Land Notes as a Case Study in Diversifying With Small Balances
By Sierra Davis, Principal & Fund Manager, Essential Income Fund IPublished Last reviewed
Short answer
A land note is a loan secured by vacant land, usually created when a landowner sells a lot or acreage with seller financing. Land notes tend to have small balances, higher interest rates, and short terms, which lets investors spread capital across many borrowers, properties, and states, though land is harder to value and sell than a house and buyers can be quicker to walk away.
Most people picture a mortgage note as a loan on a house. Some of the most useful notes we buy are loans on dirt.
Land notes are a big part of how we think about diversification. Not because land is safer than a house (it isn't, in some ways) but because small balances let us spread the same capital across far more borrowers, properties, and markets.
What a land note is
A land note is a promissory note secured by vacant land, such as a rural lot, recreational acreage, or a parcel someone plans to build on someday. Most are created through seller financing. The landowner sells the parcel, takes a down payment, and carries the loan. Some are structured as a contract for deed, where the seller keeps title until the buyer pays in full.
Banks rarely lend on raw land, so seller financing is often the only way these buyers can purchase. That's why land notes typically carry higher rates and shorter terms than home loans.
Why investors buy land notes
- Small balances: many land notes are in the tens of thousands of dollars, so a fixed amount of capital can be spread across many notes instead of one.
- Higher rates and shorter terms: seller-financed land commonly carries higher rates than home loans, with terms measured in years rather than decades.
- No structure to maintain: no roof, no tenants, no repairs, no 2 a.m. calls, and nothing to insure against fire.
- Different borrowers and markets: recreational buyers, future builders, and rural markets don't always move with suburban housing.
- Equity from day one: the buyer's down payment sits between the loan and the land's value.
The case study
Here's a hypothetical land note we'll follow through three outcomes, then put inside a portfolio.
| Item | Detail |
|---|---|
| Land value (independent valuation) | $30,000 |
| Unpaid balance | $20,000 (about 67% LTV) |
| Note rate | 11% |
| Payments remaining | 72 monthly payments of $380.68 |
| Purchase price | $16,000 (about 53% investment-to-value) |
How the price sets the yield
| Purchase price | IRR | MOIC | Investment-to-value |
|---|---|---|---|
| $20,000 (no discount) | 11.0% | 1.37x | 67% |
| $17,500 | 16.1% | 1.57x | 58% |
| $16,000 | 19.7% | 1.71x | 53% |
Same borrower, same payment. The price you pay decides both the yield and the cushion behind your money. More on that in levered vs. unlevered IRR and loan-to-value explained.
Three ways it can go
| Outcome | What happens | Total cash in | Cash back | MOIC | IRR |
|---|---|---|---|---|---|
| Performs | All 72 payments made | $16,000 | $27,409 | 1.71x | About 19.7% |
| Moderate default | 18 payments, then stops; $2,500 in costs; land resold for $18,000 at month 30 | $18,500 | $24,852 | 1.34x | About 17.1% |
| Bad default | 6 payments, then stops; $2,900 in costs; land worth less than expected, resold for $10,000 at month 36 | $18,900 | $12,284 | 0.65x | About -18.8% |
The bad case is the one to study. One land note, one wrong valuation, and you've lost about a third of your money. That's the risk diversification is built to contain.
One note vs. six notes
Now take roughly $96,000. You can put it into one larger note, or into six land notes like this one. Suppose one of the six hits the bad case and the other five perform.
| Portfolio | What goes wrong | MOIC | IRR |
|---|---|---|---|
| Six land notes | All six perform | 1.71x | About 19.7% |
| Six land notes | One moderate default | 1.66x | About 19.4% |
| Six land notes | One bad default | 1.53x | About 15.1% |
| One note, same capital | That note has the bad default | 0.65x | About -18.8% |
Same default. In the six-note portfolio it's a dent. In the single note it's the whole result. That's diversification in one table. You can't avoid every bad note, but you can decide how much any one of them is allowed to matter.
Where land notes are harder than house notes
- Valuation: vacant land has fewer comparable sales, so values are harder to pin down. A broker price opinion from someone who knows land in that county matters.
- Borrowers can walk away faster: there's no home to lose, so some buyers stop paying when plans change.
- Liquidity: land can take longer to resell than a house, especially in remote areas.
- Access, zoning, and utilities: legal access, road maintenance, flood zones, and build restrictions all affect value.
- Paperwork and state law: contracts for deed and land sales follow state-specific rules, so documents need an attorney's review.
How land notes fit with other notes
We don't think of land notes as a replacement for first-lien loans on homes. We think of them as a different slice, with smaller positions, different borrowers, and different markets. Mixed with performing notes on houses, they spread risk across more payers and more collateral types. For the broader picture, see how real estate debt can diversify a portfolio.
Frequently asked questions
What is a land note?
A land note is a loan secured by vacant land, usually created when a landowner sells a parcel with seller financing and carries the loan. The buyer makes monthly payments to the note holder, and the land secures the debt.
Why do land notes have higher interest rates?
Banks rarely lend on raw land, so buyers often rely on seller financing, and land is harder to value and resell than a home. Higher rates compensate the lender for that added risk and the lack of other financing options.
Are land notes riskier than house notes?
In some ways, yes. Land is harder to value and slower to sell, and buyers without a home on the property can be quicker to stop paying. Small balances, conservative pricing, and diversification across many notes are how investors manage that risk.
How do land notes help diversify a note portfolio?
Because land notes often have small balances, the same capital can be spread across many borrowers, properties, and states. In a hypothetical portfolio of six land notes, one bad default lowered the portfolio's IRR from about 19.7% to about 15.1%, while the same default in a single larger note produced a loss.
Does Essential Income Fund I hold land notes?
Yes. Essential Income Fund I's portfolio includes land notes alongside other performing notes and short-term real estate loans, which spreads the fund across more borrowers, collateral types, and states.
What happens when a land note borrower stops paying?
Depending on the documents and state law, the note holder may work out new terms, accept a deed in lieu, foreclose, or, under a contract for deed, follow the state's forfeiture or foreclosure process. The land can then be resold for cash or with new seller financing.
This article is for educational purposes only and is not investment, legal, or tax advice. It describes general characteristics of real estate debt investments; individual investments differ, and all involve risk, including the possible loss of principal. Essential Investment Group, LLC is not a registered investment advisor, broker-dealer, or bank. Any offer of securities in Essential Income Fund I, LLC is made only through its Private Placement Memorandum to verified accredited investors under Rule 506(c) of Regulation D.