lectu re 4.

land Valuation Techniques

I.
Lot values
Raw land values
Adjusted to reflect density
Income capitalization:
\
Direct capitalization of ground rent
Land residual technique
Yield capitalization for subdivision
Sales comparison approach
I. The use of the sales comparison approach on a land parcel is not
significantly different from its use on an improved property.
a. Property rights conveyed, financing terms, conditions of
sale. expenditures immediately after purchase, and market
conditions are all dealt with in the same way.
b. Highest and best use, including timing of use. is an
important consideration.
c. Physical suitability of the parcel should be addressed.
Examples include topography. availability of utilities,
access. site prominence, size, and shape.
d. Legal obstacles require consideration. Land use controls
such as existing zoning. the likelihood of a change in
zoning, and land subdivision regulations can come into
play. Environmental concerns are becoming an increasingly
important issue.
The sales comparison approach is the most often used and
preferred method to develop an opinion of land value.
Advanced Sales Comparison and Cost Approaches
Extraction
.
.
A.
2.
analysis
3-7
B. Allocation
1.
2.
3.
3. It can be useful in estimating land value in areas where land sales
are scarce, but improved property sales are readily available.
4. It depends on the availability of land sales and corresponding
improved property sales in other areas.
Note. The next three examples show the classic allocation method for
residential lot value as well as two extensions of it for raw land value and
raw land value involving differing densities.
4.
3-8
This method is based on the premise that a constant relationship
exists between the land value and the total property vaJue, for
speciaJ types of real estate in certain locations. This premise must
be supported before the method can be used.
and It has its theoretical foundation in the principles of balance
contribution.
It can
Advanced Sales Comparison and Cost Approaches
Example 3.1.
Allocation Method
The subject property is improved with a single-family residence, and recently sold for
$160,000. No vacant lots have sold in the subject property's neighborhood; however,
vacant Jots have sold in three nearby neighborhoods in which improved properties also
have sold.
Estimate the value of the subject site.
Advanced Sales Comparison and Cost Approaches
3-9
Suggested Solution 3.1.
Allocation Method
Analysis of sales indicates that 20.00% to 24.40% of the price is for the residential site
value. Most weight was given to the sale in Neighborhood B because its total property
price is most similar to the subject's.
The probable value of the subject site is $160,000 x 21% = $33,600. Since market
participants appear to round lot sale prices to the nearest $ 1,000, the value conclusion is
rounded to $34,000. A reasonable argument can also be made for a conclusion of
$35,000, but it would be inconsistent with the weighting of the neighborhoods to use any
percentage greater than the simple average of the three ratios.
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Advanced Sales Comparison and Cost AoDroache.r;
C. Extraction
I.
2.
3.
4.
3-]6
In this method, the unit prices for comparable land are extracted
from improved sales by deducting the estimated value contribution
of the improvements from the sale prices.
The accuracy of this method often depends on the quality of the
depreciation estimate. For that reason, it is generally used only for
properties with new improvements that suffer from no
obsolescence, or for properties where the improvements represent a
small component of the total value.
One application is the valuation of farm properties.
This method has only rare application.
Advanced Sales Com1JQ7'ison and Cost Annroache.'i
Example 3.4.
Extraction Method
The highest and best use of a 1 DO-acre vacant ]and tract is a fann suitab]e for row crops
and the raising of Hvestock. Research of market data revea]s only one vacant ]and sa]e
and two improved sa]es. The three sa]es are as foHows:
Sale A includes a rental tenant house that rents for $200 per month. Similar houses on
one-acre lots are valued with a monthly gross rent multiplier of 100. Sale A is also
improved with a livestock barn with a current cost of $10,000; it has an estimated
effective age of 20 years and a useful life of 40 years.
Sale C is improved with a livestock barn with a current cost of$12,000. The barn is
estimated to have an effective age of 5 years and a useful life of 30 years.
What is the subject land worth?
Advanced Sales Comparison and Cost Approaches
3-17
Suggested Solution 3.4.
Extraction Method
The prices paid for the
deducted from the sale
The rental house included in Sale A is estimated at a contributory price of $200 per
month rental rate times 100 GRM, or $20,000. The $10,000 (current cost) livestock barn
is depreciated by 50% (20-year effective age/40-year economic life) to arrive at a
deduction for this improvement of $5,000. The resulting estimated price paid for the land
is divided by the total acreage less one acre allocated to the rental house.
Sale C includes a barn with an estimated current cost $12,000. A depreciation charge of
about 17% (5-year effective age/30-year economic life) is deducted to arrive at an
estimated price contribution by this improvement of $10,000.
The two sales requiring extraction indicate fairly similar unit prices and bracket the unit
price of the one sale that involved vacant land only. Placing most emphasis on Sale B,
which required no adjustment, a supportable answer is $700 per acre times 100 acres, or
$70,000.
3-18 Advanced Sales Comparison and Cost Approaches
improvements included in Sales A and C must be estimated and
prices of the land as improved.
D. Income capitalization
Income capitalization is the fourth method of valuing land, with two
subcategories.
1. Direct capitalization of ground rent
Advanced Sales Comparison and Cost Approaches 3-19
The procedure is to estimate the market rental value of the
land and then capitalize it into an indication of fee simple
value using a market-derived land capitalization rate.
8.
b. Capitalization rate comparables should have the same
highest and best use as the subject. A capitalization rate
derived from a downtown office building sale and applied
to a parking lot ground lease will probably understate the
parking lot's value because parking lots commonly are
interim uses.
Many appraisers confuse the valuation of land with the
valuation of a leased fee in a grO\U1d lease situation. Ground
lease valuation uses the subject's contract rent; land
valuation using direct capitalization uses the subject's
estimated market rent under its highest and best use.
c.
d. Comparable land capitalization rates for valuing land using
direct capitalization may be hard to find and difficult to
analyze.
1)
Capitalization rates from sales of grO\U1d-]eased
properties (leased fees) can be valid comparab]es if
the comparable's land rent reflects market for the
land's highest and best use and it is expected to
track with market for the remaining term of the
lease. Sales where the land rent is below market but
will track proportionaJJy with market, and where the
remaining term of the lease is so long that the buyer
and seller did not place much weight on the
potentia] reversion, can also be considered.
2)
The existence and quality of escalation clauses in
ground leases can have a significant effect on sale
prices. It is important to compare the escalation
clauses in the comparables to the expected upside in
the subject's market rental estimate. If the
comparables have flat leases, it may be necessary to
apply the derived capitalization rates to a level-
2.
"~20 ." . Adwmced Sales Comparison tmd Cost A.
equivalent estimate of the subject property's market
land rent.
3)
Ground leases are often periodically revalued to
"market." Some escalation clauses are so poorly
written that they result in litigation at every
revaluation period. A common problem is for the
lease to be vague about the basis for the land
revaluation. Is the land to be valued based on its
existing use or its highest and best use?
4)
Subordination clauses also have a significant effect
on sale prices and therefore capitalization rates.
Some lessors subordinate their interest in the land to
a loan on the improvements, which increases the
lessor's risk, decreasing the value of the leased fee
interest.
5)
Due to the problems with using leased fee
capitalization rates in direct capitalization for
valuing land, it may be necessary to rely on investor
interviews, to perform a risk analysis of other
investments, or to consider transactions in other
cities to support the capitalization rate.
This method has applications in inner-city valuation e.
problems.
Direct capitalization: land residual technique
a. In the land residual technique, the net operating income
attributable to the land is isolated and capitalized to
produce an indication of the land's contribution to total
proPerty value.
b. To develop an opinion of the land value under its highest
and best use as if vacant, the procedure for the land residual
technique involves the following steps:
1) Hypothetically construct an optimum building on
the land parcel (i.e., highest and best use in all
respects, or "ideal" improvement).
2) Estimate the net operating income from the property
as improved, using market rents and expenses.
3.
Other land valuation issues ll.
Excess vs. surplus land: Both tenDS refer to land that is part of an existing
ownership, but is not needed to support the highest and best use of the
property as improved.
A.
1. . Surplus land is additional land that allows for future expansion of
the existing improvements but cannot be developed separately and
does not have a separate highest and best use. It is associated with
an improved site that has not been developed to its maximum
productivity according to its highest and best use as if vacant.
2.
3.
Advanced Sales Comparison and Cost Approaches
3) Calculate the amount of income required to pay a
proper return on the building, using a building
capitalization rate extracted from market sales.
4) AlJocate remaining income (residual) to the land.
5) Capitalize residual income into land value using a
market-derived land capitalization rate.
c. The technique is very sensitive to estimates concerning the
building. Slight errors in the net operating income translate
into big swings in the land value.
Yield capitalization: discmmted cash flow or subdivision analysis
Land subdivisions are not covered in this course because
they are covered elsewhere, particularly in Courses 510 and
550.
a.
b. Discounted cash flow can be used instead of or in addition
to direct capitalization, to value land subject to a ground
lease.
Excess land, for an improved site, is land not needed to serve or
support the existing improvements. For a vacant site or a site
considered as if vacant, it is the land not needed to accommodate
the site's primary highest and best use. Such land may be separated
from the larger site and have its own highest and best use, or it may
allow for future expansion of the existing or anticipated
improvement.
These concepts will be reviewed in the practice problems for
Session 8.
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