Foundations of Land Valuation: Site Characteristics and Appraisal Techniques

Chapter: Foundations of Land Valuation: Site Characteristics and Appraisal Techniques

Introduction

Land valuation is a critical process in real estate appraisal and development. It involves determining the economic worth of a parcel of land, considering its unique characteristics and potential uses. This chapter delves into the fundamental aspects of land valuation, focusing on site characteristics that influence value and the appraisal techniques employed to estimate land value.

1. Site Characteristics and Their Impact on Value

The value of land is significantly influenced by its inherent characteristics and any improvements made. These characteristics can be broadly categorized into physical, legal, and economic factors.

1.1 Physical Characteristics

• Location: Location is arguably the most crucial factor. It encompasses proximity to amenities, transportation networks, employment centers, schools, and other desirable attributes. Locations in high-demand areas command premium prices.

  • Principle of Accessibility: Land value is directly proportional to its accessibility.
    • Formula: Value ∝ Accessibility
    • Practical Application: Land near major highways will generally have higher value due to easier access.
  • Related experiment: By comparing the value of similar sized land with same characteristics but varying distance to highways can validate above principle.

• Size and Shape: The size and shape of a site directly impact its utility and potential for development. Regular, larger sites are generally more valuable than irregular, smaller ones, particularly for commercial and large-scale residential projects.

  • Mathematical Considerations:
    • Area: The total area of the site determines its potential for development.
    • Perimeter: The perimeter affects the amount of frontage and exposure.
    • Shape Factor: A dimensionless ratio that can quantify the regularity of a shape. Example: Shape Factor = 4π * Area / Perimeter^2. Values closer to 1 indicate a more circular (and efficient) shape.
  • Practical Application: A long, narrow lot might be difficult to develop efficiently, reducing its value.

• Topography: The terrain of the land significantly affects construction costs and usability. Flat, well-drained land is generally preferred over steep, uneven, or flood-prone areas.

  • Engineering Implications:
    • Slope Stability: The angle of the slope affects the risk of landslides and erosion.
    • Drainage: Proper drainage is essential to prevent water damage and ensure site stability.
  • Example: A property at the bottom of a hill may suffer from drainage problems if all the water from above drains down onto the site.

• Soil Conditions: The type and composition of the soil affect its suitability for building foundations, landscaping, and agricultural uses. Poor soil conditions (e.g., expansive clay, unstable soils) can increase construction costs and limit development options.

  • Geotechnical Considerations:
    • Bearing Capacity: The ability of the soil to support the weight of structures.
    • Permeability: The rate at which water flows through the soil, affecting drainage and septic system design.
  • Experiment: Soil testing can determine bearing capacity and identify any contamination.

• Environmental Factors: Environmental conditions, such as the presence of wetlands, endangered species habitats, or contaminated sites, can significantly restrict development and reduce land value.

  • Ecological Impact:
    • Biodiversity: The variety of plant and animal life on the site.
    • Water Quality: The condition of surface and groundwater resources.
  • Example: A conservation easement may preclude or inhibit certain uses or any development at all.

• Utilities: The availability of public or semipublic utilities (water, sewer, electricity, gas) is a critical factor. Land that is not connected to utilities may be difficult and expensive to develop.

  • Infrastructure Considerations:
    • Capacity: The ability of existing utilities to handle increased demand from new development.
    • Proximity: The distance to utility lines affects connection costs.
  • Example: Sewers drive development.

• View Amenities: Scenic views of natural landscapes (e.g., mountains, lakes, ocean) or urban landmarks can significantly enhance property value.

  • Psychological Factors:
    • Sense of Place: The feeling of belonging and connection to the environment.
    • Stress Reduction: Exposure to nature can have a calming effect.

1.2 Legal Characteristics

• Property Rights: The bundle of rights associated with land ownership, including the right to possess, use, enjoy, and dispose of the property. Restrictions on these rights can impact value.

  • Real Property Law:
    • Fee Simple: The most complete form of ownership, granting the owner all rights to the property.
    • Easements: The right to use another person’s land for a specific purpose.
    • Liens: A claim against the property to secure a debt.
  • Example: In some states, property owners can sell their rights to develop land to another property owner in the same jurisdiction.

• Zoning Regulations: Local zoning ordinances dictate the permitted uses of land, building height and size restrictions, setback requirements, and other development standards. Zoning significantly influences the potential for development and the value of land.

  • Land Use Planning:
    • Density: The number of dwelling units or commercial square footage allowed per acre.
    • Setbacks: The minimum distance a building must be from property lines.
  • Practical Application: In an area of predominantly commercial development, you may find a property on a busy street that is still improved with a one-unit home.

• Deed Restrictions: Private agreements that restrict the use of land. These restrictions can be more specific than zoning regulations and can further limit development options.

  • Contract Law:
    • Covenants: Promises made by the property owner to abide by certain restrictions.
    • Conditions: Events that can trigger a forfeiture of ownership if violated.
  • Example: There shall be no commercial land use on any lot in this subdivision.

• Public Controls: State, local, and court case laws should be reviewed before assuming a change is possible.

1.3 Economic Characteristics

• Market Demand: The overall demand for land in a particular area, driven by population growth, employment opportunities, and economic conditions. High demand typically leads to higher land values.

  • Supply and Demand:
    • Equilibrium Price: The price at which the quantity of land demanded equals the quantity supplied.
    • Market Cycles: Fluctuations in demand and prices over time.
  • Practical Application: Large areas of vacant land in the path of development may remain undeveloped if the land is not yet connected to public utilities.

• Location Relative to Economic Activity: The proximity of land to economic centers (e.g., business districts, industrial parks, retail centers) influences its value. Land closer to these centers generally commands higher prices.

  • Economic Geography:
    • Agglomeration Economies: The benefits that firms derive from locating near each other.
    • Transportation Costs: The cost of moving goods and people to and from the site.

• Highest and Best Use: The most profitable and legally permissible use of the land, considering its physical, legal, and economic characteristics. Determining the highest and best use is a crucial step in land valuation.

  • Land Economics:
    • Opportunity Cost: The value of the next best alternative use of the land.
    • Residual Value: The value of the land after deducting the cost of development from the total value of the completed project.
  • Example: Land is appraised as though vacant and available for development to its highest and best use, and that the appraisal of improvements is based on their actual contribution to the site.

2. Appraisal Techniques for Land Valuation

Several appraisal techniques are used to estimate land value. The most common methods include the sales comparison approach, the extraction method, the allocation method, land residual method, and the discounted cash flow analysis.

2.1 Sales Comparison Approach

This is the preferred method of land valuation, based on the analysis of historical prices paid for similar sites in the same market area. The appraiser compares the subject property to comparable sales, making adjustments for differences in size, location, topography, zoning, and other relevant factors.
* Principle of Substitution: A buyer will pay no more for a property than the cost of acquiring an equally desirable substitute.
* Process:
1. Identify comparable sales.
2. Verify the data.
3. Select relevant units of comparison (e.g., price per square foot, price per acre).
4. Make adjustments for differences between the subject property and the comparables.
5. Reconcile the adjusted values to arrive at an estimate of value for the subject property.
* Formula: Adjusted Sale Price = Sale Price ± Adjustments
* Example:
Exhibit 17.1 provides an example of Sales Comparison Grid with adjustments for sale conditions, date of sale, location, size, zoning, and more.
* Paired Data Analysis
Appraisers measure the difference in the sale prices of two properties and explain it by studying differences in the sites.

2.2 Market Extraction

This method is used when there are few or no comparable land sales. It involves estimating the value of the improvements on a property and subtracting that value from the total sale price to arrive at an estimate of the land value. This method is less reliable than the sales comparison approach, as it relies on accurate estimates of improvement value.
* Formula: Land Value = Total Sale Price - Value of Improvements
* Limitation: The accuracy of the extraction method depends on the accuracy of the estimate of the value of the improvements.

2.3 Allocation Method

The allocation method is often used for valuing land in developed areas where vacant land sales are scarce. It involves estimating the typical ratio of land value to total property value for similar properties in the area and applying that ratio to the value of the subject property.
* Formula: Land Value = Total Property Value * Land-to-Value Ratio
* Limitation: The accuracy of this method depends on the availability of reliable data on land-to-value ratios.

2.4 Direct Capitalization: Land Residual Method

This method is used to estimate the value of land by determining the residual income attributable to the land after deducting the cost of developing the improvements and a reasonable return on investment for the developer. This method is often used for valuing land for potential development projects.
* Process:
1. Estimate the gross income of the proposed development.
2. Deduct operating expenses to arrive at net operating income (NOI).
3. Deduct the return on investment attributable to the improvements.
4. The remaining income is the residual income attributable to the land.
5. Capitalize the residual income to arrive at an estimate of land value.
* Formula: Land Value = Land Income / Land Capitalization Rate

2.5 Discounted Cash Flow (DCF) Analysis

The DCF analysis projects all future cash flows associated with the land and discounts them to present value.
* Formula: PV = ∑(CFt / (1+r)^t)
* PV = Present Value
* CFt = Cash Flow at time t
* r = Discount Rate
* t = Time period

3. Conclusion

Land valuation is a complex process that requires a thorough understanding of site characteristics and appraisal techniques. By considering the physical, legal, and economic factors that influence land value, and by applying appropriate appraisal methods, appraisers can provide reliable estimates of land value for a variety of purposes, including real estate transactions, property tax assessments, and development planning.