Land Valuation: Site Characteristics and Techniques

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Chapter: Land Valuation: Site Characteristics and Techniques

Introduction

Land valuation is a critical component of real estate appraisal and development. Accurately determining land value unlocks potential investment, informs decision-making, and ensures equitable transactions. This chapter explores the key site characteristics influencing land value and examines various valuation techniques applicable across diverse scenarios. We will delve into the scientific basis of these techniques and illustrate their practical applications.

1. Site Characteristics Influencing Land Value

The value of a parcel of land is intrinsically linked to its inherent characteristics and potential for development. These characteristics can be broadly classified into physical, legal, economic, and locational factors.

1.1 Physical Characteristics

• Topography: The surface configuration of the land significantly impacts development costs and usability.

  • Steep slopes increase construction costs due to the need for extensive grading, retaining walls, and specialized foundation systems. These costs can be estimated using geotechnical engineering principles and cost-benefit analyses.
  • Formula: Construction Cost Increase = f(Slope Angle, Soil Type, Required Grading Volume) (Where f represents a complex function derived from engineering analysis)
  • Poor drainage, often associated with low-lying areas or impervious soil, can lead to flooding, soil instability, and increased risk of property damage. Hydrological studies are crucial to assess drainage capacity and potential mitigation strategies.
  • Formula: Runoff Coefficient (C) = Runoff Volume / Rainfall Volume (Higher C indicates greater runoff and potential drainage issues).

• Soil Composition: Soil properties dictate foundation requirements, suitability for vegetation, and potential for environmental contamination.

  • Soil bearing capacity, measured in pounds per square foot (psf) or kilopascals (kPa), determines the load-bearing capabilities of the soil. Low bearing capacity necessitates the use of deep foundations (e.g., piles, caissons), increasing construction costs.
  • Equation: Bearing Capacity = cNc + qNq + 0.5γBNγ (Terzaghi’s Bearing Capacity Equation, where c = cohesion, q = overburden pressure, γ = unit weight of soil, B = foundation width, and Nc, Nq, Nγ are bearing capacity factors based on the soil’s friction angle).
  • Soil permeability influences drainage rates and the potential for groundwater contamination. Highly permeable soils can lead to rapid contaminant migration, requiring remediation measures.
• Size and Shape: The dimensions and configuration of a site directly affect its usability and development potential. Irregularly shaped parcels or those with limited frontage may restrict building design and site layout. The concept of “highest and best use” is important here. The size and shape of a site may inhibit certain uses and causes changes in the highest and best use. For example, a site next to a major commercial thoroughfare may have diminished value because the parcel is only 30 feet wide and no retailer can use it.
• View Amenities: Desirable views (e.g., water views, mountain vistas, green spaces) can significantly enhance property value, particularly for residential developments. Hedonic pricing models can be used to quantify the value attributable to view amenities. Conversely, views of undesirable features (e.g., industrial areas, highways) can negatively impact value.

1.2 Legal Characteristics: Property Rights and Public Controls

• Zoning Regulations: Zoning ordinances dictate permissible land uses, building height restrictions, setbacks, and density limitations. Zoning analysis is fundamental to determining the development potential of a site. Appraisers working outside their own markets should research zoning carefully to ensure that they understand how these controls will affect value.
• Deed Restrictions and Easements: Deed restrictions, also known as restrictive covenants, impose limitations on land use and development. Easements grant specific rights to third parties to use a portion of the property for a defined purpose (e.g., utility easements, access easements). Conservation easements, preservation easements, or other agricultural easements may preclude or inhibit certain uses or any development at all.
• Transferable Development Rights (TDRs): In some jurisdictions, property owners can sell their rights to develop land to another property owner in the same jurisdiction. These TDRs foster higher-density development in urban and suburban areas where utilities are available and infrastructure is in place and preclude development in more remote areas.

1.3 Economic Characteristics

• Utility Availability: Access to public or semi-public utilities (e.g., water, sewer, electricity, gas) is a critical factor influencing land value, particularly in developing areas. The cost of extending utility lines to a site can be substantial and can impact the feasibility of development.
• Market Conditions: Overall economic conditions, interest rates, and demand for real estate influence land values. Market studies and feasibility analyses are essential to assess the economic viability of proposed developments.

1.4 Locational Characteristics

• Accessibility: Proximity to transportation networks (e.g., highways, public transit), employment centers, and amenities (e.g., schools, shopping centers) significantly impacts land value. Location near busy streets might be a positive or a negative factor depending on the intended use and should be carefully analyzed.
• Neighborhood Characteristics: The quality and character of the surrounding neighborhood influence property values. Factors such as crime rates, school district quality, and the presence of amenities contribute to the overall desirability of a location. Proximity to desirable view amenities such as a golf course can significantly increase property value.

2. Land Valuation Techniques

Several techniques are employed to estimate land value, each with its own strengths and limitations. The choice of technique depends on the availability of data and the specific characteristics of the subject property.

2.1 Sales Comparison Approach

• Principle: This approach is based on the principle of substitution, which states that a rational buyer will pay no more for a property than the cost of acquiring an equally desirable substitute. The sales comparison approach is the simplest to apply and the easiest for appraisal clients, brokers, judges, and juries to understand.
• Methodology: The appraiser identifies comparable land sales in the subject property’s market area and adjusts the sale prices of the comparables to account for differences in site characteristics, market conditions, and other relevant factors.

• Adjustment Process: Adjustments can be made using either dollar amounts or percentages. In some markets, a “buildable” site is the primary unit of comparison. Adjustments were made in the grid to compensate for the price range of surrounding homes. Adjustments are made for the price range of improved properties to compensate for the market phenomenon of progression, which means that buyers will pay more for a lot in a higher-priced neighborhood than one in a lower-priced area.

  • Formula: Adjusted Sale Price = Sale Price ± Adjustments for Differences
  • Paired Data Analysis: This technique involves analyzing pairs of comparable sales to isolate the impact of specific site characteristics on value. For example, in paired data sales analysis of land sales, appraisers measure the difference in the sale prices of two properties and explain it by studying differences in the sites.
  • The extracted adjustments can be used to analyze price changes over time. For example, comparing the sales of Lots 2 and 4 shows that the price has increased by $1,000 over the last six months, which implies an appreciation rate of $2,000 per year.
  • Example: The provided sales comparison grid (Exhibit 17.1) illustrates the adjustment process, considering factors such as size, location, topography, and market conditions.

2.2 Market Extraction

• Principle: This method estimates land value by subtracting the depreciated cost of improvements from the overall sale price of an improved property. It is most applicable when there are limited comparable land sales available.

  • Formula: Land Value = Sale Price of Improved Property - Depreciated Cost of Improvements
  • Depreciation Estimation: Accurate depreciation estimation is crucial to the reliability of this technique. Depreciation can be estimated using various methods, including the straight-line method, the cost-to-cure method, and market-based depreciation rates.
  • The premise behind extraction can be stated as:

If X amount is what the house and land sold for, then what’s left over after removing the value of the house from X amount must be the value of the land!

2.3 Allocation

• Principle: This method estimates land value by applying a typical land-to-value ratio observed in the market to the overall property value.

  • Formula: Land Value = Overall Property Value x Land-to-Value Ratio
  • Ratio Derivation: Land-to-value ratios are typically derived from sales of comparable properties where both the land value and overall property value are known.
  • Applicability: This technique is most applicable in areas with relatively homogenous properties and stable market conditions.

2.4 Direct Capitalization: Land Residual Method

• Principle: This method isolates the income attributable to the land and capitalizes that income to estimate land value. The land value is the present value of the expected future income.
• Methodology: The appraiser estimates the net operating income (NOI) of a hypothetical development on the site and allocates a portion of that income to the improvements (based on their cost and a required rate of return). The remaining income is attributed to the land and capitalized to arrive at the land value.
  • Formula:
    • Land Value = Land Income / Land Capitalization Rate
    • Land Income = NOI - (Improvement Cost x Improvement Rate)
• Capitalization Rate: The land capitalization rate reflects the market-derived rate of return expected for land investments.

2.5 Direct Capitalization: Ground Rent Capitalization

• Principle: This technique is applicable when land is leased to a tenant who constructs improvements. The land value is estimated by capitalizing the ground rent income.
  • Formula: Land Value = Ground Rent / Ground Rent Capitalization Rate
• Ground Rent Capitalization Rate: The ground rent capitalization rate reflects the market-derived rate of return expected for ground leases.

2.6 Yield Capitalization: Discounted Cash Flow (DCF) Analysis

• Principle: This method estimates land value by projecting the future cash flows expected from a hypothetical development on the site and discounting those cash flows back to their present value.
  • Formula: Land Value = Σ [CFt / (1 + r)^t] (Where CFt is the cash flow in year t, r is the discount rate, and t is the year).
• Cash Flow Projections: The accuracy of this technique depends on the reliability of the cash flow projections, which require detailed market analysis, development cost estimates, and revenue projections.
• Discount Rate: The discount rate reflects the risk associated with the development project and the opportunity cost of capital.

3. Applicability and Limitations of Valuation Techniques

Sales comparison is the preferred method of land valuation, but other methods must often be used. For example, if the subject property is a 90-year-old home in an area of similar older homes, there may not have been a vacant land sale in many years. When market data is scarce, a variety of alternative techniques can be used to estimate land value.

Conclusion

Accurate land valuation is a complex process requiring a thorough understanding of site characteristics, applicable valuation techniques, and market conditions. This chapter has provided a comprehensive overview of the key factors influencing land value and the scientific principles underlying various valuation methods. By applying these principles and techniques, appraisers and developers can unlock the true potential of land and make informed decisions.