Site Valuation Methods

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Chapter 6: Site Valuation Methods

I. Introduction: The Significance of Site Valuation

In the realm of property valuation, the accurate assessment of a site’s worth stands as a cornerstone of reliable appraisal practices. A dedicated site valuation is frequently performed for a number of reasons. In particular, the cost approach❓❓ to value and the building residual technique of income capitalization both require a separate estimate of site value. In cases involving property tax assessment and condemnation, a distinct site evaluation may be legally mandated. Site valuation plays a crucial role in appraisal techniques and legal contexts.

II. Highest and Best Use (HBU) Analysis: A Foundational Principle

A. Defining Highest and Best Use
The highest and best use (HBU) is a crucial concept underpinning site valuation. It represents the most probable use of a property that is:

• Legally Permissible: Compliant with all relevant zoning ordinances, building codes, environmental regulations, and other legal restrictions.
• Physically Possible: Feasible given the site’s size, shape, topography, soil conditions, access, and other physical characteristics.
• Economically Feasible: Likely to generate sufficient income or utility to justify the costs of development or operation.
• Maximally Productive: Among all legally permissible, physically possible, and economically feasible uses, the one that yields the highest present value to the property owner.

B. HBU as a Constraint Optimization Problem
HBU can be conceptualized as a constraint optimization problem. The objective function is to maximize property value (V), subject to constraints related to legal (L), physical (P), and economic (E) feasibility:

Maximize V(Use) subject to L(Use) ≤ 0, P(Use) ≤ 0, E(Use) ≤ 0

Where:

• V(Use): Property value as a function of the proposed use.
• L(Use): Legal constraints violation function. A negative value indicates compliance.
• P(Use): Physical constraints violation function. A negative value indicates compliance.
• E(Use): Economic constraints violation function. A negative value indicates economic feasibility.

C. The Interplay of Vacant vs. Improved Site

The HBU analysis must separately consider the land as if vacant versus the property as improved. The HBU as vacant may differ from the current HBU as improved. The decision to continue the existing use or redevelop is dictated by whichever maximizes value.

• HBU as Vacant: Considers the most profitable use assuming the site is cleared of existing improvements.
• HBU as Improved: Considers the incremental value of existing improvements and the cost of demolition to determine the optimal course of action.

D. Interim Use and Consistent Use

• Interim Use: A temporary HBU while waiting for market conditions or regulatory changes to make a more profitable use feasible.
• Principle of Consistent Use: The land and improvements must be valued under the same HBU scenario. This principle is crucial for avoiding valuation errors.

E. Excess Land vs. Plottage

• Excess Land: Land exceeding what’s needed for the HBU. It may have a separate HBU and value.
• Plottage: Incremental value created by combining two or more parcels, allowing for a more productive use.

III. Site Valuation Methods: A Comparative Analysis

A. Sales Comparison Approach (SCA): The Primary Method

1. Principle: The value of the subject site is indicated by the sales prices of comparable sites, adjusted for differences.
2. Data Sources: Public records, MLS, commercial data providers (e.g., CoreLogic, FNC), real estate professionals, land developers.

3. Elements of Comparison:

   • Real Property Rights Conveyed: Adjustments for fee simple vs. leasehold interests, easements, deed restrictions.
   • Financing Terms: Adjustments for below-market financing, seller concessions. Calculate the present value of the financing advantage to determine the required adjustment.
   • Conditions of Sale: Adjustments for non-arm’s length transactions, distressed sales.
   • Expenditures Immediately After Sale: Adjustments for required remediation, demolition costs (negative adjustments).
   • Market Conditions: Adjustments for changes in value over time. Employ trend analysis, repeat sales analysis, or paired sales analysis to quantify market movements. A simple linear model is:
     Adjustment = (Time Difference) * (Monthly Appreciation Rate)
   • Location: Adjustments for neighborhood amenities, proximity to undesirable features, access, and other locational factors. Use paired sales analysis or statistical techniques to isolate the value contribution of location attributes.
   • Physical Characteristics: Adjustments for size, shape, topography, soil conditions, frontage, and other physical attributes. Depth tables can be useful for adjusting for lot depth, though their accuracy is limited.
   • Economic Characteristics: Adjustments for development potential, zoning, and other economic factors.

4. Comparable Sale Price Adjustments: Apply adjustments consistently and transparently. Document the rationale for each adjustment.

B. Allocation Method

1. Principle: Estimate land value by allocating a percentage of the total property value to the land component.

2. Formula:

   Land Value = (Total Property Value) * (Land Value Ratio)
   3. Limitations: Ratios can be imprecise, and may not reflect the unique characteristics of the subject property. This method is best used to support a more robust valuation from the sales comparison approach.

C. Extraction Method

1. Principle: Estimate land value by subtracting the depreciated cost of the improvements from the total property value.

2. Formula:

   Land Value = (Total Property Value) - (Depreciated Cost of Improvements)
   3. Depreciation Estimate: This method hinges on an accurate assessment of accrued depreciation (physical deterioration, functional obsolescence, and external obsolescence). Detailed cost manuals and depreciation models are required.
   4. Limitations: Accuracy depends on reliable cost and depreciation estimates. This method is most reliable when improvements are relatively new or have a small impact on total value.

D. Development Method (Subdivision Analysis)

1. Principle: Estimate land value by subtracting all development costs (including profit) from the projected gross sales revenue of the completed development.

2. Discounted Cash Flow (DCF) Analysis: This method requires a detailed DCF analysis to account for the time value of money.

   Land Value = Σ [Net Cash Flow / (1 + Discount Rate)^t]

   Where:

   • Net Cash Flow: Projected sales revenue less development costs in period t.
   • Discount Rate: The required rate of return on the investment.
   • t: Time period (e.g., year).
     3. Key Considerations: Market absorption rates, construction costs, marketing costs, regulatory hurdles, and a realistic discount rate are critical inputs for this method.
     The higher the risk, the greater the rate of return required by the investor and greater the discount rate.

E. Land Residual Method

1. Principle: Estimate land value by allocating a portion of the property’s net operating income (NOI) to the improvements, and capitalizing the remaining income to the land.

2. Formulas:

   • Income Attributable to Improvements = (Building Value) * (Building Capitalization Rate)
   • Income Attributable to Land = (Total NOI) - (Income Attributable to Improvements)
   • Land Value = (Income Attributable to Land) / (Land Capitalization Rate)
     3. Capitalization Rates: These should be extracted from market data on similar properties.
     4. Limitations: This method is highly sensitive to the accuracy of income projections, capitalization rates, and the estimate of building value.

F. Ground Rent Capitalization

1. Principle: Estimate land value by capitalizing the ground rent paid under a long-term lease.

2. Formula:

   Land Value = (Ground Rent) / (Capitalization Rate)
   3. Lease Terms: The terms of the ground lease are crucial. Adjustments may be needed for rent escalations, renewal options, and other lease provisions.
   4. Capitalization Rate: Selected based on market data for ground leases with similar risk profiles.

G. Depth Tables

1. Principle: Apply pre-determined percentages to reflect the value of portions of land.
2. Limitations: Highly subjective, relies on percentages not directly tied to the specific market.
3. When used: Used for quick assessments, generally do not support valuation.

IV. Reconciliation and Final Value Estimate

After applying multiple site valuation methods, reconcile the value indications to arrive at a final value estimate. Give the greatest weight to the most reliable methods and data. Document the rationale for the final value conclusion.

V. Practical Applications and Related Experiments

A. Market Research Experiment
The most reliable method for determining the value of land requires an appraiser to obtain and verify comparables.
The most common, convenient, and effective means to do this is to examine the history of sales within an appropriate amount of time of comparables that most closely resemble the target property.

B. Highest and Best Use Sensitivity Analysis
As seen above, one of the most critical components for an accurate appraisal and land valuation is the assessment of the most legally, physically, and economically feasible and maximally productive use.
While an analyst may believe their decision on the ideal use and value is sound, the sensitivity of that result should be tested by varying the factors that feed into that decision, to analyze how drastically or trivially the output is affected.

C. Financial Modeling of Subdivision Potential
As previously stated, a proper analysis of land value through discounted cash flow requires an analyst to thoroughly review and test every input.
It may be more practical to test these factors in a vacuum before adding them to the large model, to more thoroughly assess how influential they may be on the end-result and value of the assessment.

D. Depth Table Analysis
While previously described as highly subjective, the method for assessing value via depth tables can be improved by analyzing a statistically significant range of depth:value tables that have been compiled from various sources throughout history.
This would improve a reviewer’s confidence in the outcome to a degree, but could not replace an individualized analysis of the target property’s characteristics and relevant markets.

VI. Conclusion

Accurate site valuation is essential for sound real estate appraisal and decision-making. A thorough understanding of HBU analysis and the various site valuation methods is crucial for appraisers to develop credible and reliable value opinions.

VII. Chapter Quiz (As provided in your template)

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