UCLA Economist Warns: Land Investment Risky After Real Estate Booms
- Oct 17, 2012
While land comprises a major part of wealth and is consequential for any type of economic activity, it has become a high-risk investment for investors and lenders alike—more so than commercial property.
“It would be a different story if we rolled back the clock 200 years, when land was very plentiful in the United States and all you had to do was cut down trees and move out as far as you wanted from the center of the city and land was not a constraint. But now the land supply is limited,” said Stephen Oliner, senior fellow at UCLA Ziman Center for Real Estate and senior economist at UCLA Anderson Forecast.
Oliner published a study on land price swings spanning from 1996 through middle of 2011, cautioning lenders and investors against lending or investing in land after a real estate boom, when prices peak, and the future is unknown.
A house is a bundled good, which means it consists of two parts: the structure in which people live and the land on which the structure sits. The structure price does not change significantly, when you consider the cost of labor and the materials. Land is a much riskier asset because of basic economics: The supply of land is less flexible than the supply of structures. Buildable land is limited by geographic constraints and land-use regulation, while the amount of new structures could be increased without much added cost by hiring more labor or buying more materials.
“Land is a high-risk investment because it is susceptible to very large price swings, so it’s possible to buy a piece of land at what turns out to be at the top of the market and then find that the value plummets from there,” said Oliner.
That scenario was the case in 2005-2007 when land price was at its peak, only to dip in 2008 at the start of the Great Recession. Land prices today have come down dramatically, with a reasonable valuation, posing a smaller investment risk than a few years ago. Nevertheless, historically, land prices tend to be unstable, strongly dependent on time and economy. The risk increases in more heavily condensed cities such as New York City, Los Angeles and San Francisco, as opposed to Oklahoma City or Kansas City where there is more surrounding land.
“In both 2005 and 2012, the bank should keep the loan-to-value ratio lower for loans against land than loans against structures, because land prices tend to be volatile. This is the sense in which lenders should be cautious in lending against land value,” Oliner concluded.