What is Residual Land Valuation & Why is it Useful?
If you wish to know the value of land with development potential, you would use the residual method of determining that 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 CRE project as thoroughly and accurately as possible.
The residual land and property value will also tell you what you can afford to pay for the land or property you plan on developing or redeveloping. This is especially important because you would 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.
Calculating the residual land value helps determine the potential profitability of the land once all expenses from developing it are accounted for.
Deciding the Highest and Best Use (Gross Development Value)
To determine the highest and best use, or the gross development value (GDV), first examine the site and study market trends. The information you find 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 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.
The GDV provides the final capital value of a projected, completed property upon its sale at a specific time.
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 and what they will cost. 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 is 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
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
Next, you’ll calculate the value of the property once it’s completed. The easiest way is to use the income method of appraisal. By estimating the income you expect from the property, you can 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.
Now Calculate the Residual Value
(Gross Development Value) – (Construction + Fees + Profit) = Residual Value of Land or Property
Although the residual method of calculating land 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. The calculation is 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.
To Wrap it Up – Residual Land Value Method
Unlike other methods of estimating value, the residual land or property value method will help build your budget, identify projected expenditures, and pre-plan a CRE project as thoroughly and accurately as possible. This method will also guide you on what you can afford to pay for the land or property you plan to develop or redevelop.
If you have questions about this blog or would like to learn about recession-resistant, reliable, triple-net lease investing, feel free to contact Westwood Net Lease Advisors for a no-obligation conversation. 314-997-5227