Buying "Raw" Land: A Guide to Due Diligence

Overview of Purchasing Unimproved Land.  Purchasing "raw" (unimproved) land, in the hope of building improvements on that land in the future, is an inherently risky investment.  There are many factors that might adversely affect your plans for the property and your investment in the property.  These factors include, among other things, the following: (a) title issues, (b) survey issues, (c) hazardous waste issues, (d) land use approvals (e.g., zoning, site plan approvals, building permits, lot size and set-back issues, fire safety issues, health issues regarding water and septic disposal, environmental issues regarding septic systems, storm water management, stream, wetlands, and shoreline management issues), (e) availability of utilities (e.g., water, sewer/septic, electricity, gas, telephone, cable television, internet service), (f) access (e.g., legal means of physical access, as well as the type, condition and cost of maintaining access roads), and (g) physical characteristics of the property (e.g., topography, soil and slope stability, drainage and flood hazards).

Minimizing Risk: Due Diligence.  It is all but impossible to list or anticipate every possible source of risk, expense or delay that might be encountered during the process of attempting to develop raw land.  However, pursuing a thorough program of "due diligence" before buying the property can help minimize those risks.  The usual means of conducting due diligence is to hire several different experts (as to each of the various risk categories identified above) to conduct inspections and make certain inquiries on your behalf.  This will, of course, take time and cost money.  So, before making these investments, you will want to have the property in question "under contract" or otherwise controlled in a manner that will give you the right to purchase the property and prevent the owner from selling it to someone else while you are conducting your due diligence.

Inspection Periods.  In a typical purchase and sale agreement for raw land, the buyer will usually be given anywhere from 30 to 90 days (an "Inspection Period") within which to conduct its due diligence (and perhaps also to satisfy its financing and other contingencies).  Typically, the buyer may choose, at any time prior to the expiration of the Inspection Period, whether or not to purchase the property.  Also typically, if the buyer elects not to purchase the property, then any deposits that buyer has paid will be returned to the buyer in full.  However, the degree to which a buyer can identify and mitigate risks through the use of an Inspection Period is limited by several factors, including: (a) the quality of the advice that the buyer receives (usually from his/her attorney) as to the appropriate types and scopes of due diligence inspections, (b) the competence of the professionals conducting the inspections, (c) the ability of buyer and/or buyer's attorney to interpret the inspection reports (including their stated exclusions and limitations), (d) the amount that the buyer is willing to spend on these inspections, and (d) the length of the Inspection Period.

Land Use Approval Contingencies.  Another means of mitigating the risks of purchasing raw land is through a provision in the purchase and sale agreement that makes the buyer's obligation to purchase the property "subject to" the buyer's ability to obtain all necessary land use approvals and permits.  Such a provision can be used either with or without an Inspection Period (although, from a buyer's perspective, it is best to have both if possible).  In a typical Land Use Contingency scenario, the buyer would have the right to submit to the applicable authorities (typically the local planning, fire and health departments) a specific site plan and specific building plans, and to have a certain amount of time (typically 3 to 6 months) within which to obtain all applicable land use approvals for buyer's specific plans.  This method risk management has the significant advantage of "flushing out" most of the myriad possible latent problems that a buyer might encounter during the process of attempting to build improvements on the land. However, there are several disadvantages and difficulties of this approach, including the following: (a) the owner of the land might not be willing to "tie up" the land for the length of time necessary for the buyer to obtain all of the land use approvals, (b) the buyer might not know at the time of contract what specific improvements the buyer might wish to build at some distant time in the future, (c) the cost of creating, submitting and having approved a specific set of plans might be significant, without any guaranty that approval will be obtained within the period allowed under the purchase and sale agreement, if at all, (d) the approvals obtained are specific to the plans submitted and might lock the buyer into plans that might later prove undesirable, (e) the approvals are, in most cases, temporary and might expire if the improvements are not commenced or completed by a given date, and (f) if the improvements are not promptly constructed according to the approved plans, the applicable laws might change in a ways making impossible the future construction of the approved or other desired improvements.

Use of Option Agreements.  Yet another means of mitigating risk is through the use of an "option agreement" under which the buyer usually pays some amount to the seller in exchange for a right or "option" on the part of the buyer to purchase the property at a pre-determined price and on pre-determined terms.  Option agreements are useful when the buyer needs to "tie up" the property for a significant length of time (whether to conduct lengthy inspections, or to pursue land use approvals) and when the seller is not willing to allow the property to be "tied up" for such a length of time unless the seller is compensated in some manner.  The amount that the buyer pays to the seller for the option to purchase (called "Option Money") is typically some amount less than or equal to seller's "opportunity cost."  The seller's opportunity cost is a somewhat subjective amount determined by taking into account: (a) the amount of the seller's equity in the property, (b) the length of time within which the seller could reasonably expect to sell the property, and (c) the available re-investment opportunities for seller's proceeds of sale (less any amounts that the seller will have to pay in capital gains taxes on account of the sale).  Another means of calculating a reasonable amount of Option Money (and an approach favored by buyers) is to consider the amount of the seller's "carrying costs" (i.e., the amounts that the seller is paying out in interest on existing mortgages and for property taxes).  The "carrying cost" approach often (but not always) results in a lesser amount than does the "opportunity cost" approach.  Other issues relating to the option agreement include: (a) the length of the option period, (b) the amounts and timing of Option Money payments, (c) whether or not the Option Money is applicable to purchase price.  All of these issues are up for negotiation between the buyer and the seller.

Building in the Distant Future.  It is not unusual for someone to purchase property in the hope of "one day" building a home on the property.  In such situations, I suggest attempting to negotiate with the seller an arrangement that allows the buyer to: (a) have an inspection period of approximately 90 days, within which the buyer can conduct primary due diligence (i.e., title review, survey and financing arrangements), (b) draw up and submit to the applicable authorities a "dummy" site plan and set of building plans (collectively, the "Dummy Plans"), (c) have approximately 6 months (without payment of any Option Money) within which to seek and obtain all of the buyer's land use approvals for the Dummy Plans, failing which the buyer will not be obligated to purchase.  If the seller is not pressed to sell quickly, and if the seller has not previous sought land use approvals for the property, the buyer might be able to persuade the seller to agree to these terms by informing the seller that the buyer is willing to spend the funds that any prospective buyer would need to spend in order to investigate all of these matters, and that if the buyer decides not to purchase the property the buyer will give all of the applicable materials to the seller at no cost.  Having such materials would be a large marketing (and time saving) advantage to the seller in his/her future attempts to sell the property.  Of course, the Dummy Plans might be nothing like the plans that the buyer might eventually wish to build. Also, any approvals that the buyer receives for the Dummy Plans will not necessarily be transferable to the buyer's eventual plans (and might actually expire long before the buyer gets there).  Moreover, the applicable land use laws might change before the buyer is ready to build.  Such are the risks of buying and holding raw land.

Please remember that this article contains only the most basic information about its subject matter.  I do not intend this article to contain legal advice specific to any particular person or situation.  Before entering into any agreement concerning your property, I urge you to consult with a real estate lawyer and with your tax or estate planning advisor.