Raw land is always a fun topic with clients.
There is an allure to undeveloped land for home buyers and investors alike.
Essentially, it is real estate at a discount to the surrounding area. It is a blank slate with a dream to create an incredible home and estate. Invest your money in a great location, and eventually, it will pay off.
Unfortunately, it rarely delivers on that promise in Palos Verdes.
And, even when it looks like an owner turns a profit, if you really look at the numbers, it almost always under-performs compared to other investments.
Of the four markets covered in this weekly blog, Palos Verdes is the queen of single-family raw land.
For this blog, I will dive into specific land examples throughout the Hill further down in the post.
Top Three Reasons Why P.V. Raw Land Under-performs
To break it down, there are three main reasons why single-family raw land in Palos Verdes generally under-performs in a big, big way.
Rising Construction Costs
This is public enemy #1 of raw land.
If construction costs go up, it eats away at your profits down the road.
Existing homes benefit during increasing construction prices because those homes are already built. The materials used to build a home are baskets of commodities (lumber, copper, concrete, labor, etc.) which tend to go up over time. If the home is already built, you lock in those low costs and reap the benefits of inflation.
So, if you bought a piece of land for $1 million in 2001, you could have built a 3,000 square foot home for $150 a square foot during that time.
Well today, you are looking at $350 to $500 a square foot. That hurts.
That is an inflationary cost of $600,000 to $1,050,000. It ends up crushing your profits if you build later (or never at all).
Expenses Required to Hold
Remember, raw land is basically worthless because it does not have an improvement of any value to charge rent.
And, in Palos Verdes, the city is not letting you sell pumpkins on your lot during Halloween.
During the holding period, you incur property taxes, brush/fire control expenses, insurance, and debt service if you choose to finance the land.
These expenses not only add up over time, but your opportunity costs of lost cash flow from other investments and property-types (aka dividends or rent, etc.) are all lost.
Without a stream of income, this is purely an appreciation play that needs to pay off huge to compete with other investments.
I will break down the numbers further down the post.
Illiquid Market at Low Prices
Raw land is an illiquid market with very few buyers.
As a result of this dynamic, Sellers are forced to wait very long periods for just the right buyer looking to build their dream home. Those buyers are hard to find and your price has to be realistic.
For Sellers that do not have time (or do not care), they end up liquidating at low prices to get sales done quickly. Any sale due to death, divorce, or debt issues makes for poor comps and does not help to raise value of the raw land market.
Most deals are raw land deals done by professional developers, at shark-like prices, so they can build and sell right away for a profit.
*Bonus: Timing is a Wild Card
It is impossible to time markets.
However, if you purchase your raw land before a recession or market pull-back, you are going to be waiting on your raw land to return dividends for decades.
You truly need to nail your timing and have an ironclad stomach to buy raw land when there is blood in the streets, as well as have the capital behind you to ride it out to the other side.
Covered Land Play & Other Land Deals
Before I run the numbers, I want to clarify that we are strictly talking Palos Verdes raw land that is almost always zoned R1. This is undeveloped land that only a single-family home can be built on, with no previous home there before.
There are professional land speculators in Las Vegas, out in the Inland Empire, and commercial raw land professionals where a lot of money can be made. You need to know exactly what you are doing.
I want you to know that I am a HUGE fan of the “covered land pay” that you can put into practice here throughout the South Bay and greater Los Angeles.
In fact, I am such a believer in covered land plays that the properties I own 100% to my name are covered land plays where I will take smaller cash flow in exchange for the future wealth creation.
For example, buy a triplex that is on land zoned for a 25-unit apartment building. Get paid to wait.
Or, buy a small bungalow to owner-occupy that is on a lot to build three town homes. Another great way to play land but get value from the property in the meantime.
Those are COVERED land plays. They have improvements on the property.
They offer cash flow to cover expenses and debt, and the market for triplexes or a bungalow are highly liquid. Sure, construction costs still rise over time, but the density of what can be built can largely off-set those costs and lead to out-performance on ROI.
P.V. Raw Land ROI Numbers
Let us take a Palos Verdes raw land sale currently in escrow.
- 2000 Noya Place, Palos Verdes Estates
- Asking Price: $1,195,000
Per the assessor’s records, this property was purchased for just $43,000 in 1976. Wow.
If the sale closes near $1.2 million, then the owner is earning about 27 times on their money after 44 years, or a 2,700% ROI. That is simple growth of about 61% per year which we would all love to have.
What if you had bought something else? Say, Coca-Cola stock and held onto it for the same time period?
In 1976, Coke was trading around $6 per share according to Yahoo! Finance. Today, it trades at around $267 per share. That is 44 times on your money over the same 44-year period, or a 4,400% ROI.
So, simple growth in Coke stock returned 100% per year if you were a long-term holder.
The even bigger difference? Noya Place LOST you money every year with property taxes, insurance, land management which lower this owner’s returns significantly.
From the Coca-Cola dividends alone, I am sure you would be a multi-millionaire enjoying that cash flow over the last 44 years from stock ownership. Not to mention, you would probably be collecting well over $100,000 this year just in Coke dividends. What a winner!
The land returns in comparison to Coke were horrible.
OK, so clearly Coke is a a big winner that is rare. What about just buying an S&P 500 index and holding like so many experts suggest?
In 1976, the S&P 500 was around 100. Today, it is at just about 3,400.
That is 34 times return or a 3,400% ROI. So, just the overall index soundly beats the land play, dividends, or no dividends.
What about a single family-home?
I had a wonderful client hire us to sell his two bedroom El Segundo home that he had owned since 1968. He and his wife purchase the house for $26,000.
For example purposes, let’s assume it would have been worth $40,000 in 1976. Here is the our sale from last year below…
- 809 Maryland Street, El Segundo
- Sold Price: $1,345,0000
This sold after 25 offers and almost $200,000 over-asking. It made it a 33 times return or a 3,300% ROI. This far outpaced the land play…again.
Sure, the Noya Place property could have been financed to increase its returns, but then it would have been even more negative.
I am betting my client could have financed this home with 30% to 50% down and bought another one or two homes while having the cash flow to cover all his expenses.
Oh wait, he did do that…
The year prior, we sold his home in Harbor City and in Torrance that had the same, remarkably similar results over the long-term. So, rather than buy land, he bought three homes (expenses and debt covered) and earned close to 100 times on his money…not to mention the massive cash flow growth he enjoyed over time.
It makes buying raw land in Palos Verdes, and holding, look silly.
And, what is the final nail in the coffin?
This Noya sale is an example with one of the best results out there. Most other raw land sales, the owners do very, very poorly.
In the long run, the numbers prove that you can buy an index fund and crush raw land returns. If you want to own real estate over the long-term, make sure that there is an improvement that will pay you over time.
Raw land over the last 50 years in Palos Verdes is a sucker’s game. If you buy one, it needs to pencil to build today…and you should build on it ASAP.
For additional examples, here are some land sales in Palos Verdes that are on the market, in escrow, or have closed in the last 365 days to show you how much it hurts (aka under-performance) as an investment.
- 3227 Crownview Drive, Rancho Palos Verdes
- Asking Price: $550,000
This was purchased for $350,000 in 2003. You would be way ahead in the S&P, a home purchase, or income property. They will be barely hit a 50% ROI while servicing negative cash flow along the way.
- 0 Clipper Road, Rancho Palos Verdes
- Asking Price: $2,400,000
This was purchased for $1.8 million in 2005, which was about as bad a timing as you could make before the Great Recession. This owner could have taken a huge haircut, sold for $900,000 in 2009, and bought the S&P 500 or distressed REOs with the money.
Those investments, even after a recovering the huge 50% haircut, would have made more money today than what they will make with this sale.
It is likely not worth much more than they paid in 2005 and there was a $1.25 million loan recorded in 2005 that has been serviced. Ouch. More incentive to own raw land free and clear if you can.
- 74 Via Del Cielo, Rancho Palos Verdes
- Asking Price: $1,790,000
Via Del Cielo sold for $1.6 million in 2017. They spent money on plans and will have selling costs to pay. If the owner is lucky, they will break even.
- 30683 Calle De Suenos, Rancho Palos Verdes
- Asking Price: $2,249,500
Calle De Suenos sold for $550,000 in 2000 for all cash. A winner…finally! This one would have slightly outperformed the S&P 500, but with the negative cash flow, they are probably the same return.
Wouldn’t you have rather owned a rental home with cash flow or a basket of stocks with dividends? I know I sure would.
- 2004 Muros Place, Palos Verdes Estates
- Sold Price: $1,200,000
This one was purchased in 2016 for $1.15 million. After selling costs, this one is a loser…not to mention holding costs. Any home, income property, or index fund would have likely earned a profit nicely above this ladn deal.
- 30375 Diamonte, Rancho Palos Verdes
- Sold Price: $550,000
Diamonte was a property purchased way back in 1997 for $225,000. So, they doubled their money. Well, if you compare it to the S&P, their money would have quadrupled. So this investment still stinks.
The owner bought it with $210,000 in debt in 1997, so you could say it actually was a five times return, but boy oh boy, the debt service and holding costs likely brought it way down and was probably excruciating to hold for the measly ROI after 23 years.
I can go on and on!
But, per usual I am beating a dead horse over here.
Pace of Sales are Up Big Over the Past 12 Month
In conclusion, I want to leave you with some closure.
The Palos Verdes raw land market has only had four sales in the last 12 months.
In this red-hot market with low interest rates as well as buyers looking for more room amid the pandemic, the Palos Verdes raw land market has a whopping six raw land deals in escrow.
I am betting that more sales will come too. A double, or more, in raw land sales in the next 12 months is entirely feasible for the Palos Verdes market.
If you are currently holding Palos Verdes raw land, do not stick with the dream fallacy that you will outperform over the long-term. You will not. And if you have debt, even more reason to unload now into the hot market.
There are only so few times that raw land is in demand. Take advantage now.
This is a great time to reasonably price your lot and get out in a somewhat liquid market with eager buyers.
And, if you are dreaming and thinking about purchasing Palos Verdes raw land right now…forget about it!