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Cash Vs. Debt Financing: Which Has The Upper Hand In Buying Raw Land?
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Land investors are flocking to the UK because of high demand for housing. But investors with cash have significant advantages over those who work with debt financing.
The incontrovertibly rising demand for housing in the U.K. offers many opportunities to real estate investors. Homebuilders in particular, including all the subcontractors and ancillary services involved in building and real estate transactions, have a tremendous opportunity before them. It’s true that lending schemes, local planning and the extensions rule (largely disfavoured for causing strife between neighbours) may not be the magic bullets they were promised to be. But on the whole as populations increase so too must the dwellings to accommodate them.
This business opportunity arises from a confluence of demographics and economics. Already population growth was a solid 7 per cent in the past dozen years, as measured by Census 2011. Projections of population growth from 2008 to 2033 suggest that there will be 5.8 million more people in the UK as an end result, a 27 per cent increase in just a quarter century. But housing starts are at about half of what they should be to accommodate this growth, as they have been since the financial crisis began in 2008. Stringent lending in combination with working families unable to accumulate sufficient deposits have led to what is now called Generation Rent. But even as they rent, their growing families itch for more space – preferably what they themselves could own, but if not, larger rental homes.
Investors from North America, the Middle East, China and elsewhere are drawn to the opportunity British investors see in this. Many are buying single homes and flats, operating as landlords as they look for capital growth if not income from their investments.
On another level, investors are joining in syndications or joint ventures to develop raw land into new neighbourhoods. This amortizes risk among investors, but more importantly draws in professional site development specialists who understand how to do acquisitions, site planning, use designation changes, infrastructure development and ultimately sell the property to builders. From there, homebuilders who know the market will construct homes that are priced for the most likely buyers.
Some investment groups work with borrowed capital while others self-finance. A strong advantage in working free of debt is in the acquisition phase. If there is competitive bidding for land, the buyer who can offer cash has better leverage and is more likely to win the bid. There are other problems with debt financing, which include the following:
Negative leverage, such as when the project experiences a lower rate of earning profits than the mortgage interest rate (as well as out-and-out losses).
Greater risk in recourse lending, when the loan puts the borrower at personal risk, as might be the case when an individual is involved in a land investment.
Missed payments have consequences, particularly if the lender determines to foreclose on its collateral.
Of course, there are many other factors that can determine whether land investing is successful or not. Professional land investment specialists who understand how to work with local planning authorities are essential, as is having the capital to see through site preparation (development of infrastructure included).
Individuals who are considering land investments should do so under the guidance of professional financial advisors. Independent analysis of any investment relative to one’s full portfolio is always a good practice.
Advisory: None of the information contained on these pages constitutes personal recommendations or advice. If you are unsure about the meaning of any information provided on this website, then please consult your financial or other professional advisor.
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