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Site Valuation and Approaches to Value
Chapter Title: Site Valuation and Approaches to Value
Course Title: Mastering Property Appraisal: From Data to Value
I. Introduction
This chapter delves into the critical aspects of site valuation and the fundamental approaches used to determine property value. We will explore the theoretical underpinnings, practical applications, and scientific principles that guide appraisers in their assessment of real estate. Understanding site valuation is essential for accurate appraisal, as it forms the foundation for many valuation techniques. We will also cover the three primary approaches to value: the cost approach, the sales comparison approach, and the income approach.
II. Step 5: Valuing the Site
A. Definition of Site Valuation
* Site valuation is the process of estimating the value of land, excluding any existing or proposed improvements.
* For unimproved property, the site valuation is equivalent to appraising the property “as is.”
* For improved property, site valuation requires estimating the value as if the land were vacant and available for its highest and best use.
* If an existing structure detracts from the land’s value, the cost of removing the structure is deducted from the land value to determine the “as is” market value.
B. Terminology
* Site: A parcel of land that has been improved through clearing, grading, and the provision of access and utilities, preparing it for development.
* Site Improvements:
* Off-site improvements: Enhancements to the land that are considered part of the land value, such as clearing, grading, and utility installation.
* On-site improvements: Structures and landscaping that are valued separately from the land, such as buildings.
C. Reasons for Separate Site Valuation
1. Highest and Best Use Analysis: Determining the most profitable use of a property as if vacant necessitates a separate site valuation to evaluate potential development options.
2. Valuation Techniques: The cost approach and the building residual technique within the income capitalization approach require a separate site value estimate.
3. Legal Requirements: Property tax assessments and condemnation appraisals may mandate a separate site valuation.
III. Site Valuation Methods
Several methods exist for estimating site value. Each method has its strengths and weaknesses, and the appraiser must choose the most appropriate method based on available data and market conditions.
A. Sales Comparison Method (for Land)
* Principle: This method is based on the principle of substitution❓❓, which states that a buyer will pay no more for a property than the cost of acquiring an equally desirable substitute.
* Process:
1. Identify comparable vacant land sales. Focus on similarities in location, size, zoning, topography, access, and utilities.
2. Adjust comparable sale prices for differences between the subject site and the comparables. Adjustments may include:
* Location: Proximity to amenities, transportation, and desirable features.
* Size: Adjust for per-unit price variations due to economies of scale.
* Zoning: Restrictions on use and development potential.
* Topography: Ease and cost of development.
* Access: Road frontage and accessibility.
* Utilities: Availability and cost of connection.
3. Reconcile the adjusted sale prices to arrive at an estimated value for the subject site.
* Formula:
* Subject Value = Comparable Sale Price +/- Adjustments
* Example:
Suppose a comparable lot sold for $100,000. The subject lot has slightly better road frontage, which is estimated to add $5,000 in value. The comparable lot has a slightly larger size, resulting in an estimated -$2,000 adjustment to account for economies of scale. The calculation would be:
Subject Value = $100,000 + $5,000 - $2,000 = $103,000
B. Extraction Method
* Principle: This method extracts the value of the land from the sale price of a comparable improved property.
* Process:
1. Identify comparable sales of improved properties similar to the subject property, considering age and condition of the improvements.
2. Estimate the depreciated cost of the improvements (replacement cost new less accrued depreciation❓❓).
3. Subtract the depreciated cost of the improvements from the sale price of the comparable property to arrive at an implied land value.
4. Analyze several comparable sales and reconcile the implied land values to estimate the value of the subject site.
* Formula:
* Land Value = Sale Price of Improved Property - Depreciated Cost of Improvements
* Example:
Comparable improved property sold for $300,000. The estimated depreciated cost of the improvements is $200,000. The implied land value is:
Land Value = $300,000 - $200,000 = $100,000
C. Allocation Method
* Principle: This method allocates a percentage of the total property value to the land.
* Process:
1. Research the typical ratio of land value to total property value in the subject area for similar properties. This ratio is derived from market data and analysis of comparable sales.
2. Apply this ratio to the estimated value of the improved property to determine the land value.
* Formula:
* Land Value = Total Property Value x Land Value Ratio
* Example:
The appraiser estimates the total property value of the improved property to be $500,000. Market data indicates that the typical land value ratio in the area is 20%. The land value is:
Land Value = $500,000 x 0.20 = $100,000
D. Land Residual Technique
* Principle: This method is used in income-producing properties. It isolates the portion of net operating income attributable to the land.
* Process:
1. Estimate the net operating income (NOI) of the property.
2. Determine the appropriate capitalization rate for the improvements (R_B).
3. Estimate the value of the building (V_B) by using the Cost Approach (Reproduction Cost - Depreciation).
4. Calculate the income attributable to the building: I_B = V_B * R_B
5. Subtract the income attributable to the building from the total NOI to find the income attributable to the land: I_L = NOI - I_B
6. Determine the capitalization rate for the land (R_L) from market data.
7. Calculate the land value: V_L = I_L / R_L
* Formula:
* V_L = (NOI - (V_B * R_B)) / R_L
* Where:
* V_L = Land Value
* NOI = Net Operating Income
* V_B = Value of Building (using the Cost Approach)
* R_B = Capitalization Rate for the Building
* R_L = Capitalization Rate for the Land
* Example:
Suppose a property has an NOI of $50,000. The value of the building is estimated at $400,000, and the building capitalization rate is 8%. The land capitalization rate is 6%.
I_B = $400,000 * 0.08 = $32,000
I_L = $50,000 - $32,000 = $18,000
V_L = $18,000 / 0.06 = $300,000
E. Subdivision Development Analysis
* Principle: This method is used to value large tracts of land that are suitable for subdivision and development.
* Process:
1. Develop a hypothetical subdivision plan, outlining the number and size of lots, street layout, and infrastructure requirements.
2. Estimate the gross revenue from the sale of the individual lots.
3. Estimate all development costs, including construction, engineering, marketing, and financing.
4. Deduct the total development costs, and entrepreneurial profit from the gross revenue to arrive at the residual land value.
5. Discount the residual land value to present value to account for the time required for development and sale.
* Formula:
* Land Value = (Gross Revenue - Total Development Costs - Entrepreneurial Profit) / (1 + Discount Rate)^n
* Where:
* n = Number of years for the development and sale period.
IV. Approaches to Value
After valuing the site, the appraiser uses one or more of the three standard approaches to estimate the overall❓ property value: the cost approach, the sales comparison approach, and the income approach.
A. Cost Approach
* Principle: The cost approach is based on the principle of substitution, which states that a buyer will pay no more for a property than the cost of constructing an equivalent new property.
* Process:
1. Estimate the value of the site (as discussed above).
2. Estimate the cost to reproduce or replace the existing improvements (using methods such as quantity survey, unit-in-place, or comparative-unit).
3. Estimate the accrued depreciation (physical deterioration, functional obsolescence, and external obsolescence).
4. Deduct the accrued depreciation from the cost new to arrive at the depreciated cost of the improvements.
5. Add the site value to the depreciated cost of the improvements to arrive at an estimate of property value.
* Formula:
* Property Value = Reproduction Cost of Improvements - Depreciation + Land Value
B. Sales Comparison Approach
* Principle: The sales comparison approach is based on the principle of substitution and relies on comparing the subject property to similar properties that have recently sold.
* Process:
1. Identify comparable sales that are similar to the subject property in terms of location, size, age, condition, features, and amenities.
2. Adjust the sale prices of the comparable properties to account for differences between the subject property and the comparables. Adjustments may be made for factors such as:
* Property Rights: Differences in easements, restrictions, or encumbrances.
* Financing Terms: Differences in interest rates, loan terms, or seller concessions.
* Conditions of Sale: Forced sales or sales between related parties.
* Market Conditions: Changes in prices due to shifts in supply and demand.
* Location: Proximity to amenities, transportation, and nuisances.
* Physical Characteristics: Differences in size, age, condition, features, and amenities.
3. Reconcile the adjusted sale prices of the comparable properties to arrive at an estimated value for the subject property.
* Formula:
* Subject Value = Comparable Sales Price +/- Adjustments
C. Income Approach
* Principle: The income approach is based on the principle of anticipation and estimates the value of a property based on its ability to generate income.
* Process:
1. Estimate the potential gross income❓❓ (PGI) of the property.
2. Estimate the vacancy and collection losses to arrive at effective gross income (EGI).
* EGI = PGI - Vacancy and Collection Losses
3. Estimate the operating expenses (OE) of the property, including fixed expenses (e.g., property taxes, insurance) and variable expenses (e.g., maintenance, utilities).
4. Deduct the operating expenses from the effective gross income to arrive at the net operating income (NOI).
* NOI = EGI - OE
5. Capitalize the net operating income to arrive at an estimate of property value. Several capitalization techniques may be used:
* Direct Capitalization:
* Value = NOI / Capitalization Rate
* Discounted Cash Flow (DCF) Analysis: Projects future cash flows and discounts them to present value.
* PV = CF1 / (1 + r)^1 + CF2 / (1 + r)^2 + ... + CFn / (1 + r)^n + RV / (1 + r)^n
* Where:
* PV = Present Value
* CF = Cash Flow
* r = Discount Rate
* RV = Reversion Value (Sale Price at the end of the holding period)
* n = Number of periods
VII. Data Verification and Analysis
All data collected during the appraisal process must be verified to ensure accuracy and relevance. Verification may involve personal inspection, cross-checking information, and interviewing relevant parties.
- Accuracy: The appraiser must have a reasonable basis for believing the data is accurate.
- Relevance: The data must be relevant as an indicator of the value of the subject property.
Data analysis occurs throughout the appraisal process. Data is analyzed for accuracy and relevance during collection, and it serves as the basis for the analysis of highest and best use and the valuation of the subject property using the three approaches to value.
VIII. Reconciliation
After applying the three approaches to value, the appraiser reconciles the value indications to arrive at a final opinion of value. Reconciliation involves reviewing the data, methods, and assumptions used in each approach and weighing the reliability and relevance of each indication. The appraiser considers the strengths and weaknesses of each approach and selects the most credible indication or develops a weighted average.
IX. Conclusion
Site valuation and the three approaches to value are fundamental components of the appraisal process. A thorough understanding of these concepts is essential for accurate and reliable property valuation. By applying the principles and techniques discussed in this chapter, appraisers can provide credible opinions of value that are supported by market data and sound reasoning.
Chapter Summary
This chapter, “Site Valuation and Approaches to Value,” within the “Mastering Property Appraisal: From Data to Value” training course, focuses on essential steps in the appraisal process, specifically site valuation and the application of the three standard approaches to value: cost, sales comparison, and income.
The chapter emphasizes the importance of data verification, ensuring both accuracy❓ and relevance to the appraisal assignment. Verification methods range from personal inspection (e.g., measuring the subject property) to cross-checking information (e.g., interviewing parties involved in comparable sales). The reliability of data hinges on the appraiser’s reasonable belief in its accuracy and its relevance as a value indicator. Data analysis is presented as an ongoing process, starting with data collection and continuing through highest and best use analysis, valuation using the three approaches, and final reconciliation.
A key concept introduced is highest and best use analysis, which determines the most profitable use of the property, both as improved and as if vacant. This analysis is particularly important when land and improvements must be valued separately, as in the cost approach.
Site valuation, defined as estimating the value of the property excluding improvements, is a critical step. For unimproved property, it is the same as appraising the property “as is.” For improved property, it requires valuing the site as if vacant, potentially deducting demolition costs if existing structures❓ detract from the land value. The chapter clarifies the distinction between “off-site” improvements (e.g., clearing and grading) valued as part of the land and “on-site” improvements (e.g., buildings and landscaping) valued separately. Site valuation is essential for highest and best use analysis, certain valuation techniques like the cost approach and building residual technique, and in appraisals required❓ by law (e.g., property tax assessment, condemnation).
The chapter then introduces the three approaches to value. The Cost Approach estimates value by summing the land value and the depreciated cost of improvements. A key challenge is accurately estimating depreciation, the difference between the new cost of the improvements and their current value, considering physical deterioration and functional obsolescence. The Sales Comparison Approach (or Market Approach) relies on the sales prices of comparable properties, adjusted for differences from the subject property. Identifying truly comparable properties and making accurate adjustments are crucial. The Income Approach estimates value based on the income the property is expected to generate.
In summary, this chapter lays the groundwork for understanding how to determine property value, with a strong emphasis on data reliability, highest and best use, and the importance of accurate site valuation in conjunction with the three standard appraisal approaches. The subsequent chapters will delve into each of the approaches in more detail.
