Friday, May 8, 2015

What Is Land Banking? Is It A Good Property Investment Strategy?

Land banking generally refers to the practice of buying land for investment purposes in the hopes or with expectations that the land will increase in value (capital price appreciation).

Whether it's a good or bad strategy really depends on:

1) Where the land is located and whether there is any likelihood of growing demands for that piece of land or that the land will be rezoned into higher density usage and therefore increase in value

2) The land's current or potential future use for income producing purposes

Growth in demand for land can result from subdivisions for housing estates, for industrial or commercial use and so forth.

I thought it's worth writing a post on land banking because it can seriously cripple your cash flow if you don't research the land before you buy and you don't prepare for the purchase from an accounting and tax perspective simultaneously.  

Failure to ensure that your land investment can produce an income as soon as possible will mean that all your related expenses won't be immediately tax deductible in that current financial year.

In NSW, Australia, if you buy land for investment purposes and the land is not producing any income, then all expenses such as loan interest, council rates, body corporate rates, water, maintenance and repair fees (such as repairing fences) cannot be claimed each year as tax deductions. They are added to the base cost of the land to reduce capital gains tax when the property/land is ultimately sold.

If you wish to buy land for investment purposes, the best strategy is to find one in a growth location (easy to say, hard to execute or else we'd all be billionaires), ensure that it can produce income in some shape or form so that your expenses are deductible in the year that they are incurred(this is very important from a cash flow perspective) and then cross your fingers in the hope that it will increase in value if you haven't done your research.

Some of our friends have practiced land banking rather successfully. They were delving into council development application plans, town plans, zoning plans and researching which rural areas were designated for growth corridors.

I do know someone who land banked unsuccessfully years ago. She bought a cheap piece of land in the bush that had no water, no sewerage, no power, no house, was rocky and dense with shrubbery and trees. Not only was it very difficult and very expensive to build a house due to the terrain of the land, but it was impossible to convert the land use to market gardening agriculture even if you bulldozed all the trees.

So building any housing structures were out, using the land for market gardening agriculture was out and using the land for grazing cattles or sheeps was impossible and unfeasible due to the terrain. What happened was that the land didn't produce any income, so she paid years and years of bank interest on the mortgage, paid fence repair fees and council rates faithfully without being able to claim anything as a tax deduction. The land was also in the middle of nowhere so there were no subdivision plans, no development plans and no demand for it so it didn't appreciate in value. It was only until she sold it years later, with no capital appreciation, that she was able to claim all the expenses that she had incurred over the years.

When evaluating whether land banking is a good investment strategy or not, given the right research and due diligence and forward taxation planning, it can be a good strategy. And if you fail to do any due diligence or research or planning, it can be a very poor one just like the one I mentioned above.

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