6 Ways to Get Financing for Land Investments

LoopNet revised this article on August 31, 2021.

Financing for any real estate transaction is often a relatively complex process, but this can be particularly true of a land acquisition .

Due to some of the special considerations and risks that come with land investing , obtaining financing isn't as straightforward as many other commercial real estate transactions. Accordingly, before you move forward on any land purchases, it's critical to understand the financing options available to you, as well as the attributes and challenges of each alternative.

Some of the most common ways to obtain financing for land investments include:

• Institutional lenders.
• Seller financing.
• SBA 504 loans.
• Farm credit system.
• Home equity loan.
• Retirement accounts.

Institutional Lenders

Among institutional investors, local credit unions and community banks are more likely to offer loans to land investors. Chane Steiner, CEO of Crediful, a company that helps consumers understand loans, mortgages and credit, also notes that banks consider land loans riskier than traditional loans. It can hamper the process — especially if you don't have perfect credit. With most banks, Steiner notes, "The creditworthiness of the buyer is a major consideration."

To improve your chances, get your financial house in order beforehand. "Provide strong financial statements with assets well in excess of liabilities," advises Steiner. This statement should reflect robust totals of cash and other assets, such as security investments like stocks and bonds.

"On the liability side, there should be limited liabilities, such as credit card debt, mortgage debt and any loan obligations," adds Steiner.

Seller Financing

"One of the most popular ways to finance a land investment is owner-financing, which is a direct arrangement between the seller and the buyer," says Ben Mizes, CEO of Clever, a company that pairs buyers with real estate agents.

In this instance, the seller agrees to take payments from you over a set time period to cover the purchase price of the land, and it typically means banks or other lenders aren't involved in the transaction. But there are still some important considerations to pay attention to when it comes to this sort of financing.

Firstly, seller (or owner) financing usually requires a larger upfront down payment. You might also see higher interest rates as well as shorter payment periods. For example, instead of a 20-year mortgage, you might have to pay off this loan in five years.

Despite these potential concerns, for investors who struggle with financing through more traditional options, seller financing might be a good fit. However, make sure to have your lawyer review any agreements and paperwork during the process.

SBA 504 Loans

The federal government offers both loan and grant programs for people looking to invest in land. One of the more popular is the SBA 504 loan. It's guaranteed through the U.S. Small Business Administration . A 504 loan allows for the purchase of fixed assets; these are tangible assets for long-term use, including land, machinery and property.

SBA loans are small business-friendly and have a unique breakdown:

• 50% comes from a participating lender.
• 40% comes from a local community development program.
• 10% serves as a down payment from the buyer (this can sometimes go up to 15%).

SBA 504 loans tend to have low fixed interest rates, and the term for a land purchase can run 20 to 25 years. Many local credit unions will offer SBA 504 loans. Check with yours to determine if you qualify, the amount of the loan available to you and the associated fees.

Farm Credit System

Another option for land financing within the federal government is the Farm Credit System. It's run by the Farm Credit Bureau , an independent agency that provides, among other things, agricultural real estate loans.

A benefit to working with this type of lender is they typically have plenty of experience lending to land investors and can provide guidance, especially if you're new to the process.

Be aware, though, that down payments for land are usually relatively high. Mizes notes that raw land is considered riskier when it comes to financing, so the down payment required could be as high as 20% to 50%.

However, for younger or first-time investors, there are some programs run by the Farm Service Agency that help reduce the down payment required.

Home Equity Loan

Your current home can be another place to turn for financing. A home equity loan is essentially a second mortgage based on the equity remaining in your home.

There are two types of home equity loans. A standard home equity loan is a fixed rate loan where you'll get a lump sum of cash upfront that you'll repay over a set term with a fixed interest rate.

The other option is a Home Equity Line of Credit (HELOC). In this case, a lender would approve a maximum amount available for you to borrow as a line of credit versus a lump sum. You can tap into that credit at any time for any amount (as long as it doesn't exceed the maximum limit), very much like you would with a credit card.

With a HELOC, you only pay interest on the amount of money borrowed. You will have to pay back the money you used in full, usually in fixed monthly payments over a set period.

However, it's important to remember these loans don't come without risk. If you can't meet your repayment terms, your home could be in jeopardy.

Retirement Accounts

Some investors tap their retirement savings as another source of funds for a land purchase. However, the Internal Revenue Service (IRS) has a plethora of rules and regulations that cover the use of retirement funds for real estate purchases.

Plan administrators might allow you to borrow against your 401(k), but there are limits. The maximum borrowable amount is typically up to 50% of your savings or $50,000, whichever is less. The loan will also have a set repayment period; if you miss it, you'll face taxes on the loan and an early withdrawal penalty tax.

Borrowing from a Self Directed IRA is also available thanks to the Employee Retirement Income Security Act of 1974. However, there are a few important things to note up front about this approach. You can't live in or actively manage any property you purchase through your IRA — that needs to fall to a third-party custodian. You also can't mortgage the property, and any income generated gets fed back into your IRA.

If you're thinking about pursuing this route, check with retirement and tax professionals to go over any potential long-term impacts and tax implications.

Investigate Your Options

When considering the types of financing available to you for land investments, Steiner stresses it's best to shop around. "It is important to secure the best possible and most flexible financing terms, such as interest rate and term of the loan."

Moreover, before you make any decisions, thoroughly investigate the details of the financing. Have a plan ready and speak to the appropriate individuals, including tax, retirement and loan experts who can help you make the right financing choice.