3 Most Common Down Payment Strategies for Land Purchases

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As in nearly every industry, the entry-level conversation starts with a budget. How much money have you earmarked for land investment? But that is usually the easy question. Our clients know how much they have to spend. Usually, it’s a range, but clearly, most clients have gotten this far in the process when they get to us. The more important initial conversation revolves around preferred investment strategy. It involves risk tolerance, position in life, predicted income. And most often, these elements first display themselves when we discuss down payment strategies. For this exercise, let’s set aside the type of property someone wants…because 1) while that can reveal someone’s risk tolerance, that isn’t always the case and 2) we typically see no difference in down payment strategies between buyers of tillable or recreational land.

In our experience, down payment strategies can be broken down into three main categories. That doesn’t mean that each down payment falls 100% into one of these buckets. In fact, most down payment scenarios are a hybrid approach. But a confident approach comes from understanding each down payment strategy.

Paid in Full

The easiest option to cover is a 100% down payment strategy. I am aware that this strategy is not an option for many land buyers. And just because you can’t pay cash for a property, that doesn’t mean you shouldn’t get involved in land investing. This strategy is most commonly used by individuals who are either in or close to retirement and individuals who have accumulated a significant amount of wealth early in life. The thought process is simple…a land purchase using this strategy is no different than buying stock. It is moving money from one investment to another. It diversified risk. Typically, individuals who employ this strategy are educated on the historical performance of land values and see it as a way to decrease risk while enjoying some of their investments.

Monthly Payment Calculation

This option typically incurs the biggest risk but also allows the investor to back into his or her exact comfort level in terms of the out-of-pocket expense. It is the most common down payment strategy. It is primarily used by buyers who are in the middle of their earning days. The end numbers are different for everyone but the theory is the exact same. The questions that you must ask yourself to begin this down payment are as follows.

• How much money am I comfortable with putting down on a property?

• How much money am I comfortable with coming out a pocket annually to pay for the property?

The answers to these questions reveal what kind and size of the property the individual can buy. It doesn’t back you into an exact answer, but it reveals a range of properties you can buy.

For example, let’s say a buyer has $50,000 to put down on a potential property. And the buyer is comfortable with coming out of pocket with $10,000 annually. The formula for revealing potential property targets goes like this…

Expenses – Income = Net Annual Payment

Each farm has its own specific expenses and income but most commonly they are…

Expenses

• Mortgage Payment

• Property Taxes

• Maintenance

Income

• Farm Rent

• CRP Payments

• Hunting/Fishing Leases

The easiest way to get a range of potential property targets using this method is to run the formula on a property with zero income, and then again on one with 100% tillable. Sure, you are going to have to apply some logic to your unique situation…if you are looking specifically for a deer hunting property, you may swap out that 100% tillable property with one that has the highest percentage of tillable that you are willing to consider. For most deer hunters, that typically falls around 50%, but the exercise remains the same. To start this exercise, it is easiest to make some ballpark assumptions…we can fine-tune these numbers when we start looking at specific farms but this will provide us with a range of farms that fit our financial capabilities. They typically go like this…

Assumptions

– 100% Timber Property with no immediate income

– Property Tax = $1200/annually ($100 Month)

– No ongoing maintenance costs

Under these circumstances, the formula would be…

Comfortable Annual Payment – Property Taxes – Maintenance Expenses = Target Annual Mortgage Payment

For this buyer, we know the comfort zone out of pocket is $10,000. So we then plugin that amount and the assumed property taxes to reveal a mortgage amount. For a 100% timber property, we are also going to assume no ongoing maintenance expenses.

$10,000 – $1200 – $0 = $8800

So now we have backed into an $8800 annual mortgage payment ($733/month). Now simply run that number against the current loan climate. For example, banks now are around 4% interest on a 30-year amortization schedule. If you plug in those numbers on a mortgage calculator, it reveals that a $150,000 loan has an annual payment of around $8600.

This portion of the exercise reveals that this specific buyer has a ceiling of $200,000 ($150,000 mortgage plus $50,000 down payment) when there is no income.

Now we run the same formula on a property with 100% tillable.

Assumptions

– 100% Tillable with $9,000 annual income

– Property Taxes = $2400/annually ($200/month)

– No Ongoing Maintenance Costs

To get to some of these assumptions, we ballpark some projections based on the first portion of the exercise. For example, if the max spend on a timber property is $200,000, we know the max spend on a 100% income property is going to be greater than the $200,000 (based on increased income). So let’s plugin $300,000 for a 100% income property to see where that number lands in terms of annual out-of-pocket expenses.

Assumptions

– $300,000 purchase price

– Average 3% Return (This will change based on your local return averages…chat with a local broker to get some averages in your area) = $9,000 annual income