It’s often been recommended that people should buy land due to its scarcity. With this in mind, investors need to understand the practicality of owning land and of running a land-based business venture. They also need to be aware of the specific types of land-related investment options available through investment products such as exchange traded funds (ETFs) and exchange traded notes (ETNs).
Types of Land Investments
Independently wealthy people can purchase land for personal use, recreation, and yes, investment. Unfortunately, most people do not fall into this category. This begs the question: Are land-ownership opportunities and business ventures capable of generating an acceptable return on investment for small investors, while still affording them the joys and attributes associated with land ownership? To answer this question, you need to be able to evaluate 10 general categories of potential land investments:
Residential development land
Commercial development land
Row crop land
Mineral production land
Residential and Commercial Land Investments
Residential and commercial land development offers a feasible entryway into investment because virtually an unlimited number of land development opportunities can be structured to meet an investor’s capital and time constraints. For most small investors, real estate investment trust (REIT) ETFs are an ideal choice because they do not require direct management, they are broadly diversified by property type, they are geographically diversified, they can be purchased or sold on a real-time basis, and they are very inexpensive. Some specialize in a type of real estate, but others, such as the Vanguard REIT ETF (VNQ), provide diversified exposure to industrial, office, retail, healthcare, public storage, and residential property developments.
Unfortunately, these types of investments negate the ability of the landowner to enjoy using the land. Therefore, residential and commercial land developments are not feasible options for people that want to truly experience the feeling of land ownership.
Row Crop Land and Land for Livestock Operations
Land purchased for row-crop farming or for running a livestock operation affords the ability to enjoy land in the homeowning sense, as well as from the standpoint of generating income. However, there are a host of problems for small investors who purchase land in order to operate these types of enterprises. First, the scale required to operate a row-crop operation or livestock operation has to be very large to be financially viable. This, in turn, requires a significant upfront capital outlay far beyond what most people can afford. Moreover, the ongoing fixed costs associated with running these types of farming operations are extremely high.
This, in turn, means that the financial leverage and business risk for such operations are very high as well. As a result, a significant amount of stress is put on the landowner to make these types of business ventures financially successful. In many cases, the stress level far exceeds the benefits that people yearn for as landowners. With this in mind, it is a fair assessment to say that most small investors should avoid pursuing these types of large-scale farming operations, as the risks and hardships of such activity will likely exceed any benefits.
While owning a traditional row-crop or livestock farming operation is probably not feasible for most small investors, many agricultural investment options provide acceptable investment exposure to traditional farming enterprises. For example, some funds provide exposure to soybeans, corn, wheat, cotton, sugar, coffee, soybean oil, live cattle, feeder cattle, cocoa, lean hogs, Kansas City wheat, canola oil, and soybean meal. Therefore, by investing in this product, small investors will have broad investment exposure to traditional farming operations. This, in turn, can be used by the investor to help keep abreast of traditional farming practices, as well as to generate an attractive return on investment over time.
Small investors can also utilize a variety of exchange traded notes (ETNs) to invest in specific types of traditional farming operations. For example, the iPath Bloomberg Agriculture Subindex Total Return ETN (JJATF) provides investment exposure to soft commodities such as corn, wheat, soybeans, sugar, cotton, and coffee, and the iPath Series B Bloomberg Livestock Subindex Total Return ETN (COW) provides investment exposure to cattle and hogs.
In terms of utilizing ETFs and ETNs as land- and agriculture-related investment options, investors need to understand that many of these types of products use derivative instruments such as futures contracts to generate market exposure. As a result, investors need to perform a thorough due diligence on these types of investments to fully understand their potential risks and rewards. Nevertheless, the use of ETFs and ETNs are likely to pose the best opportunity for engaging in traditional large-scale farming operations.
Small Farm Investment Opportunities
For small investors to truly enjoy the more traditional sense of land ownership, perhaps the best options are timber farms, mineral development lands, vegetable gardens, orchards, vineyards, and recreational land. These types of agricultural endeavors are much more attractive to small investors: The scale of the land purchase can be tailored to meet the investor’s capital constraints; operations have the potential to generate an ongoing income stream, and investors can enjoy being on the land while it is being used.
With that said, a host of ETFs and ETNs also are directly tied to these types of farming endeavors. Therefore, small investors may want to consider investing in them, if they decide that running a small-scale farming operation requires too much of their time and resources.
The MSCI Global Timber ETF (CUT) is designed to track the performance of timber companies around the world and includes holdings in firms that own or lease forested land and harvest the timber for commercial use and sale of wood-based products. In addition, the SPDR S&P Oil & Gas Exploration & Production ETF Fund (XOP) is one of the many investment options that provide exposure to mineral land development.
Issues to Consider
Once the decision has been made to purchase raw land as an investment or for development, investors need to understand many issues about the legalities associated with the use of specific parcels of property. For example, land-use restrictions may curtail the manner in which the land can be used by the owner, land easements may grant access to a portion of the property to an unrelated party, and the conveyance of mineral rights may grant an unrelated party the authorization to extract and sell minerals for financial gain.
In addition, riparian and littoral rights may stipulate the access that the landowner has to adjacent waterways, and the lay of the land may dictate if it lies in a flood plain, which would greatly impact the manner in which the land could be utilized. Fortunately, prospective land buyers can get answers to these questions by reviewing the legal specification for a parcel of land, which is found in a document known as a land deed. This type of document is typically available to the public via the internet, or it can be obtained the old-fashioned way, by visiting the land records and deeds division of the appropriate county clerk’s office.
In addition to legal issues, small investors should consider the land’s access to basic utilities such as electricity or telecommunications. Investors should also review the land’s annual property-tax obligation, assess the potential for trespassing violations, and analyze the remoteness of the land from the landowner, as well as from the nearest community. All of these issues are important, because the lack of utilities may greatly hinder the ability to utilize the land, the land’s remoteness may impact the opportunities a landowner has to enjoy the property, and property taxes may impact the land owner’s finances. With these issues in mind, prospective landowners should undertake a comprehensive due-diligence assessment before deciding to purchase land.
General Overview of Land Valuation
Investors considering a raw-land purchase need to realize that they are engaging in a purely speculative investment. This is because undeveloped land does not generate any income, and therefore any return on investment will have to come from the potential capital gain that may be received once the land is sold. With this in mind, the cost of debt for a farm real-estate loan can be used to help conduct a preliminary investment analysis.
From a pure investment standpoint, raw land has a very unattractive return on investment, particularly when one considers the length of time that investors typically must own land to generate a return on investment. Plus, interest rates for farm-land loans may increase in the future, which means that the break-even rate for future land purchases will rise as well.
If the cost of debt for a farm real-estate loan does not dissuade small investors from wanting to purchase land as a speculative investment, and they truly believe they can establish a small farming operation that will meet their capital requirements, income requirements and time constraints, many valuation reports are readily available. These reports can be obtained from the agricultural departments of public state universities to help assess the feasibility of establishing a small-farm business operation. Therefore, small investors that want to establish a timber farm, vegetable farm, vineyard, or orchard should be able to find a comprehensive and timely analysis that explains how to establish these types of operations, the amount of work they will likely entail, the capital outlay required, the length of time necessary to receive a return on investment, and the likely return on investment that the small-farm operation will achieve over time.
Finally, and perhaps most importantly, investors need to understand that investing in land to operate a small-farm business enterprise is likely to be the most difficult and risky type of business venture that can be pursued. This is because, in addition to the risk found in all business endeavors, farming operations take on a host of risks that non-farm businesses do not have to deal with. Examples are the threat of a variety of crop diseases, the potential for pest infestations, an ever-changing weather environment, and unstable market prices. For these reasons, coupled with the fact that operating a small-farm business takes a significant amount of physical strength, stamina, and a very strong work ethic, the vast majority of investors will not likely be able to handle all of the farming demands on a sustainable basis.
The Bottom Line
Buying raw land is a very risky investment because it will not generate any income and may not generate a capital gain when the property is sold. Moreover, utilizing a farm real-estate loan to purchase land is very risky. With these points in mind, it is recommended that most small investors with a yearning to own land or operate a small farm business should utilize the wide variety of ETFs and ETNs which are now made available to small investors that were once only available to hedge funds. By utilizing these types of investment products, investors should be able to fulfill their desire for land-related recreational activities while generating a reasonable return on investment over time.
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