A well-located pond will enhance late season water storage, can lower insurance costs if accessible to rural fire trucks as a water source and can provide additional source or augmentation for irrigation depending upon your water rights. Again, a single action achieves many goals. Many times these improvements can generate values in multiples of $5 to $10 for each dollar expended.
Using Rock Point Ranch as our example, we fenced off all the riparian areas, about seven miles of fence, which at that time cost approximately $35,000. Half was paid through a cost share obtained from an EQIP contract from the USDA. After proper permitting we enhanced several existing ponds that were in pathetic condition, and various other water features. Virtually all bolstered the irrigation system. Several enhanced existing fisheries. With the new fencing in place to control livestock, we were able to reseed a number of fields doubling grass yield. We completed other land, resources and agricultural fixes, too. We also did some work in the ranch compound—mostly the visible, such as restoring the exterior of several deteriorated structures—painting, repairing, replacing rundown fencing and revamping the corral system.
It was the sum of the resource, agricultural and land improvements that created additional real value and increased operational income on Rock Point Ranch. The carrying capacity of the ranch increased by almost one hundred AU. Hay production rose by 40%. That stretch of the Big Hole River, along with several miles up and down stream owned by other groups of ours or neighbors of like mind, saw dramatic increases of fishery productivity according to Montana Fish, Wildlife and Parks (MFWP) biological reports. I can say from personal observations that big and small game populations, and migrating waterfowl numbers increased significantly, as did the quality and size of antlered animals.
Our group had purchased Rock Point Ranch in a joint venture with a delightful couple. For a number of reasons they needed to divest themselves of their interest in the ranch and it was agreed that it would be sold. It is noteworthy to mention that we purchased this property with a conservation easement from the Nature Conservancy already in place. There was enough latitude in the easement, and the property was spectacular and unique enough that we went ahead with the purchase; however, it’s not how we would have negotiated the easement had we been the original grantors (see Section V).
Despite being encumbered by a less-than-perfect conservation easement, the ranch sold relatively quickly in the early 2000s and there was a gain of approximately $700,000 over and above original purchase cost, cost of carry and the cost of improvements. Our original combined investment, plus improvement costs, was approximately $500,000. That’s an approximate 125% cash-on-cash return in six years. Though the venture had planned on keeping this ranch for decades, that age-old reality, “Life happens,” happened. Had we not made the value-added improvements to agricultural, ecological and recreational resources, such a gain would have never been realized.
Another ranch, in Wyoming, managed by my firms and owned by another group with which I’m involved, began an ambitious Upland Water Improvements Program when they acquired the property in the early 2000s. Twenty three ponds of one half to several acres each were planned and permitted at spring sources and along small creeks. To date, eleven have been built. All store water for release in the late dry summer and fall months, benefiting the entire basin for miles and miles downstream from the ranch. Two are key to full utilization of valuable Territorial (pre-statehood) Irrigation Rights. All increase livestock carrying capacity. All but one have become viable self-sustaining fisheries. The storage helps to stabilize flow in the main creek that runs through the ranch. The higher, more constant flow has greatly improved that fishery. Migratory and resident elk populations doubled and though we haven’t done a formal count, just via visual inspection mule deer populations have likewise expanded. There are now antelope in certain parts of the ranch near these features that were never there before. Build it and they will come. This ranch is being held for the long-term. In fact, this group hopes to hold most of it forever. Therefore there’s no sales data to rely on, but the appraisals of portions of the property after these upland water improvements indicate an increase in value of 400% or more within a year of the improvement being completed. That’s four dollars of value, plus the boost to operational income, added for every dollar of improvement cost.
Some of you reading this are asking, “What does this have to do with me? I own an acre, or five acres. I can’t build eleven ponds or build seven miles of fence.” True. But you can undertake the exact same types of improvements on your land regardless of size. All things are relative. If you own a small acreage with a viable water source, research the permit process and construction cost of a water feature, pond or fisheries enhancement project. Literally any piece of property over two acres, or on which you will be running livestock and horses should be properly fenced. In the case of smaller properties the fence can be electric or portable giving you greater latitude. A small acreage agricultural improvement will not be an eight-hundred-acre crested wheat seeding, or a one-hundred-acre alfalfa project, but you can certainly put in a few acres of hay, if you have the space, the water and the growing season. Even our one-third acre residential example can contain one or two large vegetable gardens for your family. If America’s current course continues, this could have value greater than simple economics. On the smaller —less than two acre—land tracts, the major component of value will likely remain the structure, i.e., the house. However, there are many things you can do—most of them gratifying work you can do yourself—to enhance the appearance of your property and capitalize on the aesthetic component of value with landscape, plantings, proper orientation of shade and creative use or construction of deck spaces and outdoor living areas.
None of these things are likely to happen, or if undertaken are likely to be successful, if they are not part of your thought process prior to purchasing the land. One more example of the “PPPPP” rule. Volume Two of Land for Love and Money will contain additional stories of monies well spent on all types and sizes of land for successful improvements, monies wasted on bad ideas and the most cost-effective approach in ram rodding all of these types of enhancements. These improvements can both fulfill your heart and fill your wallet.
1A conservation easement grant is the donation of certain property rights. In simple terms these rights have value. The appraised value of the rights donated decrease income tax liability. The grant of conservation easements is discussed in Section V. Additional discussion of easements will be covered in great detail with more real-life examples in upcoming volumes of Land for Love and Money.
2Using capital gains rates as an example: when capital gains rates were cut in the early 1980s revenues to the government increased by approximately 28%. In 1993 when capital gains rates rose, revenues to the government decreased by an estimated 21%. In 2003 when capital gains rates were again pared down, revenues to the government again increased 21%. The pattern is irrefutable and is true with virtually any and all individual or business taxes, including the death tax.
3Fencing types are varied, but four strand wire, intermittent wood and metal posts, runs about $1.75/per lineal foot. Labor charges vary in different parts of the country. With light equipment the fences can be built by the owner.
4For detailed information on appraiser designations and changing appraisal requirements, see url links in the Resources section.
5Location, design, depth, permitting, cost and a number of other factors must be considered.
In this chapter, I’m going to lay it on the line for you with some fundamental facts about the current regulations, explain sordid situations that cost you money, all guaranteed to drop your jaw and what all this means to you as a potential borrower. Then I’m going to give you some pointers on how you can maneuver successfully in economic conditions where the deck is already stacked against you, and get you ready for the flipside of the coin—the silver lining of great opportunities and terrific imaginative finance options
outlined in Chapter 13.
Today’s economic, financial and regulatory environment is not conducive to land loans from conventional lenders. In many cases, such financing is impossible to obtain. Cash equity of 30 to 50% is a necessity, as is impeccable credit. Even then there are virtually no banks making land loans. The primary outlets for land loans at the current time is a federal agency known as Farmer Mac (Federal Agriculture Mortgage Corporation), which is in actuality a guarantor of a large percentage of a loan which might be originated through a participating bank, or Farm Credit Services, a land bank with quasi government ties but privately owned and operated. Both outfits prefer production land—farm or ranch that produces income (land that will produce operational income—crops, livestock and ancillary cash flow).
Underwriting criteria for all loans, especially land loans, has tightened considerably. Appraisals are discussed in Chapter 10. Review (second) appraisals are now commonplace in real estate lending and land loans. In addition, the borrower or guarantor must show sufficient ability to pay the interest and principal on the loan. None but the very largest corporations can get land financing without a person, a human being, being liable somewhere in the chain of the loan security, whether as a maker (the person who signs the note) or as a guarantor of a note executed by another party, for instance your farm, land, or property GP, LP, LLC, or S-Corp.
So, unless you have lots of cash, sterling credit, enough personal income to service the loan after all of your other monthly expenses, and the operational cash flow of the property can additionally debt service the loan, you will probably not be getting a land loan from a bank.
Dodd–Frank
Horrible to Begin with, Barreling Toward Horrific
Under Dodd-Frank, there are a myriad of regulations now percolating down from folks who know little to nothing about markets, next to nothing about real estate, and, in some cases have motives other than providing opportunity to citizens and strengthening the economy. Even the few lenders still lending on land require very significant cash equity and very low loan to values ratios. The loan to value ratio, or LTV, is the ratio of the loan amount to equity based on appraisal. If your appraisal is $100, and the loan is $50, you have a 50% LTV.
This situation will worsen before it improves, if it ever does. The knee-jerk reaction to the financial meltdown which spawned Dodd-Frank punishes the market, buyers and sellers of real estate, and banks (when the problem was caused by government policy to begin with). Though the regulations behind Dodd-Frank are only 20% drafted, there are already calls by Senators, such as Dianne Feinstein (D-Calif.), for more regulation, yet another knee jerk to the just announced $2 billion trading loss by JP Morgan Chase. This insidious degradation of the system has been compounded by political and ideological expediency.
Loans for smaller residential acreages on which you intend to construct your home are possible if you tackle the problem in reverse order. If the land needs to be purchased prior to building (a good idea!) then, first, get a commitment for the permanent mortgage on the home based on your credit, but subject to final plans, specs and appraisal based on its future construction. Next, use that mortgage commitment to obtain a commitment for a construction loan to build the home and pay off the land. Finally, use the construction loan commitment to obtain a short term land loan, which will contain many of the onerous terms referenced earlier in the chapter. You could streamline the process by using the same bank for the land and construction loans. Ridiculous? Preposterous? Yes. But, you ain’t heard nothin’ yet. Read on.
Unless repealed, the 80% of the regulations yet to be written for Dodd-Frank promise to impose even more stringent guidelines on lending in general, real estate, and in particular, land loans. The regulators believe most land ownership is speculative. This may or may not have to do with sinister policies and attitudes at the national and international level such as the United Nations so-called Agenda 21 (see Chapter 12).
Banks in a Vise You Get Squeezed
It is important to understand generally how banks are monitored, regulated and slapped—or shut down—if they don’t follow rules and regulations developed by clueless folks in an out of touch, far away capitol.
Because land is number one on the hit list at the highest levels of government, that corporate culture is filtered down through rules and regulations to the folks in the field. If a bank does not adhere to these rules, it is scrutinized far more closely by government auditors known as Bank Examiners. Bank Examiners visit banks between one and four times a year. A very strong, highly solvent bank (the great majority of its loans performing—i.e., timely paying interest and principle as required) may only get one visit a year. When the examiners visit the bank they go through the loan files. They check to see if the bank is in compliance with all the rules, that all those countless pieces of paper your banker asked you for when you obtained your loan, are in the file in proper form and order. They also check the value of the land, the appraisal, the loan amount, terms, whether or not it’s current (performing) and the financial wherewithal of the borrower at that time. Financial statements more than ninety days old now must be renewed. Appraisals must be within the last twelve months for existing loans and within ninety days for new loans.
If the bank is out of compliance on any of these matters, including missing or misplaced documents, the loan file is red tagged and the asset may be “classified”. Without getting down in the weeds, there are five basic levels of classification. The first is just “pass,” which means they’re going to review this file for sure next time they visit the bank, or they have some doubt as to the bank’s compliance. The worst is level five, “loss.” That’s a nonperforming asset on which collection has or is likely to commence. Collection means a lawsuit, foreclosure, or other type of legal action.
There are many other government regulations that affect your purchase of real estate, the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA), Department of Housing and Urban Development (HUD) Disclosures, Truth in Lending, the list is endless.1 I’m not even going to explain what these acronyms mean or we will get sucked into the weeds of tens of thousands of pages of government regulation, most of which do little to protect you, all of which make borrowing, especially on land in the current environment, more time-consuming, costly and far less likely to be approved. Dodd-Frank is the umbrella silliness and exponentially more dangerous and debilitating than the rest of this bureaucratic blizzard.
It is critical as a purchaser or owner of land or real estate that you have a general concept of what is happening behind the scenes at banks of all sizes, particularly small and midsize banks in smaller communities. These “little” banks are the lifeblood of main street, small business, and local real estate. One needs to understand the regulatory nightmare that has been created by a partnership of politicians—many of whom have no experience in land, real estate, or free markets. Some of these politicians really believe that they’re protecting the consumer or financial system. Others dislike free-market capitalism, land ownership, and banks. Still others are driven by ideology or ascribe to principles, theory and policy such as Agenda 21—a United Nations edict that is beginning to infiltrate various areas of this country. Mixed together, this cauldron boils a witch’s brew of red tape, rules and regulations and hard regulatory hammers over banks. The result is that your land financing is difficult, if not impossible to obtain, and more costly on every level.
Though you may grit your teeth, don’t despair. The wet blanket of regulations and the paralysis of banks has opened other doors—in many cases involving financing methods and paths far more friendly and lucrative then one could ever obtain from a financial institution, even in the good ol’ days! (See Chapter 13)
When Bad Becomes Terrible
Back to the nitty-gritty. Here’s what happens behind the scenes at your local bank if they currently have a land loan of any type on the books, or you’ve submitted a loan request to acquire land. The land must be s
elf-supporting and you must have the financial wherewithal and credit to carry the property as if there is not a penny of income. The LTV must be 50% or less, in some hard-hit economic locations 40% or less. Exceptional credit purchasers of larger production tracts might be able to raise LTV to 60% or 70%. The appraisal process has become a nightmare. Even the most qualified appraisers are regarded with a jaundiced eye. More often than not, review appraisals2 will be required, creating additional expense. Appraisals, and the new definitions of “conforming property”, as it now applies to the comparable properties and sales that appraisers rely on in putting together their appraisal product, is discussed in later in this chapter. You’ll shake your head in wonder.
When a bank is visited by bank examiners, (once again I’m not going to let us get sucked down into the weeds) these examiners are from the state if it is a state bank, and from the Federal Deposit Insurance Corporation (FDIC), and Office of the Comptroller of Currency (OCC) if it is a federally chartered bank. These examiners go through most, if not all, of the loan files. Paperwork must be in perfectly proper order. Many of you have received calls from your banker requesting updated financial statements, tax returns, or “this, that or the other” document. That probably means files are being cleaned up in anticipation of a visit by the examiners. In addition to looking at the propriety of the paperwork, the examiners attempt to interpolate current regulations—ever fluid edicts having been handed down from on high—with their opinions of value, income and borrower credit worthiness and cash flow.
Before 2008, although you needed decent credit (unless you were the recipient of a residential subprime mortgage), banks loaned primarily on the asset. Was the value of the asset relative to the loan amount and under the worst conditions, such that the bank comes out of it with no loss? The cash flow, financial statement and other related paperwork were icing on the cake. Now, in the new climate, the asset is no longer the object and focal point of the loan, and carries far less weight than does the borrower and the borrower’s cash flow. In an economy where premium cash flow is hard to come by, it is easy to see why this confluence of the new regulatory environment and land finance has collided in a terrible wreck.
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