By: Rosemary Johnston – Tuesday, April 26, 2016
Land banking has helped developers create fortunes over the years. They have bought and held large tracts of land on the edge of cities and towns that have eventually been developed for new housing. This was a speculative investment that required holding the land with no income for many years.
ASIC has recently successfully prosecuted several cases involving spruikers and their ‘get rich schemes’ involving forms of land banking.
The broad outline of the scheme was the investor paid a fee to ‘secure’ an option. This option entitled them to buy a block of land on which to build in ten year’s time. The concept was that the land would have doubled in value over that time. The fee was low value, about $37,000 compared to the ‘finished’ value. Also it was cleverly designed so there was a very limited chance the investor would consult other professionals such as a solicitor, accountant or financial planner.
The spruikers further discouraged this through making it seem that if everyone knew about the opportunity they would be doing it too and the returns would be diluted. Without this independent professional input and in the face of pressure from charismatic sales people it became a ‘no brainer’. You were crazy not to do it. However, there were huge assumptions in place.
Risk: What were they buying?
There was no title until the land was subdivided. The investor owned an option to buy a title on something that wasn’t created yet. The terms of the agreement were not clear as the it had been written by the spruiker. Had they included some future obligations for the investor? Would it require them to complete at title and at what price? Did they need to pay interest annually to hold the land?
The client needed legal advice and an assessment of the contract before they sign anything as an absolute minimum.
Risk: Where were my fees held and how do I know how they are to be used?
The considerations here are speculative however it is unlikely they went towards interest re payments. The fee of $37,000 wouldn’t go far to service any borrowing for ten years unless the land was very, very cheap.
If there were no servicing fees why would the directors of the scheme be willing to hold land on the investor’s behalf at no cost? The only way to make sense of this is to assume there must have be some huge financial reward for them, at the beginning in fees, and at titling this cheap land must be sold at prices that were exorbitant compared to its true value.
In these situations it is important to establish total costs required to complete and all obligations before signing. Investors could be responsible for paying considerable fees and too much for the land at completion.
Risk 3: Where is the land?
In a recent case of land banking that ASIC pursued in front of the Victorian Courts, the land was in the Pilbara. When this region is entered into Google Maps a huge area of northern Western Australia is indicated with Port Headland, Karratha and Dampier as the larger towns. These areas are in the middle of a massive down turn due to the end of the mining boom. Capital values for property are about 25% of what they were about several years ago.
Investors need to consider what are the economic drivers to make this land attractive in ten year’s time and how likely are they to be delivered? Are iron ore prices forecast to rise significantly and recreate these circumstances?
Conclusion
In many cases after prosecution the schemes are found to be insolvent. Most investors lose their money. This some may be a blessing in disguise if we consider that they may have been responsible for far more losses at settlement.
It costs money to get advice. Many people struggle to justify paying it. However, if the people, who invested in these schemes, had spent $500 on legal, or property investment advice could have saved their $37,000 and invested it into something that might actually make a return for them. Good advice is inexpensive when it ensures your success.