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Site Valuation Techniques
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Chapter 6: Site Valuation Techniques
I. Introduction
- Brief overview of site valuation importance in real estate appraisal.
- Purpose of site valuation: Cost approach, building residual technique, legal requirements (tax assessment, condemnation). (Referencing Chapter 8 & 10)
- Outline of the chapter’s contents and techniques to be discussed.
II. The Foundation: Highest and Best Use (HBU)
- A. Defining Highest and Best Use
- The most probable and legal use of a property that is physically possible, appropriately supported, financially feasible, and that results in the highest value.
- Emphasis on the dynamic nature of HBU – it is not static.
- Important Note: HBU influences the selection of comparables, valuation methods, and overall appraisal accuracy.
- B. The Four Tests of Highest and Best Use
- 1. Legally Permissible:
- Zoning regulations: setbacks, height restrictions, permitted uses, FAR (Floor Area Ratio).
- Environmental regulations: wetlands restrictions, endangered species habitat.
- Private restrictions: deed restrictions, easements, covenants.
- Mathematical representation: Let
Lbe the set of legally permissible uses. Then, HBU ∈L.
- 2. Physically Possible:
- Site size, shape, topography, soil conditions, access to utilities.
- Geotechnical analysis: soil bearing capacity, drainage, stability.
- Constraints can eliminate development options.
- Example: Steep slopes might preclude certain building designs.
- 3. Financially Feasible:
- The use must generate sufficient income or return to justify investment.
- Cost-benefit analysis: costs of development vs. potential revenue.
- Consideration of current market conditions❓❓, absorption rates, and construction costs.
- Formula:
NPV = ∑ [Cash Flow / (1 + r)^t] - Initial Investment, whereNPVis Net Present Value,ris the discount rate, andtis the time period. A feasible use requiresNPV > 0.
- 4. Maximally Productive (Most Profitable):
- From the feasible uses, select the one that yields the highest net return or present value.
- This requires forecasting future income streams and discounting them back to the present.
- This is where the principle of anticipation is most relevant
- 1. Legally Permissible:
- C. Highest and Best Use “As Vacant” vs. “As Improved”
- 1. As Vacant:
- Analysis assumes the site is cleared of all existing improvements.
- Focus on potential uses considering legal, physical, and financial constraints.
- 2. As Improved:
- Considers the existing improvements and their contribution to value.
- Does the existing structure contribute to HBU, or is it an underimprovement?
- Consider demolition costs vs. the increased value of a new development.
- Decision Rule: If
Value (New Use) - Demolition Cost > Value (Existing Use), then redevelopment is indicated, and vice versa.
- 1. As Vacant:
- D. Interim Use
- A temporary use of a site that is not the long-term HBU.
- Often occurs when market conditions are not yet ripe for the ultimate development.
- Example: Parking lot on land slated for future high-rise development.
- E. Legal Nonconforming Use
- A use that was legally established but no longer conforms to current zoning regulations.
- Valuation must consider the restrictions and limitations on these uses.
- F. consistent use❓ Principle
- Land and improvements must be valued based on the same HBU, whether “as vacant” or “as improved.”
III. Site Valuation Techniques: Quantifying Land Value
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A. Sales Comparison Approach (Most Important)
- Based on the principle of substitution: a buyer will pay no more for a property than for a comparable one.
- 1. Data Collection:
- Gather sales data on similar vacant sites.
- Verify data sources (deeds, MLS, assessors, developers).
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2. Elements of Comparison (Adjustments):
- a. Real Property Rights Conveyed: Fee simple, leasehold, etc.
- b. Financing Terms: Adjust for non-market financing.
- c. Conditions of Sale: Arm’s length transactions only.
- d. Expenditures Immediately After Sale: e.g. Cost to cure needed
- e. Market Conditions: Account for changes in value over time.
- Formula:
Adjustment = Sales Price * Market Change Percentage
- Formula:
- f. Location: Adjust for differences in neighborhood, access, amenities.
- g. Physical Characteristics: Size, shape, topography, soil.
- Example: a larger lot may not be proportionally more valuable if the excess land cannot be developed.
- h. Economic Characteristics: Zoning, development potential.
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3. Adjustment Process:
- Quantitative adjustments are preferable (dollar amounts), but qualitative adjustments (superior/inferior) may be necessary.
- Example: Comparable Sale Price:
- Important: Focus on bracketing. The subject property should fall within the range of adjusted values of the comparables.
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B. Allocation Method
- Estimates land value by allocating a percentage of the total property value to the land.
- Based on typical ratios of land value to improvement value in the market.
- Formula:
Land Value = Total Property Value * Land Ratio - Limited reliability – use primarily as a check on other methods.
- C. Extraction Method
- Estimates land value by subtracting the depreciated cost of improvements from the total property value.
- Formula:
Land Value = Total Property Value - Depreciated Cost of Improvements - Requires accurate estimation of depreciation. Like allocation, is better as a check.
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D. Development Method (Subdivision Analysis)
- Estimates land value based on the potential profit from developing and selling subdivided lots.
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1. Steps:
- Determine the highest and best use for development (e.g., single-family homes).
- Develop a subdivision plan: lot layout, infrastructure, utilities.
- Estimate the total sales revenue from selling all lots.
- Estimate all development costs: construction, marketing, fees.
- Calculate the developer’s profit margin.
- Discount the future net cash flow back to the present value.
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2. Formulas:
- Total Revenue = (Number of Lots) * (Average Lot Sales Price)
- Total Cost = Development Costs + Marketing Costs + Fees
- Net Income = Total Revenue - Total Cost - Profit
- Present Value = Net Income / (1 + Discount Rate)^Years
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This is where plottage value and excess land become very relevant. If combining or subdividing land into different sized parcels will increase NPV, it should be accounted for here.
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E. Land Residual Method
- A type of income capitalization method where land value is the residual after accounting for the income attributable to the improvements.
- 1. Steps:
- Estimate the total net operating income (NOI) of the property.
- Estimate the value of the improvements.
- Determine an appropriate capitalization rate for the improvements.
- Calculate the income attributable to the improvements:
Income (Improvements) = Value (Improvements) * Cap Rate (Improvements) - Subtract the improvement income from the total NOI to find the income attributable to the land.
- Capitalize the land income to determine land value.
- 2. Formulas:
- Land Income = Total NOI - Income (Improvements)
- Land Value = Land Income / Cap Rate (Land)
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F. Ground Rent Capitalization
- Applies to leased land, where the land value is derived from the capitalized ground rent.
- Formula:
Land Value = Annual Ground Rent / Capitalization Rate - The capitalization rate must reflect the risk associated with the ground lease.
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G. Depth Tables
- Percentage tables used to estimate the value of land based on its depth.
- Assumes that the front portion of a lot is more valuable than the rear portion.
- Example: “4-3-2-1 Rule”: Front 25% of lot value=40%, second 25%=30%, third 25%=20%, rear 25%=10%.
- Should be used carefully, as specific use cases can change.
- Generally, they are outdated and rarely used due❓ to other methods being more accurate.
IV. Special Considerations
- A. Excess and Surplus Land
- Excess Land: Land that has the potential to be sold separately
- Surplus Land: Land that does not have the potential to be sold separately
- How to handle this with the various site valuation techniques
V. Conclusion
- Recap of the importance of accurate site valuation.
- Summary of the six techniques and their appropriate applications.
- Emphasis on ongoing market analysis and data collection to improve appraisal accuracy.
VI. Practice Problems
- Include several example problems demonstrating the different site valuation techniques.
- Provide step-by-step solutions and explanations.
VII. Review Questions
- Include multiple choice and short answer questions to assess understanding of the material.
I’ve tried to provide a structured and scientifically sound framework for the chapter. Remember to incorporate visual aids, examples, and case studies throughout the chapter to enhance understanding and engagement.
Chapter Summary
Site Valuation Techniques: A Scientific Summary
This summary encapsulates the core scientific principles, conclusions, and implications discussed in the chapter “Site Valuation Techniques” from the training course “Mastering income❓ property❓ Valuation: From Fundamentals to Advanced Techniques.” The central theme is the accurate and reliable valuation of sites (land prepared for use) as a crucial component of income property valuation.
Key Scientific Points:
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Highest and Best Use (HBU) Analysis: The foundation of site valuation is determining the HBU – the legally permissible, physically possible, economically feasible, and maximally productive use of the land. This analysis is vital, whether valuing a vacant site or as a step in evaluating improved properties. HBU guides the valuation process and ensures the property is assessed based on its most profitable potential. A careful appraisal requires analysis of both the HBU “as if vacant” and “as improved,” to determine the “true HBU”.
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The Interrelationship of Factors: HBU requires careful consideration of the interaction of legal, economic, and physical constraints that might alter a site’s use or value❓.
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Interim Use: It is important to determine any planned “interim uses” that occur while a property is awaiting it’s “true HBU”.
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Principle of Anticipation: market❓ value is affected by future benefits of ownership, therefore, long-term possibilities or restrictions❓ must be considered for property valuation.
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Principle of Consistent Use: This principle demands that land and improvements must be valued for the same use, which is the “true HBU” even if, as a result, income and costs are not comparable.
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Sales Comparison Approach Limitations: Accurate adjustments for differences among comparable properties are critical. Significant adjustments suggest a less reliable comparison.
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Data-Driven Valuation: Validations are made by careful collection and analysis of data for comparable sites and for existing or potential income streams. The appraisal process requires ongoing data review.
Conclusions and Implications:
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Accuracy of HBU is Paramount: The entire valuation process relies on the correctness of the HBU analysis. Errors at this stage invalidate subsequent steps and undermine the accuracy of value estimates.
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Context Matters: Valuation is not simply about the inherent characteristics of a site, but about its interaction with regional, community, and neighborhood factors.
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Site Valuation is Multifaceted: Different techniques are applicable depending on data availability, property type, and valuation goal. There’s no single “best” method❓.
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Sales Comparison Method is Preferred: As a reliable means of accurately assessing value, the Sales Comparison Method, which relies on an analysis of actual sales in the marketplace, is most often the ideal option for a property.
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Integration of Math: There are a wide variety of ways to apply and use math to assess a property. It may be necessary to use units of Area or Volume.
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Technology is Vital: Real estate professionals should keep on top of the newest technological advances, both those for appraisal specifically, and for organization generally.
Implications for Appraisal Practice:
- Due Diligence: Thorough research, data gathering, and verification are essential for accurate site valuation.
- Market Understanding: Appraisers must deeply understand the local real estate market, including legal, economic, and social conditions, trends, and expectations.
- Judgment and Experience: Site valuation is not a purely formulaic process. It requires skilled judgment to select and apply appropriate techniques, weigh the relative importance of various factors, and interpret the results.
- Transparency and Justification: Appraisers must clearly document and justify their assumptions, methodologies, and conclusions to ensure transparency and build confidence in the value estimates.
By understanding the underlying scientific principles, appraisers can confidently and competently apply the appropriate site valuation techniques, ensuring accurate and reliable property valuations.
