As the U.S. real estate market downshifts, a strategy that seemed like a sure bet a year or two ago--investing in land--suddenly isn't working out so well.

When commercial and residential development was proceeding at a fever pitch, entrepreneurial investors projected future growth patterns and snatched up land in the path of where developers would likely want to build something two or three years later. As a result, when developers came knocking, investors steeped in this practice--called land banking--could turn a tidy profit as the value of the land increased sharply during the holding period.

Fueled by the increases, private firms such as Apollo Real Estate Advisors and Greenstreet Real Estate Partners, both of New York City, and the Adler Group, of Miami, as well as retail REITs including Chicago's General Growth Properties, snapped up land parcels (with some of them borrowing heavily to fund their acquisitions), with the expectation of holding them and then selling them at a profit later. For example, in the nine months since December 2006, the value of General Growth's land holdings increased more than 11 percent, to $3.29 billion. As of the beginning of the year, the REIT owned 16,516 saleable acres of land. And, Inland Real Estate Development grew its land portfolio by more than 17 percent, to 4,000 acres valued at $250 million.

For a time, that strategy worked. As recently as 2006, the value of commercial land was still appreciating. The median price for parcels zoned for office, retail, apartment or hotel use rose to $170,940.00 per acre, up 7 percent from the $159,753.00 per acre in mid-year 2005, according to Chicago-based brokerage firm Grubb & Ellis.

Today, things look a bit different.

The single-housing development market has evaporated. The pace of home construction has dropped down to 1.2 million units, the lowest level in 14 years and about half the volume at the market's peak in February 2006, when 2.3 million units were under construction. Construction on commercial property, meanwhile, hasn't slowed as much, but developers are stepping back. As a result, prices on parcels of land, especially those zoned for master-planned communities, have plummeted 50 percent to 60 percent from where they were two years ago, notes Steve Lehr, managing director for land services with brokerage firm CB Richard Ellis.

"You have a group of people who got into the land business during the up cycle and they don't have patient money and, in some cases, their lenders are making them eager to sell," says Matt Fiascone, senior vice president of Inland Real Estate Development, a Chicago-based subsidiary of the Oakbrook, Ill.-based Inland Real Estate Group of Companies.

Both Fiascone and Lehr predict the market has yet to bottom out. In the first quarter of 2008, they anticipate a lot of bankruptcy sales and foreclosures on parcels that are highly leveraged.

And that's creating a host of problems. Investors who borrowed cash to buy land face an unpleasant conundrum. The pace of development is dropping and the demand for land disappearing with it. That's driving land prices down. But to avoid defaulting on loans some land investors are being forced to sell anyway. Suddenly, those sure bets seem poised to become steep losses.

Faced with the crumbling market, land bankers may have no choice but to sell at a discount or hold on to their properties longer than expected, says Rich Walter, president of Irvine, Calif.-based retail brokerage firm Faris Lee Investments. On properties with no entitlements, the wait period could be double the two or three years the bankers were counting on. And if land speculators do hang on to their parcels through 2008, Walters adds, retailers are more than likely to be unwilling to pay the rents they agreed to in 2005 and 2006.

That could become a problem for those holding over-leveraged parcels and banking on short-term payouts. For seasoned land bankers, however, this can be a time of opportunity. Inland Real Estate Development, for example, which entered the land banking business in the 1990s, plans to establish new funds for commercial land acquisitions in the near future, targeting at least 10 or 20 parcels with a holding period of two to four years.

"We share the opinion that values are going to be flat or declining, and that's the time to buy," says Fiascone. "The time to buy is when everybody else is selling."

That is not to say the downshift is market-wide. Parcels in urban infill locations including New York, Chicago, Washington, DC, San Francisco and Los Angeles continue to draw real estate developers and retailers, says Bernie Haddigan, national director of the retail practice with Chicago-based brokerage firm Marcus & Millichap Real Estate Investment Services. However, in secondary markets, and those areas where retail development is predicated on residential growth, prices are trending downward. With more rigorous lending requirements, developers are foregoing new projects in favor of acquisitions.

"There is a very low tolerance for risk right now, even if your project is brilliantly conceived, " Haddigan says. "The difference between asking price and bidding price is as broad as it has been in seven or eight years, so I think transactional velocity is really going to slow down."

--Elaine Misonzhnik