Land banking is a real estate investment scheme premised on the acquisition of sizable parcels of vacant land (and/or the right to acquire them at an agreed future date by exercising a lease option) for sale at some predetermined future date.
The incentive to an investor is obviously the opportunity to cash out of the scheme with significantly higher capital gains than would otherwise have been achievable through an outright purchase of the property.
The proponents of the scheme “acquire” the right, theoretically, to sell the land via a leasing option and to either finalize the transfer to their investors upon maturity of the agreed term of the contract; or to redeem the option at the prevailing market rates at such agreed future date.
Usually, the property under the scheme is undeveloped but falls within the precincts of fast-developing areas, emerging towns, and cities or in the path of upcoming major infrastructural developments. The proponent of the scheme (seller) usually buys or leases the land and then theoretically “divides” it into smaller parcels for offer to investors. Investors will then acquire parcel(s) of land, usually via a lease or a redeemable option contract that gives them the right purchase the land at an agreed future date.
These contracts are not outright for the sale of the land to the buyer but are instead referred to as Option Contracts which usually have a predetermined maturity date (sunset clause) and an agreed contract price. Sometimes, the vendor of the scheme also structures them as managed investment schemes with an assigned financial incentive to entice buyers to commit to them.
The arrangement is very similar to seller-financing in the sense that the “buyer” secures the right to purchase the property from a seller at a fixed price and a predetermined future date. The right to purchase the property can be either obligatory or optional. The buyer reserves the right to buy the property at a predetermined price by paying a fee for the option to buy. This also obligates the seller to reserve the land for the buyer, should he choose to exercise the option.
By paying for the option to acquire the property, the buyer commits to paying the full purchase price at the expiry of the option. The fee to acquire the right is usually pegged on the period for which the option is purchased (usually between 10 and 25 years) and whether or not it is mandatory or optional. Because it is a form of investment, the option will usually be transferable by the buyer to third parties. However, these transfers would have to be registered with the proponent of the scheme
The Investment Rules for Land Banking
Each land-banking scheme will usually have its own investment rules elaborating the rights of the buyers and the sellers, the contract periods of the options as well as exit clauses to protect the rights of both parties. The general idea with these schemes is very similar to off-plan investing – buy today at an understated/undervalued price with the prospect of making significant returns at maturity of the project. Similar to off-plan schemes, they are often sold on concept unlike actual subdivision schemes so that the investor is basically pooling their funds with other investors to acquire a larger parcel, as if on the basis of shares and not necessarily with the rights that attach to actually owning the property.
The investor will be looking at the scheme to see if the opportunity to invest today makes economic sense and whether the returns that will be accrued in capital gains/ appreciation in value over time offer a sound investment. Obviously, the main factors that will cause the appreciation in value include settlement of local populations within the vicinity of the property, development of multi-dweller residential properties, institutional and commercial developments. However, forecasting the progression of these factors 10, 15 or even 20 years down the line may not be as easy as many investors may be given to think.
The investor’s success in a land banking scheme lies in their knowledge of the market and their ability to think strategically and follow paths of development in undeveloped areas in proximity to growing towns.
The ability to identify and invest in strategic properties or real estate market segments that are poised for strong growth in the near to long-term is a useful tool in the arsenal of savvy real estate investors.
It is a great equity growth strategy but one that requires patient capital and a high investor acumen.
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Inherent Risks in Land Banking Schemes
Land banking schemes are complex. Unlike subdivision schemes, they are based on theoretical or notional allocation without any formal transfer or actual ownership of the land in question. As an investor, before you consider land banking as a possible investment avenue to expand your real estate investment plans, you should be adequately informed about how the scheme you are investing in works and understand the risks you would be assuming.
- Buying anything on the concept rather than on actual tangible evidence of the same is always fraught with a higher level of risk. The risks of investing in land-banking are much akin to those of investing in off-plan schemes. Not dissimilar to off-plan schemes or fractional property ownership schemes, land banking schemes are often touted as a cheaper, more affordable option of real estate investing.
- Are you familiar enough with the market to understand the proposition? There are risks to do with rezoning and even reclamation of the property during the life of the option which may interfere with the buyer’s rights under the Option Contract. In addition, the contract is premised on the vendor’s prospects of the market. If compelled to exercise the option earlier than the sunset clause, there may be stiff penalties resulting in loss or negative returns.
- Like off-plan schemes, land-banking schemes are not uniquely regulated financial instruments. Their proponents are essentially leveraging a high-risk capital-raising mechanism with little to no risk on their part. Indeed because there is no requirement compelling the vendor offering Option Contracts to demonstrate legal ownership of the property, the investor may very well be scammed.
- All high-yielding opportunities also carry a high degree of risk. In the case of land-banking, the risk that the vendor can over-subscribe a project leaving investors high and dry is imminent. There is also the risk of the scheme’s complete failure owing to insolvency if the scheme was premised on creating new property developments which are eventually not approved by local authorities.
- For the investor, a land banking contract is not much more than options to exercise the right to acquire land. They rely heavily on the proponents of the schemes transacting and conducting their business with a very high level of integrity and trust. Additionally, because the investor isn’t provided with any formal ownership documents (title), the investor cannot leverage the “acquisition”. Equally, transfers can only be authorized by the schemes’ proponents.
An investor must take all measures to secure their investments in these schemes by individually determining whether land banking opportunities are compatible with their investment plans. A good place to assess the opportunity would be your investment goals and strategy.
It is important for each investor to also determine if a land banking scheme under consideration comports with their individual appetite for risk. To gain a clearer understanding of the opportunity, be sure to understand what disclosures you must have in order to make an informed choice by consulting with independent, competent financial and legal advisors.