Placing a Limit: Should We Be Capping the Profit Sellers Can Make on Land?

After years working in the construction and land development industry, Dan Greenhalgh and Colin Lacey understand the challenges surrounding affordable housing. There are many layers to this hot topic that need to be considered including the profits sellers and land speculators are making on the sale of property.

Cap Rate is a minimum standard to measure returns on investment. It can be used to compare a real estate investment from other investments, such as bank account or mutual funds. Here’s the formula you can use to compute the cap rate.

                     CAP RATE = Net Income/Price

It has two types: Builder’s Cap Rate and Market Cap Rate. The Builder’s Cap Rate, as defined by the Canadian Federation of Apartment Associations (CFAA) is “net operating income as a percentage of purchase price.” Market Cap Rate, on the other hand, is “the net operating income available from existing rental projects as a percentage of purchase price.”

The cap rate is a reflection of risk in the market. The more mature the market, the lower the risk and the cap rate someone is willing to accept. Think of it as your return on investment. The interest rate you can earn is likely the lowest rate. As the risk of the investment increases, so does the interest you will earn. For instance, in a safe and mature market like Vancouver which has cap rates ranging from 2.5 to 3.00, you would have to invest 40 million at 2.5 (1,000,000 divided by 2.5%). In another market where cap rates are ranging from 7.00 or 8.00, you would have to invest 14,285,714 to make a million (1,000,000 divided by 7%).

What happens in a “hot” market is that land speculators go out and tie up a piece of land for one or two years before they close on it. They do this by putting down, for example, $100,000.00 on a $2 million dollar piece of land. Then they hold that land for one or two years without closing on it (as per their contract). When they do close on the deal, they’ll flip the land immediately or (until recently) assign the deal to someone else. This is one of the primary causes of speculative land uplift as developers who are looking to actually build something have these middlemen trying to maximize their land uplift.

Overall, whether low or high cap rates are preferable depends on who is evaluating the land. Buyers aim for a high cap rate. On the other hand, sellers would want to see a low cap rate since the selling price of land is high.

Of course, when buying and selling land, you want to make sure that you obtain a high return on investment. Let's take a look at some of the best ways to maximize a land property with minor investments.

• Buy and Hold Strategy

Investors look for properties that they can buy at low prices. You would want to buy land that is strategically located in an area that is likely to be developed in the future. Over time, the cost of these properties will accumulate. The longer you hold on to a property, the higher will be the price.

• Quick Selling

Numerous bids on a property means a high return on investment. The key is to buy the land in cash. Doing this will give you more chances of getting the land with higher discounts. Afterward, you can sell the property to other potential buyers for up to 30% higher.

 

• Line Installation

Line installation is a major selling point, reducing the need for potential buyers to traverse when buying the land and starting the construction.

Dan Greenhalgh, Colin Lacey, and the rest of the ENM Construction Management team understands the development and construction industry in British Columbia, particularly Metro Vancouver. Our team strives hard to develop properties into functional and modern spaces that offer rental housing options for professional couples and families. Be sure to subscribe to our newsletter to stay up-to-date with the latest trends and developments in the construction industry.