make an offer, build in lots of time to
cover off the issues we’ve discussed above because the
vast majority of lenders will require third party
assessments of value and liability before they will be
forthcoming with an offer for land financing.
If want to purchase a property that is not revenue
generating at the time of purchase and does not have
much of an active market, be prepared to require a down
payment of 50% or greater.
Depending on what your intended us of the property is,
make sure you’ve done an economic analysis of your
business opportunity to determine what you can afford in
carrying costs. Bare land financing in many areas comes
from private money sources that know the localized
areas. While private financing can be an excellent
source of capital, it will almost always be more
expensive than institutional financing, so make sure
your business can afford the full carrying costs.
For existing property you own and want to borrow against
the same issues apply. The amount you can borrow against
the property will increase relative to increases in
generated revenue, property improvements the market
values, the likelihood of future value increasing,
defined risks being minimized or removed, additions of
re-sellable structures.
Because of the due diligence associated with land
financing situations, time required to close a deal can
range from a month to several months, so make sure you
factor sufficient time into the process to keep your
business plan on track.
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