[Pamphlet No. 2]

THE REMOTE SUBDIVISION-ECONOMIC AND LEGAL ASPECTS OF LAND SALES

PROMOTION

(Summary of Research Reports by Claude E. Elias, Jr., and William D. Warren)

(The two reports summarized in this pamphlet are available in mimeographed copies at the Library of the Real Estate Research Program, University of California, Graduate School of Business Administration, Los Angeles 24, California.) The opinions expressed in this study are those of the authors. They do not necessarily represent the views of the Real Estate Research Program or of the University of California.

FOREWORD

This is the second in a series of short and easily readable pamphlets published by the Real Estate Research Program at the University of California, Los Angeles. The purpose of the series is to make the main results of the Program's research work more widely known and more easily accessible.

Large and increasing numbers of people have a broad interest in urban problems, housing, real estate and its financing, and similar matters, but do not have the leisure or opportunity to delve into the Program's major and often lengthy publications. Communicating the results of scholarly studies to citizens concerned with public or business affairs has become an increasingly important task and one of growing difficulty as these affairs, as well as research itself, have grown in complexity. Universities must redouble their efforts to meet this task.

The Program's field of study affects everyone living in urban areas, and this is now the vast majority of the population. More and more people have become acutely aware of the problems posed by metropolitan and urban growth. Locating freeways, the rise in land prices, the suburban "sprawl," the search for more economical home financing, zoning, urban renewal, and the journey to work are a few among the many issues created or accentuated by the phenomenal growth and the increasing complexity of cities. Federal, state, and local programs to deal with some of these issues have multiplied, but a well informed public is essential to wise decisions in a democratic society. In addition, the Program's research is of direct professional concern to many thousands of real-estate brokers, property managers, investors, and mortgage lenders.

The Real Estate Research Program at the University of California was established in 1950 to advance knowledge and education in this field. The select list of its publications on the back cover illustrates the kind of research work performed to date.

This pamphlet presents a summary of two reports prepared for the National Conference on Interstate Land Sales, which was held on October 1-2, 1962 in San Francisco. The meeting was sponsored by The Western Conference of Attorney Generals, The Association of Better Business Bureaus, Inc., The National District Attorneys' Association, and the National Association of License Law Officials, and it was chaired by the Attorney General of California.

The Conference was called in recognition of the urgent need for more effective regulation of interstate land sales through cooperative action of the states and of federal agencies. The volume of interstate offerings of parcels in remote subdivisions, often characterized by misleading promotion or incomplete disclosure of vital facts, and sometimes accompanied by fraudulent practices, has increased at a rapid rate. Hence, regulatory and law-enforcement agencies, as well as organizations of the real-estate industry and others concerned with the maintenance of sound business practices, have felt that the public interest requires more effective control of this development. Such control usually involves the state in which the subdivision is located and the state in which investors receiving offers of parcels reside. The Conference was initiated by the California State Government which is also arranging for publication of the proceedings.

Meanwhile, it is highly desirable to make a summary of the two research reports prepared for the Conference more widely available. The promotion of land sales in remote subdivisions is not limited to interstate offerings. It applies to transactions within states as well. For this reason, the papers summarized

in this pamphlet address themselves to the more pervasive economic and legal problems of land sales promotion. This is an important subject unduly neglected in current business and economic analysis. The temper of the times has changed markedly since about the mid-fifties. The growing promotion of land sales has become part and parcel of a general increase in speculative transactions, often backed by credit. As such, it reflects qualitative changes in the economy which may be as significant as the quantitative changes in national output, business investment, and other aggregates that receive so much attention. The pamphlet is designed to help correct this imbalance. At the same time, it represents merely the beginning of an inquiry that must be extended through further research. Hence, the reports summarized herein are preliminary rather than final.

What is meant by the "remote subdivision" and by other terms used in this preface will become apparent in the following text.

The prepartion of the papers was aided by a grant from the Division of Real Estate of the State of California.

LEO GREBLER, Director, Real Estate Research Program.

ECONOMIC ASPECTS

(Claude E. Elias, Jr., Real Estate Research Program, University of California, Los Angeles)

The kind of land offering investigated in this report involves purchase arrangements calling for the use of the installment sale contract. In such a contract, the purchaser puts down a nominal deposit and makes a series of monthly payments over a period of time ranging up to five years, and even beyond in some cases. This marketing device is not new in the sale of land. What is new is the amount of land offerings made on this basis. Mass merchandising has come to the land market. Mass merchandising requires relatively low dollar amounts both in terms of downpayments and monthly payments. Hence, the land must be low in cost. But mass merchandising also requires a large sales volume. Hence, the amount of land must be large. To find large tracts of low-cost land, developers have had to market land located at great distances from existing metropolitan areas; land of this kind is typically characterized by the absence of commercial, industrial and residential uses; such land is remote and such subdivisions are unanchored.

CHARACTERISTICS OF REMOTE SUBDIVISIONS

During the six-year period from fiscal 1956-57 through fiscal 1961-62, public reports issued by the California Commissioner on all subdivisions, both inside and outside of the state, covered a total of 667,854 acres. Forty-seven percent, or 313,692 acres, was land in subdivisions located outside California. A survey of public reports issued on out-of-state subdivisions by the Los Angeles office of the Real Estate Commissioner for the same period reveals that the typical outof-state parcel averages about 2.16 acres in size. It is located in Nevada or Arizona, which means in either case that it is likely to be both hot and dry. It has no fire protection, no sewage disposal, road maintenance, water service or any other utility service; no public transportation, including school buses, is available; it is twelve miles or more from a junior high school, senior high school or grammar school; and it is twelve miles or more from the nearest shopping center. Costs of the land plus improvement and promotional expenses by the developer average $157 per acre, and the land is sold for an average price of $731 per acre.

If the California purchaser had bought all of the 313,692 acres of out-of-state land on which public reports had been issued and had paid the average price calculated from a survey of 11 percent of the out-of-state land, he would have invested slightly more than $229 million in land the total cost of which amounted to $49 million. Possessed of an acre of land on which a price appreciation of 366 percent had already occurred, the investor would then begin a period of waiting for the investment returns described in the advertising brochures, or he would sever his city ties to take up residence on his smog-free rural parcel located at some distance from the nearest population explosion.

PROBLEMS FACED BY DEVELOPERS

The land development firm is a fascinating feature of the modern financial landscape. Firms of this type have enormous potential in enlarging the competition for the investor's dollar, and to the extent that such competition may result in raising the level of operating efficiency for all investment outlets, they are desirable. But land developers often have to meet pressing cash claims which may inhibit their ability to create the kind of subdivision described in glowing broachures and advertisements. These cash claims stem from the arrangements for the purchase of the land and the payment of commissions to sales personnel. The developer must meet payments on mortgages which helped finance the acquisition of the land. Salesmen usually receive commissions amounting to 20 percent of the purchase price, and 50 percent of this obligation usually must be paid when the downpayment is received, with the balance being paid at the rate of about 30 percent of the monthly payments. Since downpayments are low to begin with, the net cash available to the developer is limited. Meanwhile, promotional expenditures, which are extremely heavy as a rule, must be maintained in order to create a rate of sales in the subdivision which will produce a cash flow large enough to enable the developer to meet mortgage obligations and previously incurred commission expenses. Sometimes cash needs are met by factoring installment sales contracts, but the high interest rate paid for these funds, typically around 20 percent, merely intensifies the ultimate need for cash. Any slowing in the rate of sales can result in curtailment of plans to install improvements in the area, and this, in turn, restricts the value of the land purchased by the individual investor.

PROBLEMS FACED BY INVESTORS

Offering of land in remote subdivisions are made to individual purchases on the basis of potential value enhancement. Typically, the individual is not being asked to consider the purchase of a parcel of land because he expects to occupy or use the land himself, but rather because he will be able to reap investment gains from the land. The question whether such a purchase is to be labelled a speculation or an investment is immaterial for analytical purposes. The task of distinguishing between "investment" and "speculation" is much like attempting to unscramble eggs, and about as meaningful.

Regardless of the semantics, it is essential for the investor to understand that it is the developer, and not the individual buyer, who is in control of the process by which speculative price increases may be initiated and maintained. It is the developer who can utlize all the methods of public relations to win buyers. It is the developer who can initiate across-the-board price increases without fear of wholesale unloading of parcels by first purchasers, because the developer can offer installment credit terms which the individual investor cannot match. It is the developer who controls the supply of land in the particular subdivision so that the individual's potential gains are sharply limited by the amount of unsold acreage left. And since buyers of large amounts of land want to avoid the difficulties of dealing with large numbers of individual owners, control of the supply by the promotor insures that any large-scale transactions must be handled by the developer.

Since the purchaser typically is making an investment decision, it is esssential that he marshal all the relevant information in a logical framework suitable for making an intelligent decision. He must not only obtain all relevant data but analyze the data properly.

WHAT THE INVESTOR NEEDS TO KNOW

First, the investor must make a thorough calculation of the total cost of the land. This is more than the dollar amount he contracts for when he signs the sales contract. To find the true cost of the land, the individual must know: (1) the purchase price;

(2) taxes to be assessed on the land during the anticipated holding period; (3) special assessments for improvements or other purposes during the holding period.

In approaching the problem in this manner, the investor is brought face to face with the impact of time on his costs. Since he is typically buying by means of

installment credit, he should realize that there is a difference between the purchase price and the actual amount paid by him over the life of the contract and the difference between the two is the basis on which the true interest costs to the investor should be calculated. Of even greater impact on his total costs is the period in which the investor expects to hold his parcel of land. Since he could employ his funds in alternative investments, he should find the present value of the sum of the land costs, taxes and assessments by discounting this sum at the alternative investment earnings rate for the anticipated holding period. This amount is the total investment outlay made by the purchaser.

Second, in order to estimate the time period over which the land must be held, the investor must make a calculation of the feasibility of price appreciation. This requires that the purchaser know:

(1) the total amount of land under the developer's control;

(2) the cost of the land to the developer plus the cost of any improvements to the land;

(3) the developer's marketing and promotional expenses;

(4) the developer's plans for future land use of the area;

(5) the rate of sales in the subdivision and in all land under the developer's control:

(6) the form of organization of the development concern, its officers and management;

(7) any restrictions on the use of the land;

(8) the existence of any unusual physical, geographical or geological features.

The first five items in this list represent fundamental information about the probable supply of land of similar location by the same developer and the rate at which it will be channelled into the market. Certain relationships are of obvious significance. For example, if the investor knows that the parcel of land he is considering is part of a holding of 500,000 acres, he will estimate the future supply quite differently than if he is under the impression that only 50,000 acres are involved. And an investor who knows that the offering price to him represents an increment of several times the developer's costs is in a better position to make decisions than the investor who does not know how much price appreciation has already occurred.

At the present time, only the last two items of information listed above are available in the public report issued by the California Division of Real Estate. Thus, there are serious gaps in the data available to the purchaser of land. These gaps are especially serious to the buyer of out-of-state land, for the likelihood that such a buyer will inspect the site diminishes with distance. For example, he may be unaware of the existence of subdivisions adjacent to the parcel of land where he contemplates purchase.

In addition, of course, the investor must be armed with information about the probable future demand for the land in question. Data on population and economic growth in the area can usually be obtained by the intelligent investor. But the suggested items of information about the probable future supply of land can only be furnished by the developer, and he should be required to do so. Community facilities of remote subdivisions in 8 States1

1 The states are: Arizona, Florida, Hawaii, Idaho, New Mexico, Nevada, Oregon and Utah.

Source: The data are compiled from public reports on out-of-state subdivisions issued by the Los Angeles Office, California Division of Real Estate from 1956 to 1961.

Distance of remote subdivisions in 8 States from schools and shopping centers1 [Percentage of total acreage with specified distances]

1 The states are: Arizona, Florida, Hawaii, Idaho, New Mexico, Nevada, Oregon and Utah.

2 Percent of total acreage for which relevant data were listed.

Source: See preceding page.

LEGAL PROBLEMS IN PROTECTING INVESTORS

(Prof. William D. Warren, With the assistance of John M. Carmack, and John M. Vincent, School of Law, University of California, Los Angeles)

Never in the history of real estate transactions has a buyer of land stood so naked of legal protection as does the purchaser of remote promotional subdivision land. He has no lawyer to advise him, for the amount of money involved does not justify such an expenditure. No title search is made in his behalf, no title insurance policy is procured, and no escrow procedure is entered into. He has no assurance that the money he pays in each month is applied against the existing encumbrances on the land.

Usually the land is sold to the buyer on contract whereby the buyer receives no title until he makes the final installment payment. Often his contract is not recorded, leaving record title in the seller, thus raising the possibility that subsequent purchasers from and creditors of the seller may take free of the buyer's interest. Moreover, the buyer may find that when he has made all of his payments he will have difficulty in obtaining a deed from his seller who may then be dead, or in bankruptcy, or out-of-state. If the buyer goes into default on his payments, he will find that under the terms of the contract he loses all his interest in the land and forfeits all the money he has paid in.

Only a few states have thus far legislated in this area, and, of these California has the most comprehensive statutory scheme. State regulation falls under two general headings: (1) assuring the buyer that he will get clear title to the land he contracted to buy, and (2) protecting the buyer from entering into contracts to buy near worthless land.

STATE LAWS TO PROTECT THE BUYER'S TITLE

Several states now have provisions designed to give the buyer protection against blanket encumbrances and which set up impound requirements. The problem stemming from blanket encumbrances is that a subdivision purchaser acting without advice of counsel may buy a lot which is burdened by a mortgage