Site Valuation Techniques and Appraisal Math

Chapter 6: Site Valuation Techniques and Appraisal Math

Inclusion Rationale: This chapter is critical for appraisers of diverse property interests, as accurate site valuation underpins the cost approach for manufactured homes and prefabricated dwellings. understanding❓ how lease terms (for ground leases) affect site value is crucial, especially concerning timeshares and partial ownership interests, where site control and access are paramount. Mastering the building residual technique aids in assessing the impact of existing improvements on site value, particularly relevant for properties subject to HUD codes or unique market influences.

6.1 Introduction: The Scientific Foundation of Site Valuation

Site valuation, often perceived as an art, is fundamentally based on scientific principles, demanding rigorous application of economic theory, statistical analysis, and mathematical modeling. An accurate site valuation is essential for applications of the cost approach and the building residual technique, each critical components in value determination. The process requires understanding the interplay between market forces, land characteristics, and legal frameworks. In unique instances such as timeshares or partial ownerships, the appraiser’s understanding of ground leases and building residual technique would be paramount.

6.2 Highest and Best Use: The Cornerstone of Site Valuation

At the heart of site valuation lies the concept of Highest and Best Use (HBU). This principle, grounded in economic theory, dictates that a site’s value is determined by its most profitable, probable, and legally permissible use.

6.2.1 Defining Highest and Best Use

HBU is defined as the reasonably probable and legal use of a property that is physically possible, appropriately supported, financially feasible, and results in the highest value. This use must be:

1. Legally Permissible: Zoning regulations, building codes, and environmental regulations all influence the range of legally permissible uses.
2. Physically Possible: The site’s size, shape, topography, soil conditions, and access to utilities dictate the range of physically possible uses.
3. Financially Feasible: A proposed use must generate sufficient income to justify the costs of development and provide a reasonable return on investment. Economic principles of supply and demand drive this analysis.
4. Maximally Productive: Among all feasible uses, the HBU is the one that generates the highest net return or benefit, contributing the most to property value.

Mathematical Context:

• NPV (Net Present Value) Analysis: This calculation determines the current value of a proposed development project by discounting future cash flows.

  • Formula: NPV = Σ (CFt / (1+r)t) - Initial Investment

    Where:

    • CFt = Cash flow in period t
    • r = Discount rate (reflecting risk and opportunity cost)
    • t = Time period
    • IRR (Internal Rate of Return): Determines the discount rate at which the NPV of an investment becomes zero.

6.2.2 Highest and Best Use “As Vacant” vs. “As Improved”

The HBU must be analyzed considering both the site “as vacant” (assuming no existing improvements) and “as improved” (considering the existing structure). This distinction is critical when existing improvements do not align with the site’s full potential. Consider a manufactured home park on land potentially suitable for higher-density residential development.
In such cases, the cost of demolition or conversion must be factored into the “as vacant” analysis.

Example: A mobile home park currently generates a cash flow of $100,000. However, if vacant and redeveloped into a high-rise apartment, it could generate $500,000. Demolition costs are estimated at $150,000.

• Analysis: The optimal redevelopment requires more than just the cashflow difference as the decision to redevelop would need a deep-dive consideration of the Net Present Value of both options. A detailed feasibility study would be key for the appraiser to assess which path leads to a higher market value.

6.2.3 Interim Use and Legal Nonconforming Use:

• Interim Use: A temporary use employed while awaiting optimal redevelopment or market conditions (such as parking lots before office developments).
• Legal Nonconforming Use: An existing use that was legally established but no longer conforms to current zoning regulations. These uses may contribute to site value but also pose limitations.

6.2.4 Highest and Best Use Considerations for Diverse Property Interests

Timeshares: HBU considerations will have to factor legal restrictions on construction, and restrictions on the number of units per lot.
Manufactured Housing❓ Parks: HBU analysis needs to factor tenant relocation costs and the impact to cash flow during the conversion process.

6.3 Site Valuation Techniques: Scientific Application

Several methods can be employed to determine a site’s value. These techniques are applied with scientific rigor, relying on market data and statistical analysis to derive credible value opinions.

6.3.1 Sales Comparison Approach: Direct Market Analysis

This is the most reliable and widely used method. It relies on analyzing recent sales of comparable sites, adjusting for differences to arrive at an indication of value. This includes:

• Data Collection: Gather detailed information on comparable sales, including price, date of sale, location, physical characteristics (size, shape, topography), zoning, and permitted uses. Sources include sales records, MLS data, interviews with brokers and developers, and public records.
• Quantitative Adjustments: Apply adjustments for differences. This may involve statistical techniques such as regression analysis or paired sales analysis. For example, if comparable sales are available with and without a particular feature or location, an appraiser could calculate adjustments necessary.
• Elements of Comparison: This may include the market conditions at the time of sale.

Mathematical Application: Regression analysis can estimate the impact of variables (like size, location) on sales prices.

• Formula: Sales Price = b0 + b1(Size) + b2(LocationScore) + ε
  (Where b0 is the intercept, b1 and b2 are coefficients, and ε is the error term)

Example: Analyzing vacant land sales to value the site for a manufactured housing community.

• Data: 5 comparable sales with prices and characteristics.
• Adjustments: Calculate price per square foot, then adjust for lot size, access to utilities, and location relative to amenities (schools, shopping).

6.3.2 Allocation Method: Percentage-Based Allocation

The allocation method estimates land value as a percentage of the total improved property value. This method is based on historical ratios between land and improvement values in the market. While easy, this technique is simplistic and less reliable, primarily used for mass appraisals (e.g., tax assessments).

• Formula: Land Value = Total Property Value x Allocation Percentage

6.3.3 Extraction Method: Value Subtraction

This approach subtracts the depreciated cost of improvements from the total property value to derive the land value. Accurate cost estimating and depreciation analysis are crucial.

• Formula: Land Value = Total Property Value - Depreciated Cost of Improvements

6.3.4 Development Method (Subdivision Analysis): Discounting Future Revenue

This complex method estimates the value of raw land for subdivision. It involves projecting future lot sales revenue, subtracting development costs (infrastructure, marketing, etc.), and discounting the remaining cash flow back to present value.

• Detailed Feasibility Analysis:
  • Market Analysis: Project demand and absorption rates for the proposed lots.
  • Cost Estimation: Accurately estimate all development costs, including infrastructure, permits, marketing, and overhead.
  • Discount Rate Selection: Choose a discount rate that reflects the project’s risk and the time value of money.

• Discounted Cash Flow (DCF) Analysis: Project future cash flows from lot sales and development costs. Discount these cash flows to their present value using the selected discount rate.

  • Formula: Present Value = Σ (Cash Flowt / (1 + Discount Rate)t)

6.3.5 Land Residual Method: Income Capitalization of Residual Income

This technique separates the income streams generated by the land and the improvements on a property, then capitalizes the income attributable to the land to determine its value. It is primarily applicable when improvements represent interim uses.

• Income Allocation:
  • Estimate the Net Operating Income (NOI) generated by the property.
  • Determine the portion of the NOI attributable to the improvements by multiplying the improvement value by an appropriate capitalization rate (based on the risk associated with the building).
  • The remaining NOI is attributed to the land.

• Capitalization:

  • Divide the land income by the land capitalization rate to derive the land value.

  • Formula: Land Value = (NOI - (Improvement Value x Improvement Cap Rate)) / Land Cap Rate

6.3.6 Ground Rent Capitalization: Leasing Value Indicator

In instances involving ground leases, the capitalization of associated rents is another viable approach for estimating the value of leased land. The formula for assessing land value in relation to ground lease payments can be expressed as follows:

• Formula: Land Value = Annual Ground Rent / Capitalization Rate

6.3.7 Depth Tables: Apportioning Lot Value According to Depth

Depth tables help in the analysis and adjustment of value for sites where the depth of the site impacts utility or value of the land. This is most common in CBD (Central Business District) areas, or older urban areas, and is less common in newer developments.

6.4 Application of Site Valuation to Diverse Property Interests

Timeshares and Fractional Ownership: These properties often involve unique lease arrangements and access restrictions, necessitating meticulous analysis of legal documents and their impact on site value.
Manufactured Housing and Prefabricated Dwellings: Given their depreciating value, understanding and applying the cost approach to such properties is crucial and in turn, an accurate site value is key.
Ground Leases: These instruments are inherently complex as lease terms impact the value the land.
Partial Ownership Interests: Accurate site valuation plays a crucial role in assessing the value of partial ownership, as each owner can control part of the property and the associated value.

6.5 Appraisal Math in Site Valuation

Accurate mathematical calculations are vital. This includes:

• Area and Volume Calculations: For determining site size and building dimensions.
• Percentage Calculations: For allocation and adjustments.
• Capitalization Rate Calculations: For income capitalization methods.
• Discounted Cash Flow Analysis: For development methods, involving present value calculations.
• Statistical Analysis: Regression analysis for sales comparison, calculating adjustment amounts.

6.6 Risk Mitigation and Sensitivity Analysis

Site valuation is subject to uncertainty. Factors like zoning changes, environmental regulations, and market shifts can impact value. Sensitivity analysis is key:

• Assess the sensitivity of the final value to variations in key assumptions (discount rate, income projections, cost estimates).
• Analyze the potential impact of zoning changes or environmental regulations on site value.
• Communicate uncertainties and potential risks in the appraisal report.

6.7 Conclusion: Ethical and Competent Practice

Accurate site valuation requires rigorous data collection, a deep understanding of economic principles, scientific application of appropriate valuation techniques, and clear communication. This is foundational for appraisers who value diverse property interests, requiring specialized expertise to navigate complex real estate landscapes competently and ethically. The appraiser must always prioritize objectivity and avoid bias, ensuring credible and defensible value opinions.