The residual method of valuating land or property is essential if you’re a developer interested in quickly calculating a value.
Unlike other methods of estimating value, it is used at the beginning stages of development or redevelopment in order to build your budget, identify projected expenditures, and pre-plan a project as thoroughly and accurately as possible.
It will also tell you what you can afford to pay for land or property that you plan on developing or redeveloping.
This is especially important because developers make a profit from the money that is left over after all expenses of developing the property have been paid. If you end up paying too much money for the land or go over on expenses, you could end up losing money.
Deciding The Highest And Best Use (Gross Development Value)
Determining the residual land value will help you determine the potential profitability of the land once all expenses in developing it are accounted for.
Before you start inputting numbers, you’ll first need to examine the site and study market trends in order to decide what the highest and best use is.
Obviously, the information you get when digging into the market will have a huge effect on the value. In addition to examining the types of properties already in the area, demographic patterns, and general market trends, you’ll also want to take a look at interest rates, consumer attitudes, and the general state of the economy in that area.
Important factors such as zoning laws and easements also impact what will legally be possible. All of these factors affect sale or lease prices and ultimately, the residual value.
Create A Rough Draft Of Anticipated Improvements
The next step is to decide what improvements you’ll need to make in order to achieve your goals. At this stage conceptual drawings are fine, but you’ll also want to get some good estimates of the amount of saleable space as well.
This stage can be quite expensive, as you’ll need to hire surveyors, planners, architects, civil engineers and other specialists like environmental and traffic engineers.
As a developer, it’s your job to take all the information you receive and put it together in a workable, marketable plan. At that point, the plan, along with documentation, will be submitted to the local planning department for approval.
Get Ready To Calculate The Property Value
Next, you’ll calculate the value of the property once it’s completed.
The easiest way to do is to use the income method of appraisal because by estimating the income you expect from the property, that will help you determine the maximum value of the property.
It’s a pretty simple formula: the value of the property is equal to the property’s annual net income, divided by its CAP rate.
Before you calculate the residual value, you’ll need to estimate expenses. These include:
Site Work and Building Construction (Build Costs)
- Rough grading and clearing
- Constructing roads and utilities
- Environmental Protection
- Sophisticated computer programs to estimate the volume of earth to be moved, lengths of road, and utility lines to be built
- Construction costs
- Architect fees
- Real estate commissions
- Financing charges
- Developer’s Profit
Now you can finally calculate the residual value:
(Gross Development Value) – (Construction + Fees + Profit) = Residual Value of Land or Property
Although the residual method of calculating value does have its cons, such as the need to use experienced professionals who are experts in their particular specialty, it can be a powerful method.
It’s also important when obtaining financing for a project since it gives accurate estimates of the most important aspects of the project while presenting a clear, financially sound approach to development or redevelopment.Tags: cap rate, commercial properties, commercial real estate, commercial real estate investing, residual method, residual value