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Buying Rural Land in Texas
By Charles E. Gilliland Texas A&M University Press
Copyright © 2012 Charles E. Gilliland
All rights reserved.
ISBN: 978-1-60344-822-2
CHAPTER 1
Risks and Rewards of Rural Landownership
Responding to a presumptuous visitor who asked what the King Ranch land was worth, Robert Kleberg emphatically exclaimed, "It's not worth anything until you do something with it." That pithy reaction reveals a savvy understanding of land economics, an understanding imbued with astute insights into not only the fundamental technique of creating land value but also the determinants of land use. The King Ranch chief's astute grasp of the rewards gained by transforming current land uses to higher valued pursuits guided him in managing his family's vast holdings of South Texas rangeland. His acute management vision contributed to the burgeoning wealth of the fabled operation. Indeed, as Kleberg well knew, transferring land resources trapped in inferior uses to more highly valued activities builds fortunes while also promoting community and national development.
First and foremost, land markets serve as the playing field in a competition among potential users vying to control space. In essence, land markets are an arena where individuals settle a contest of ideas. Buyers have ideas about how to use the soils, forests, streams, and other natural resources in order to realize particular visions. Those visions may inspire plans designed to transform the land, thus reconfiguring it to serve a different purpose, which might range from an idyllic retreat to a thriving cotton field. Other potential buyers might envision a sea of rooftops. The competition among these ideas is resolved in the marketplace when winning bidders for particular land plots decide that the value of their ideas exceeds the price their rivals are willing to pay to realize their dreams.
Historical Land Use in Texas
In the Lone Star state, the marketplace for land has attracted owners with lucrative ideas, and in the context of that market one can see Texas history dramatically unfold. After all, people do not harbor abstract desires to own land. Rather, they seek control of space needed to conduct valued activities such as farming or recreation. The power to clearly envision new land-based activities drives buyers in their quest for landownership. The more economic value created by those land-based activities, the more an individual can afford to pay for land.
Rural land began to produce rewards when settlers transformed wilderness expanses into agricultural fields that produced crops and livestock. At first, individuals on the frontiers tamed pockets of wilderness to produce enough for their families' sustenance. Later, with careful husbanding, their land yielded a surplus that became a source of income. As the catalog of potential uses expanded in response to societal developments, benefit flows to landowners swelled, driving up land values.
In frontier times, however, as more acreage became suitable for settlement, the increasing availability of desirable land depressed land values. When Stephen F. Austin established his colony in the 1820s, settlers were flocking to Texas for its abundant, cheap land. They clearly envisioned the time when the unsettled wilderness would be transformed into an agricultural base for a thriving community. They found Texas land selling for even less than the official price of $0.125 per acre. In the United States at that time the government sold public lands into private hands for $1.25 or more per acre.
Texas enjoyed a substantial purchase price advantage in that era, but there was a catch. Austin's settlers had to carve farms out of sod-bound prairies and virgin forests in order to transform the raw, untamed expanses into assets. It was backbreaking labor. Sometimes Indians and outlaws disrupted settlers' development activities. Risk was high, but potential rewards were great for those braving the rigorous trials of frontier life. Settlers secured control of land through a validated claim to legal ownership rights eventually enforced by governments.
The first wave of modern migration to Texas was when the Spanish arrived in 1519, and other groups from foreign shores periodically swept across Texas. Each migration left impressions that persist today. Nearly three hundred years of Spanish and Mexican settlement created a symphony of melodious place-names and a chain of architectural gems that persist in the mission compounds of San José, Espada, Concepción, and San Juan, as well as the historic San Antonio de Valero, now known as the Alamo. Other ethnic groups arrived later and brought their own traditions. Anglo Americans, arriving during the period of Mexican rule, carried with them the republican principles outlined in the Magna Carta and the US Constitution. These settlers carved out of the landscape new towns that would later be known as Austin, Houston, and Dallas. German immigrants also came in large numbers and founded New Braunfels, Boerne, and Fredericksburg. Groups of Czech, Italian, Polish, and French settlers also came to use Texas land according to their unique traditions. Evidence of this social and economic development abounds in modern-day Texas maps.
For each of these settler groups, the value of the land ultimately reflected the anticipated flow of income from that land. Those income flows depended on owners' management plans gaining the greatest revenue at the lowest cost. From the heyday of settlement activities in the early nineteenth century and well into the twentieth, agriculture ruled Texas land markets as farmers and ranchers invested labor and capital on their land to produce crops and livestock. Texas thus changed from a wild frontier society to an agrarian community. Rising land prices provided evidence of this shift as Texas progressed from a rural territory to a modern state boasting twenty-five metropolitan areas following the 2010 census.
By investing capital and labor and braving substantial risks, those hardy individuals built an economy that rewarded their descendants with land valued at more than $670 per acre by 1980. According to land market studies by the Real Estate Center at Texas A&M University, this increase in land value amounts to a dramatic annual rate of return in capital gain: more than 7 percent.
By the middle of the twentieth century, economic and social changes had set the stage for a new revolution in Texas, this time in the land markets. Farmers and ranchers continued to buy land for increasingly complex agricultural production operations. However, competing buyers with diversified land use objectives began to invade even remote rural markets to promote nonagricultural activities such as hunting or birding. Not content with leasing ground for hunting and fishing, sports enthusiasts began to acquire land in order to establish sophisticated wildlife management programs. City dwellers, flush with the fruits of their own prosperity, began to seek out retreats in the countryside to escape the pressures of urban living.
Drawn by steadily rising land values, investors began to consider holding land as a potential hedge against inflation. Individuals bought rangeland not for grazing but for uses such as second homes and recreational areas. Land markets, once an exchange platform for agricultural producers, became a "trading floor" where an array of potential users competed for control of the land. Agricultural producers began competing with not only consumers who were prepared to pay well for quality recreational experiences but also investment-driven buyers holding land in order to expand their wealth. Competition among these groups severed the time-honored link between net agricultural income and land value. Land prices began to rise because they began to incorporate the value of these competing uses.
Taking Risks for Reward
Value growth stemming from social and economic development has led to arguments about the justice of enriching those who gain by simply holding land. In the late 1800s, the American economist Henry George promoted a political movement by arguing that all value increase accruing to land originated from social growth. He maintained that landowners contributed nothing to the increase in wealth created by a growing and prospering community. In his view landowners were effectively confiscating the fruits of the labors contributed by society at large, thus increasing poverty even as the economy progressed. George proposed replacing all other taxes with a single tax on land, thereby reclaiming the value society itself had created. According to George, because land was a "free gift of nature," any price demanded for it was patently unjust.
This view of land really hearkens back to more primitive times, when populations held lands in common ownership. The countryside belonged to everyone and to no one since an individual could not assert an exclusive claim to possess any particular plot. Because no individual could control access to or the use of particular locations, no one could count on capturing the fruits of their labor in using and improving land. The Native American tribes inhabiting Texas followed this approach to land use, as they had neither a tradition nor any understanding of the concept of property rights.
George's myopic view overlooks the real contributions that landowners make in the march of progress mentioned in his arguments. First, landowners maintain and develop land to make it capable of serving a highly valued use. In addition, dedicating land to a particular use prevents it from being available for other valuable uses. Those desiring to possess land are willing to bid up prices to win out over competing potential uses. Finally, George implies that landowners know for certain that they will make a profit by holding idle acreage, thus suggesting that landowners always succeed in their gamble. But what goes up sometimes comes down, and landowners face a threat of financial loss as they preserve land for an increasingly valuable use at the proper time. They face a world of uncertainty and risk their capital and management services hoping to profit in the future. Landowners lay it on the line to earn returns from current land uses until the land can support a more valuable use in the future.
Real estate professor James Graaskamp frequently reminded audiences that a person who bought land was really buying a set of assumptions about the future. At the most elemental level, those assumptions shaped the buyer's thinking during the entire decision making process, from start to finish. These basic assumptions ultimately determined how much the buyer would offer for the land. That single dollar figure—the price offered for the land—summarizes the buyer's personal judgments about anticipated benefits flowing from the set of assumptions about the future of the land. However, between the conception and creation of the envisioned use fall the shadows of unanticipated deviations from those basic assumptions.
Performance seldom matches expectations, and risk thus lurks throughout the acquisition process. For example, a farmer, anticipating adding a son to the family operation, acquires cropland, but the son chooses to pursue a career other than farming. The recreational user anticipates developing a haven for quail, but the number of quail declines, rendering that dream unfeasible. An investor, planning to convert a large tract into small ranchettes, discovers an economic downturn has diminished demand for that product. All of these situations are examples of "downside risk" in land purchases.
During the acquisition process land buyers generally strive to limit or eliminate risk. Analyzing the risk associated with the purchase of a tract of land will provide potential buyers with a list of the things that can go wrong, an assessment of the likely impact of adverse events, and estimates of the likelihood of experiencing various negative events. The potential benefits of this kind of analytical exercise depend on gaining as much information as possible about the nature of the land and its environment; with sufficient information and analysis, buyers can limit the impact of risky negative events on their plans. Well-informed buyers know that it is important to take the right risks.
MANAGEMENT RISK
Those who purchase land assume that they can use their land to pursue activities that will lead to desired ends, such as enjoying recreational experiences, generating operating income, or gaining from capital appreciation. Risk originating within the property generally arises from inappropriate expectations or mismanagement, leading to flawed operations and disappointing results. This property-related risk diminishes the rewards of landownership. For cropland owners, an analysis of the potential for disappointing results focuses on how particular features of the land may affect the anticipated income. Both location and physical features may limit possible land uses and shape future results. Whether acting as an investor who leases the land to a producer or one who personally manages the agricultural operation, cropland buyers normally forecast an anticipated income flow determined by their assumptions about characteristics of the land.
An assessment of property risk requires analysis of factors such as soil composition, water availability, access, productive features, and other characteristics that can affect costs and yields from operations. In addition, returns will also capture any change in the land's value over time. Owners must also evaluate the effects of their management on anticipated appreciation. Potential owners should define their thoughts about future operations and then estimate impacts of deviations from that envisioned ideal regimen.
Like those who purchase cropland, buyers of recreational property seek to create an ideal venue in which to pursue their envisioned activities. The quality of those activities depends on managing land to establish an environment that will optimally support recreational use. Again, the feasibility of these envisioned plans depends on the physical features of the land. An analysis of the risk for these recreational land users should examine how fully the property can support their pursuits. Finally, an effective management plan should enhance the property's appeal to future buyers and boost appreciation potential. Risk analysis for a recreational land purchase includes an honest evaluation of its potential for achieving that enhanced future value.
Investors frequently anticipate not only income from operations on the land but also substantial value growth as land use changes to more highly valued uses over time. The transition from grazing to development often contributes the major part of a return on an investment. Producers and recreational users also often anticipate upgrades in value resulting from changes in land use or increased demand for recreation. Management actions can also affect those returns, and a complete assessment of risk should rely on an analysis of trends in land markets.
Returns on investment in land, whether financial or psychological, depend on the institutional context defining the economic, social, and legal environment. Future plans for land use reflect the configuration of these external influences under current customs. This configuration of external factors is unlikely to remain constant as time passes. As the various external factors change, owners will adapt land use to address the new realities. The array of potential external influences on land use includes such things as regulations, tax policy, and societal attitudes toward landowners.
MARKET RISK
Owner and buyer preferences can shift over time, inducing changes in returns as land use mutates to conform to new realities. An example of this type of shift would be when rising gasoline prices increase travel costs, leading potential recreational buyers to limit the distance they are willing to travel to a property. In such circumstances, a seller must find a buyer close by or lower the asking price to offset the increased transportation costs. This type of external factor effectively reduces land values. In such a situation, cropland owners, who must pay the higher prices to ship inputs like fuel and fertilizer to the farm and crops to market, face a reduced bottom line. Buyers will undoubtedly factor the increase in operating cost into any bids they submit for a property.
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Excerpted from Buying Rural Land in Texas by Charles E. Gilliland. Copyright © 2012 Charles E. Gilliland. Excerpted by permission of Texas A&M University Press.
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