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The Great Land Price Swing

Lenders and Investors Beware: Land Is Still a Very Risky Asset, According To UCLA Study
October 10, 2012
While land rushes of the late 1800s left an indelible impression on the settling of the American frontier, the land grab of the late 1900s and early 2000s may not soon be forgotten either.

Using a large dataset of land sales collected by CoStar Group dating back to the mid-1990s, Stephen D. Oliner, senior fellow at UCLA Ziman Center for Real Estate and senior economist for UCLA Anderson Forecast, concluded that the run up in land values in that time have proved more volatile than even housing and commercial real estate prices rises and collapses. Joseph B. Nichols, an economist with the Federal Reserve Board, and Michael R. Mulhall, an economist with J.P. Morgan Chase, co-authored the study with Oliner.

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Oliner's analysis shows a dramatic increase in both commercial and residential land prices over several years prior to their peak in 2006-'07 and a steep descent since then. These wild swings in value have exceeded those in well-known indexes of home prices and commercial real estate prices.

Editor's Note: This is Part Two of a three-part CoStar series on the current state of land investing. Part One: Land Sales Rising for First Time in Seven Years.
Part Three: Trouble In the Heartland? Rapid Rise in Farmland Values Poses Risks for Investors and Ag Lenders Alike

At the height of the real estate boom in 2006, land in the U.S. (excluding farmland and land held by the government) was estimated to have been valued more than $17 trillion. This figure represents about 40% of the value of commercial real estate and housing in the country. Of course, much of that wealth dissolved over the next few years as real estate markets crashed, Oliner said.

"The new research… documents the huge swing in land value over the recent cycle, showing that land is indeed a high-risk investment," Oliner said. "We put together a dataset with 180,000 sales of commercial or residential land parcels in 23 metropolitan areas from the mid- or late 1990s through mid-2011. The 23 metropolitan areas encompass the major population centers in the United States and some smaller cities."

"Land prices trended up at a moderate pace from the mid-1990s through 2002 and then accelerated sharply," Oliner said. "Over the next four years, the composite index jumped nearly 135%. These gains, however, were short-lived, as land prices tumbled in 2008 and the first half of 2009, when the economy was mired in a severe recession. As of mid-2011, the composite index had fallen more than 50% from its peak."

"There were especially large swings for the residential index, likely because the excesses that led to the financial crisis were centered in the housing market," he said.

The metro-area analysis shows that the swing in land prices generally was larger on the East Coast and in the far West than elsewhere in the country.

For example, from the second half of 2002 to the peak, the composite land price index rose more than 160% in Los Angeles and San Francisco and nearly 150% in San Diego and Sacramento, compared with 90% in Atlanta and less than 60% in Dallas.

"These regional differences mirror what we've observed in house prices over the past decade," Oliner said. "The ups and downs in land prices make the movements in house prices seem tame."

According to Oliner's research, residential land prices rose roughly three times as much as house prices during the boom period and then gave back the entire gain. In individual metro areas, land prices rose and then fell much more than house prices in every case.

"Real estate investors and mortgage lenders need to recognize the inherent volatility of land prices," Oliner said. "Lenders in all metro areas should be conservative in lending against land value, especially after a large run-up in land prices."

"In addition, metro areas in which land represents a large share of property value - which includes many areas in California - are especially susceptible to booms and busts in real estate markets," he said. "Consequently, prudent lending practices dictate that loan-to-value ratios for home mortgages and commercial real estate loans should be kept relatively low in areas where land is a large share of property value."

Keep up weekly on national news, trends and property leads with the Watch List Newsletter, a weekly pdf that includes other news and leads not found on the CoStar Group web news pages. Sign up for the Watch List E-Mail Alert. A new issue is published late each Wednesday.

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