Chapter 13:Site Valuation

Approaches to Site ValuationDirect sales comparison approach

Extraction method

Development approach

Capitalization of ground rent

Allocation

Land residual

Sales Comparison Approach Most common method used to estimate the value of a site.

Land value derived by comparison to recent sales of similar properties

Sales adjustment grid (see Chapter 12)

Adjustments can be made on either a qualitative or quantitative basis. The appraiser must, however, justify the validity of the adjustments.

Sales Comparison Approach

Sale Subject Comp 1 Comp 2 Comp 3

Sales price N/A $285,000 $250,000 $300,000

Date of sale 1/1/91 6/1/90 10/1/90 1/1/90

Size (sqft) 38,000 40,312 35,400 44,840

Sales Comparison Approach

Sale Comp 1 Comp 2 Comp 3Price/sqft $7.07 $7.06 $6.69 Financing adjustment 0 0 0Cash equivalent price $7.07 $7.06 $6.69 Market conditions 2% 1% 4%Adjusted price/sqft $7.21 $7.13 $6.96 Location 10% $0.00 10%Size 0 -5% 5%Utilities 0 0 0Topography -5% 10% -5%Total adjustments 5% 5% 10%Adjusted price/sqft $7.57 $7.48 $7.65

Sales Comparison ApproachPaired Sales Analysis – the best method for arriving at and

supporting a level of adjustment between comparable properties.

For example: An appraiser could justify a correction of 10% for rolling topography as opposed to level topography using paired sales analysis of otherwise very similar properties.

Sales Comparison Approach: Paired Sales Analysis

Comparable 1 2Sales price $74,250 $60,000 Date of sale Mar-10 Apr-10Size (acres) 2.25 2Location Good GoodTopography Level RollingUtilities All city All cityPrice/acre $33,000 $30,000

€

Pr ice /acre comparable1

Pr ice /acre comparable2=$33,000

$30,000= .10

Sales Comparison ApproachFinally, using the adjusted price per square foot for

comparables, the appraiser can estimate an appropriate market rate of $7.50 per square foot and value the subject property as:

Land value estimate=$7.50/sqft x 38,000 sqft = $285,000

Extraction MethodMost often used when there is an absence of recent

comparable land sales

Land value = Value of total property minus contributing value of improvements

May not accurately reflect the value of the site as if it were vacant and ready for its highest and best use.

Highly speculative when improvements are old and/or do not represent the highest and best use of the site

Extraction Method

Total property value $1,200,000

Less contributing value of improvements $900,000

Land value estimate $300,000

Development ApproachOften used to estimate the value of a large tract of land

that has the potential of being subdivided and sold separately as smaller lots

Land value = present value of future cash flows to land

Development Approach: Cash Flow ForecastingUnit sales income

Involves creating a detailed market study of the are, neighborhood, and market segment (See Chapter 3).

Lot prices are determined using the sales comparison approach.

Absorption rates are determined by looking at past absorption rates for similar developments and accurately forecasting future demand.

Forecasted unit sales income can be derived from the expected number of units sold each month and the expected sales price of the lots.

Development Approach: Cash Flow ForecastingOther income

Some developments contain amenities that may serve as an additional source of income (pools, tennis facilities, clubhouses, parking facilities, etc.).

Lot owners may pay for a portion of the expenses in maintaining the facilities, but often the cost of the facilities is more than the income earned on them.

Site development costs

Expenses for grading the land and installation of roads, utilities, and amenities.

These costs can be enormous, which is why development is often done in phases.

Development Approach: Cash Flow ForecastingSales and marketing expenses

Developers incur costs for advertising and promotional materials as well as commissions for the sale of lots.

Administrative, overhead and operating expenses

Developers incur costs for the daily operation of the business through the development and sellout of the lots.

Development Approach: Cash Flow Forecasting Entrepreneurial profit

The job of the developer is time-consuming, risky, and management-intensive. Thus, he seeks to a profit high enough to account for that level of effort. This profit is referred to as entrepreneurial profit and can be included in the cash flow forecast in a variety of ways: Deduct a line item expense based on a percentage of sales

income Make no line item deduction and assume a higher discount rate Deduct expenses periodically from cash flows that are calculated

by means other than a percentage of sales income

Development Approach: Cash Flow ForecastingDiscount rate selection

Unleveraged basis — use land yield rate

Leveraged basis — use before-tax required rate on equity

Development Approach Example: AssumptionsAnalysis period length: semiannual

Total periods: 5

Construction period: 6 months

Sellout period: 2 years

Number of lots: 86

Typical lot price: $45,000, increasing by 2% per semiannual period

Development Approach Example: Development Costs Engineering: Period 1=$25,000/Period 2=$10,000/Period 3=$15,000

Clearing/grading: Period 1=$50,000/Period 3=$10,000

Roads: Period 1=$300,000/Period 3=$175,000

Utilities: $4,000 per unit built, increasing by 2% per period

Sales costs: 8% of sales income

Overhead: 2% of sales income

Real estate taxes: $250 per remaining lot

Developer profit: 12% of sales income

Land discount rate: 15%

Development Approach Example: Sales and Construction Schedule

Semiannual period 1 2 3 4 5

Beginning balance 0 46 16 36 16Construction 46 0 40 0 0   

Semiannual period 1 2 3 4 5

Sales 0 30 20 20 16Ending balance 46 16 36 16 0Cumulative sales 0 30 50 70 86Unsold developable sites at year's end 86 56 36 16 0Average unsold during year 86 71 46 26 8

Development Approach Example: Lot Sales Prices

Semiannual period 1 2 3 4 5

Sales price per lot $45,000 $45,900 $46,818 $47,754 $48,709

Development Approach Example: Net Cash Flows

Semiannual period 1 2 3 4 5 TotalsSource of Cash  Sales income typical lot $0 $1,377,000 $936,360 $955,087 $779,351 $4,047,798Total cash $0 $1,377,000 $936,360 $955,087 $779,351 $4,047,798Use of cash  Development cost:  Engineering $25,000 $10,000 $15,000 $0 $0 $50,000Clearing/grading $50,000 $0 $10,000 $0 $0 $60,000Roads $300,000 $0 $175,000 $0 $0 $475,000Utilities $184,000 $0 $166,480 $0 $0 $350,480Total $559,000 $10,000 $366,480 $0 $0 $935,480Selling costs $0 $110,160 $74,909 $76,407 $62,348 $323,824Total $0 $110,160 $74,909 $76,407 $62,348 $323,824Administration and overhead  Overhead $0 $27,540 $18,727 $19,102 $15,587 $80,956Real estate tax $21,500 $17,750 $11,500 $6,500 $2,000 $59,250Total $21,500 $45,290 $30,227 $25,602 $17,587 $140,206Developer's profit $0 $165,240 $112,363 $114,610 $93,522 $485,736Total uses $580,500 $330,690 $583,979 $216,619 $173,457 $1,885,246Net cash flow -$580,500 $1,046,310 $352,381 $738,468 $605,894 $2,162,552Present value cash flow -$540,000 $905,406 $283,653 $552,965 $422,040 $1,624,064Value           $1,624,064

Capitalization of Ground Rent In some markets land is leased rather than sold for

development. In those cases, capitalization of ground rent is a useful valuation tool.

Estimate the expected rent over the lease term and translate into a present value using a land capitalization rate or discount rate.

Capitalization of the first year’s rent is reliable if land lease terms are consistent in the marketplace and if tracts of land subject to leases are being sold in the market unimproved.

If this is not the case, discounting the forecasted rental payments is more reliable.

Capitalization of Ground RentEstimated Market Rent Land Lease Payments: Years 1-10: $45,000 Years 11-20: $60,000 Years 21-30: $95,000 Years 31-40: $140,000

Projected Resale Value in 40 Years=$1,500,000

Discount Rate=12%

Land Value Estimate=$461,581

Allocation Used when land sales are not directly available

Is seldom used because it does not specifically address the highest and best use of the site.

Land value = estimate of value of property multiplied by the typical land ratio observed in the market.

Land ResidualSee Example in Chapter 8 on income capitalization

Excess LandAdditional land that is not necessary to support

the improvements

Two ways to value: Assume it can be split from improved portion and

sold separately Assume it has value for future expansion