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Site Valuation: Approaches and Techniques
Site Valuation: Approaches and Techniques
Chapter Description
Unlock the secrets of valuation! This course delves into the core principles of appraisal, clarifying the economic concept of “value.” Learn how value is an opinion, not a fact, and how it is always qualified by specific definitions, such as market value, liquidation value, or investment value. Master the crucial distinctions and gain a solid foundation for confident and informed appraisal practices. This chapter focuses on site valuation, covering its scientific underpinnings, practical techniques, and relevance to appraisal fundamentals.
I. Introduction to Site Valuation
A. Importance of Separate Site Valuation
A separate site valuation is critical in several appraisal methodologies and legal contexts. Understanding the underlying principles is essential for accurate and defensible appraisal opinions.
Relevance to Course Description
Site valuation, as discussed here, is a necessary component in determining the ultimate value.
This is an area that is critical for providing an opinion as to the value of the site.
B. When is a Separate Site Valuation Required?
- Cost Approach: Requires a separate estimate of site value as the foundation for determining the overall property value.
- Building Residual Technique (Income Capitalization): Similar to the cost approach, this technique necessitates a separate site valuation for isolating the value attributable to the improvements.
- Legal and Regulatory Requirements: Property tax assessments and condemnation appraisals often mandate separate site valuations by law. This aligns with the course description’s emphasis on appraisal practices in specific legal frameworks.
- Highest and Best Use Analysis: Determining the highest and best use of a property, as a basis for the appraisal, often requires analysis of the site as if vacant.
II. Scientific Theories and Principles Underlying Site Valuation
A. The Principle of Substitution
The principle of substitution is the cornerstone of site valuation, stating that a rational buyer will pay no more for a property than the cost of acquiring an equally desirable substitute. This principle directly influences the Sales Comparison Approach❓❓, as comparables are essentially substitutes for the subject site.
Equation:
Vs <= Cs, where:
Vs= Value of the subject siteCs= Cost of an equally desirable substitute site.
B. Supply and Demand Dynamics
Site value is fundamentally affected by supply and demand. A scarce and desirable site in high demand will command a higher price than a similar site in an area with abundant land supply and low demand.
Explanation
- When demand exceeds supply, site values tend to increase.
- When supply exceeds demand, site values tend to decrease.
C. Contribution
The value of a site is directly related to its contribution to the overall value of the improved property. This is crucial in residual techniques, where the site’s value is determined by the income it generates or the cost savings it offers.
D. Anticipation
Site value reflects the present worth of future benefits anticipated from its use. This principle is particularly important in development scenarios, where future income streams determine the site’s current worth.
E. Externalities
External factors, both positive (e.g., proximity to amenities) and negative (e.g., environmental hazards), can significantly impact site value. These external influences must be carefully analyzed and quantified.
F. Land Economics
A branch of economics, land economics considers the scarcity of land and its impact on supply, demand, and value.
III. Site Valuation Approaches and Techniques
A. Sales Comparison Approach
The sales comparison approach is the most reliable method when sufficient data is available. It involves analyzing sales of comparable sites and adjusting their prices to account for differences with the subject site.
Practical Application
- Data Collection:
- Gather data on recent sales of comparable sites (e.g., size, location, zoning).
- Verify sales information (e.g., financing terms, conditions of sale).
- Elements of Comparison:
- Property Rights Conveyed: Adjust for any differences in property rights (e.g., fee simple vs. leasehold).
- Financing Terms: Adjust for below-market financing or seller concessions.
- Conditions of Sale: Eliminate sales that were not “arm’s length” transactions.
- Market Conditions: Adjust for changes in market conditions since the comparable sale (time adjustment).
- Location: Adjust for differences in location (e.g., proximity to amenities, traffic).
- Physical Characteristics: Adjust for differences in size, shape, topography, soil conditions, and environmental issues.
- Zoning and Permitted Uses: Account for different zoning regulations.
- Adjustment Process:
- Make adjustments to the comparable sales prices❓❓ based on the identified differences.
- Ensure that the adjustments reflect market participants actions.
- Value Indication:
- Reconcile the adjusted sales prices to arrive at an indicated value for the subject site.
Mathematical Formula:
Subject Value = Comparable Sales Price +/- Adjustments
Vs = Cp +/- A1 +/- A2 +/- ... +/- An, where:
Vs= Value of the subject siteCp= Sales price of the comparable siteA1, A2, ..., An= Adjustments for differences in elements of comparison
Example:
Comparable property sold for \$200,000, but its size is 10% smaller than the subject site. If the market indicates that a 1% increase in size would add \$1000 in value, the indicated value of the subject site would be:
Vs = \$200,000 + (10 x \$1000) = \$210,000
B. Allocation Method
The allocation method assumes that the site value represents a consistent percentage of the total property value. This technique is most useful when there are numerous sales of improved properties but limited data on vacant land sales.
Practical Application
- Determine the ratio: Calculate the typical ratio of site value to total property value in the area.
- Apply the ratio: Multiply the total value of the improved property by the established ratio to estimate site value.
Mathematical Formula:
Vs = Vp * R, where:
Vs= Value of the subject siteVp= Total value of the improved propertyR= Ratio of site value to total property value
Example
An improved property is valued at \$500,000. If comparable properties have a site-to-total-value ratio of 20%, the allocated site value is:
Vs = \$500,000 * 0.20 = \$100,000
C. Extraction Method
The extraction method involves subtracting the depreciated cost of the improvements from the total property value to estimate the site value. This approach is useful when there are limited vacant land sales and the improvements can be accurately valued.
Practical Application
- Estimate total property value: Use sales comparison or income capitalization to estimate the total value of the improved property.
- Estimate improvement cost: Estimate the replacement cost new of the improvements.
- Calculate depreciation: Estimate the accrued depreciation of the improvements.
- Subtract depreciation: Subtract the depreciation amount from the replacement cost new to estimate the current value of the improvements.
- Calculate site value: Subtract the depreciated value of the improvements from the total property value to estimate site value.
Mathematical Formula:
Vs = Vp - Vi, where:
Vs= Value of the subject siteVp= Total value of the improved propertyVi= Depreciated value of the improvements
Example
The total value of an improved property is \$600,000. The replacement cost of the building is estimated at \$400,000, and the accrued depreciation is \$50,000. The extracted site value is:
Vs = \$600,000 - (\$400,000 - \$50,000) = \$600,000 - \$350,000 = \$250,000
D. Land Residual Method
The land residual method separates the total net operating income (NOI) of a property into components attributable to the land and the improvements, and then capitalizes the income attributable to the land to estimate its value.
Practical Application
- Estimate total NOI: Estimate the net operating income of the property.
- Estimate improvement value: Estimate the value of the improvements.
- Capitalize improvement value: Determine a capitalization rate appropriate for the improvements, and multiply the improvement value by this rate to estimate the income attributable to the improvements.
- Calculate residual income: Subtract the income attributable to the improvements from the total NOI to find the income attributable to the land.
- Capitalize land income: Determine a capitalization rate appropriate for the land, and divide the income attributable to the land by this rate to estimate land value.
Mathematical Formula:
Ii = Vi * Ri, where:Ii= Income attributable to the improvementsVi= Value of the improvementsRi= Capitalization rate for the improvements
Il = NOI - Ii, where:Il= Income attributable to the landNOI= Net operating incomeIi= Income attributable to the improvements
Vs = Il / Rl, where:Vs= Value of the siteIl= Income attributable to the landRl= Capitalization rate for the land
Example:
A property generates an NOI of \$80,000. The improvement value is \$500,000, and the improvement cap rate is 8%. The land cap rate is 6%.
Ii = $500,000 * 0.08 = $40,000Il = $80,000 - $40,000 = $40,000Vs = $40,000 / 0.06 = $666,667
E. Ground Rent Capitalization
This technique is used when the site is leased under a ground lease, where the tenant leases the land and constructs improvements. The site value is estimated by capitalizing the ground rent.
Practical Application
- Determine ground rent: Calculate the annual ground rent paid by the tenant.
- Determine capitalization rate: Determine an appropriate capitalization rate for ground rents in the area.
- Capitalize ground rent: Divide the annual ground rent by the capitalization rate to estimate site value.
Mathematical Formula:
Vs = GR / R, where:
Vs= Value of the subject siteGR= Annual ground rentR= Capitalization rate
Example
The annual ground rent for a site is \$30,000, and the capitalization rate is 7%. The site value is:
Vs = \$30,000 / 0.07 = \$428,571
F. Development Method
This method is used to value land for a prospective development project. It involves estimating the future revenue from the project and subtracting all development costs to arrive at the residual land value.
Practical Application
- Estimate development costs: Estimate the total costs to develop the site, including construction, financing, marketing, and professional fees.
- Estimate revenue: Estimate the revenue from the sale or lease of the developed project.
- Calculate profit: Calculate the developer’s profit or entrepreneurial incentive, typically a percentage of the total project cost.
- Subtract total costs: Subtract total costs (including profit) from the projected revenue to arrive at the residual land value.
Mathematical Formula:
Vs = PVr - PVc, where:
Vs= Value of the subject sitePVr= Present value of the project’s revenuesPVc= Present value of the project’s costs (including profit)
This often requires discounted cash flow (DCF) analysis, which is beyond the scope of this chapter, but can be calculated using computer programs or financial calculators.
IV. Reconciliation and Final Value Estimate
After applying multiple site valuation methods, the appraiser must reconcile the value indications to arrive at a final value estimate.
A. Weighing the Indicators
- Consider the reliability and relevance of each method.
- Give greater weight to the method with the most credible data and the closest alignment with the subject property.
- Consider the course description concepts: “value is an opinion, not a fact”.
B. Final Estimate
- Provide a clear and well-supported rationale for the final site value estimate.
- Ensure that the final estimate aligns with the definition of value being sought (e.g., market value).
- Document the entire process thoroughly in the appraisal report.
V. Conclusion
Site valuation is a critical component of the appraisal process, with distinct methodologies and techniques. A strong scientific foundation, careful data collection, diligent analysis, and well-reasoned judgment are essential for generating credible and defensible site value estimates. Mastering these skills will enhance the appraiser’s ability to “unlock the secrets of valuation” and provide confident and informed appraisal practices, aligning with the core objectives of the “Understanding Value: Appraisal Fundamentals” course.
Chapter Summary
Scientific Summary: Site Valuation: Approaches and Techniques
This chapter summary for “Site Valuation: Approaches and Techniques,” within the broader training course “Understanding Value: Appraisal Fundamentals,” focuses on method❓s for determining land value, emphasizing its importance in appraisal practices. The chapter ties directly to the course description by clarifying how value, an opinion grounded in specific definitions❓ and techniques, can be rigorously assessed for sites. It builds upon the foundational understanding of “value” presented earlier in the course.
Main Scientific Points and Conclusions:
- Highest and Best Use (HBU): The core principle underpinning site valuation. HBU is defined as the legally permissible, physically possible, economically feasible, and maximally productive use that yields the highest present value. Understanding HBU guides appraisers in valuing both vacant and improved properties. The principle of anticipation suggests that property is valued in light of its future possible uses.
- HBU Analysis: Involves a process of elimination, considering legal, physical, and economic constraints. The analysis also differentiates between HBU as if vacant and HBU as improved, highlighting the impact of existing improvements. True HBU is the use (vacant or improved) that yields the highest value, factoring in demolition costs if applicable.
- Principle of Consistent Use: Dictates that land and improvements must be appraised for the same use, aligning with the determined HBU.
- Site Characteristics: The chapter outlines essential characteristics influencing site value, including location, size, shape, topography, soil conditions, access to utilities, zoning, and any potential environmental hazards.
- Six Methods of Site Valuation:
- Sales Comparison Method: The preferred and most reliable approach. Involves analyzing sales of comparable vacant parcels, making adjustments for differences in property rights, financing, sale conditions, market conditions, location, and physical characteristics. Adjustments are applied to the comparable sales prices.
- Allocation Method: Estimates land value based on a typical ratio between land value and total property value. Less reliable due to its inherent inaccuracy and dependence on market data.
- Extraction Method: Derives land value by subtracting the depreciated❓ cost of improvements from the total property value. Relies on accurate estimation of improvement value.
- Development Method (Subdivision Analysis): Analyzes the costs of developing raw land into finished lots. Future net cash flows from lot sales are discounted to arrive at the present land value.
- Land Residual Method: A capitalization technique that isolates the income attributable to the land and capitalizes it to derive land value.
- Ground Rent Capitalization Method: Applies income capitalization to ground rent payments to estimate land value.
- Depth Tables: Shows the additional value for additional depth. While there are complex mathematical tables, a simple evaluation method is the “4-3-2-1 Method.”
Implications and Relevance to Course Description:
- Value as an Opinion: The chapter reinforces that valuation is an opinion, not a fact, by detailing the subjective nature of HBU analysis and the appraiser’s judgment in selecting and applying valuation methods.
- Specific Definitions of Value: The chapter highlights how the definition of value (e.g., market value) influences the choice of valuation methods and the interpretation of data. It emphasizes the need for a clear definition to guide the appraisal process.
- Crucial Distinctions: The distinction between HBU as if vacant and HBU as improved is crucial for understanding how existing improvements can both contribute to and detract from overall property value. This understanding directly impacts appraisal practices.
- Solid Foundation for Appraisal Practices: By mastering these site valuation approaches and techniques, students gain a solid foundation for confident and informed appraisal practices. The ability to accurately value land is essential for various appraisal scenarios, including cost approach applications, tax assessments, and development feasibility studies.
- Practical Application Appraisers are provided tools such as the use of mobile technology to improve the valuation process.
In conclusion, this chapter provides a comprehensive overview of site valuation principles and techniques, equipping trainees with the knowledge and skills necessary to accurately assess land value within the framework of established appraisal standards and ethical considerations. The importance of data collection, analysis, and the appraiser’s judgment are emphasized throughout, reinforcing the core principles of the “Understanding Value” course.
