Should I look to buy undeveloped land or buy an existing house?

EthanR answered one year ago …

Major, I always advise my clients to favor investing in homes over land. To me, buying land is like buying a CD. You have to pay cash for it, because if you took out a mortgage, whatever appreciation you received each year would probably be wiped out by your mortgage interest. And banks don't like to lend money for more than a few years anyway on land. So if you pay cash for the land, unless you either put a mobile home on the land, or sell a resource from the land (timber, grow corn, sago palms, etc), all you can bank on is the appreciation. And if you buy land in an area that doesn't grow as you expected, then your appreciation will be minimal. So to me, unless you are really savvy and know that an area is about to boom, you are better off investing in a CD than in land.

Now contrast that with buying a house for investment. Say the house is $100,000. You put down $20,000 (20%). You will also have start up expenses, such as closing costs and repairs/improvements. So perhaps your true cost basis is $25,000-30,000. Then through the years you will have to pay an occasional mortgage payment when the house is vacant, and fix things. And of course you have taxes and insurance. But here is where the beauty of this investment comes in. About 95% of your mortgage payments, including the taxes and insurance, will be paid by your tenants. Historically, over a long period of time, real estate averages about 5% appreciation per year. So in 30 years, that house will be worth about $446,000. However, even though you paid $100,000 for the house, you only had $25-30,000 out of pocket, plus whatever money you put into it through the years.

It is also possible that if you bought an undervalued house, say a foreclosure, that you would have had $20-30,000 of start up equity in it after you fixed it up. If that house was worth say $130,000 after you spruced it up, then after 30 years it will be worth $580,000. Additionally, you also may get some positive cash flow on it each month (the rent is greater than the total mortgage payment). Say you get $100 positive cash flow. That's $1200 a year x 30 years, or $36,000. That is enough to cover most of the occasional mortgage payment or repairs you have to make.

Now for most of that 30 year period, you will also get a tax break in the form of depreciation. For how to calculate depreciation, see the link below.

http://www.bankrate.com/brm/itax/tax_adviser/20030327a1.asp

So all in all, I believe that buying a home as investment property will generate a better return over the years. However, in fairness, I do have to say that investing in houses and dealing with tenants is a lot more time, energy, and occasional headaches than investing in raw land. So the decision you make should also reflect your own lifestyle and how much time you have to devote to real estate investing.

Whichever way you decide to go, best of luck!