Site Valuation Techniques: A Comprehensive Approach

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Chapter 6: Site Valuation Techniques: A Comprehensive Approach

Introduction

In the dynamic realm of real estate valuation, accurately determining the value of a site, independent of any improvements, is a cornerstone skill. This chapter delves into the science and methodologies of site valuation, providing a comprehensive approach essential for mastering income capitalization, residual techniques, and yield analysis – the core elements of this course. As emphasized in the course description, this is about unlocking the power of real estate valuation and elevating your appraisal skills to maximize investment potential. Site valuation forms the foundation upon which the residual techniques for isolating land and building values are built. In certain cases of high land value coupled with older improvements (often a change in use for the property is indicated) careful consideration of the Site value and demolition costs needs to be considered.

6.1 The Significance of Separate Site Valuation

A separate site valuation is not merely an academic exercise; it is a crucial step in several valuation methodologies, particularly when the highest and best use of a site is different from its current improvements and must be carefully analyzed to determine the most profitable path. The book content establishes the following reasons for site valuation:

• Cost Approach: As detailed in Chapter 8, the cost approach relies on estimating the site value separately from the improvements. The formula is:

  Property Value = Site Value + Cost (New) of Improvements – Depreciation
  * Building Residual Technique: (Chapter 10) of income capitalization also mandates a separate site valuation.
  * Legal/Statutory Requirements: Property tax assessments and eminent domain proceedings frequently require independent site valuations.
  * Highest and Best Use Analysis: Site value is the starting point for determining how property should be optimally used.

This chapter builds upon this by exploring the theoretical underpinnings and practical techniques for such valuations.

6.2 Theoretical Framework: Highest and Best Use (HBU) as Foundation

The cornerstone of site valuation is the concept of Highest and Best Use (HBU). This principle dictates that a site’s value is directly linked to its most profitable, legally permissible, physically possible, and financially viable use. understand❓ing HBU is essential for this course and has major implications to the income capitalization: residual techniques and yield analysis described in the course description.
Note: Highest and best use may need to be calculated “As is” and “As if vacant.”

• 6.2.1 Components of HBU:

  1. Legally Permissible: Zoning ordinances, building codes, environmental regulations, and private restrictions (e.g., deed restrictions, easements) all influence what uses are legally allowable.
  2. Physically Possible: The site’s size, shape, topography, soil composition, drainage, access to utilities, and environmental conditions determine what types of development are physically feasible.
  3. Financially Feasible: A potential use must generate sufficient income or return on investment (ROI) to justify the costs of development and operation. This requires market analysis, cost estimation, and income projection.
  4. Maximally Productive: Among all feasible uses, the HBU is the one that maximizes the site’s present value. This requires considering the time value of money and the compounding and reversion factors outlined in the course description.

• 6.2.2 The Principle of Anticipation: HBU is not static. Appraisers must consider anticipated future changes in zoning, market conditions, and infrastructure that could influence the site’s most profitable use. This is where yield capitalization methods for long-term investment analysis become critical.

6.3 Site Valuation Methodologies: A Scientific Approach

Several methodologies are used to estimate site value, each with its strengths and weaknesses.

• 6.3.1 Sales Comparison Approach (SCA): Direct Market Analysis

  • Principle: The most reliable method when sufficient comparable sales data exist. Based on the principle of substitution (a prudent investor will pay no more for a property than the cost of acquiring an equally desirable substitute).

  • Process:

    1. Identify Comparable Sales: Locate recently sold, vacant sites that are similar to the subject property in terms of location, zoning, size, topography, access, utilities, and development potential.
    2. Verify Data: Confirm the sales prices, dates of sale, and terms of the transactions with reliable sources (e.g., real estate brokers, county records).

    3. Analyze Elements of Comparison: Identify key differences between the comparable sales and the subject property that could influence value. This may include:

       • Property Rights Conveyed: Fee simple, leasehold, easements, etc.
       • Financing Terms: Cash, seller financing, below-market interest rates.
       • Conditions of Sale: Arm’s-length transaction, motivated buyer/seller.
       • Expenditures Immediately After Sale: Costs to remediate, legal fees.
       • Market Conditions: Changes in market values over time.
       • Location: Access to amenities, proximity to transportation, school districts, neighborhoods, location characteristics (such as views) etc.
       • Physical Characteristics: Size, shape, topography, soil conditions, drainage.
       • Economic Characteristics: The type of property permitted to be improved.

    4. Adjust Comparable Sales Prices: Make quantitative adjustments to the comparable sales prices to account for the differences identified in step 3. Adjustments can be in the form of dollars or percentages.

    5. Reconciliation: Analyze the adjusted sales prices and reconcile them to arrive at an estimated value for the subject site. Give the most weight to comparables that are the most similar to the subject property and require the fewest adjustments.
       • Mathematical Representation:

    • Adjusted Sales Price (Comparable i) = Sales Price (Comparable i) ± ∑(Adjustment Factor j)

      Where:
      * i = Comparable sale number
      * j = Element of comparison (e.g., location, size)
      * Practical Application:
      An appraiser finds three comparable land sales in close proximity to the subject property. The sales prices, time of sale, and site sizes are shown in the table below.

The adjusted sale prices for the comparable sales range from \$95,000 to \$110,500. Based on the appraiser’s professional judgment, the reconciled value of the subject property is \$105,000.
This example involves an economic characteristic: size of improvement.

• 6.3.2 Allocation Method: Ratio Analysis

  • Principle: This method allocates a portion of the total improved property value to the land based on a typical ratio observed in the market.

  • Process:

    1. Research market data to determine the typical land-to-value ratio for similar properties in the subject area.
    2. Estimate the total value of the subject property (land + improvements) using other valuation methods (e.g., sales comparison, income capitalization).
    3. Multiply the total property value by the land-to-value ratio to estimate the site value.
       • Mathematical Representation:
    • Site Value = Total Property Value × Land-to-Value Ratio
      • Practical Application: An appraiser determines that a \$500,000 house, the lot comprises 20% of the total value based on market data. Then, the site value is estimated to be \$100,000 (500,000 * 0.20).
      • Limitations: This method is less precise than the SCA because it relies on market averages rather than direct analysis of comparable sales. This should be considered secondary to the Sales Comparison Approach.

• 6.3.3 Extraction Method: Value Subtraction

  • Principle: This method estimates site value by subtracting the depreciated cost of the improvements from the total property value.

  • Process:

    1. Estimate the total value of the improved property using sales comparison or income capitalization.
    2. Estimate the cost (new) of the existing improvements.
    3. Estimate the accrued depreciation of the improvements (physical deterioration, functional obsolescence, external obsolescence).
    4. Subtract the depreciated cost of the improvements from the total property value to estimate the site value.

  • Mathematical Representation:

    • Site Value = Total Property Value - (Cost (New) of Improvements – Accrued Depreciation)

  • Practical Application: An appraiser estimates that an improved property is worth \$750,000. The cost (new) of the improvements is \$600,000, and the accrued depreciation is \$100,000. Site value is estimated to be \$250,000.

  • Limitations: Accuracy hinges on reliable cost and depreciation estimates. This method is best suited for properties where the improvements are relatively new or contribute minimally to the overall value.
    Note: “Accrued Depreciation” can be quite difficult to determine due to the many variables affecting value that are outside the realm of normal depreciation.

• 6.3.4 Development Method: Future Value Discounting

  • Principle: Used for valuing land that is ripe for development. It estimates the present value of the land based on the projected future sales prices of the developed lots, less all development costs, and compounded discount factor for the project.

  • Process:

    1. Determine the HBU of the site (e.g., residential subdivision, commercial development).
    2. Prepare a detailed development plan, including the number of lots or units, the size of each lot/unit, the projected sales prices, and the absorption rate (the rate at which the lots/units will be sold).
    3. Estimate all development costs, including construction, infrastructure, marketing, legal fees, and financing costs.
    4. Project the future cash flows from the sale of the developed lots/units, considering the absorption rate and the development costs.
    5. Select an appropriate discount rate❓❓ to reflect the risk and time value of money. (This is critical and relates directly to the course description regarding yield analysis).
    6. Discount the projected future cash flows back to their present value to estimate the site value.
       • Mathematical Representation:

    • Site Value = ∑ (Net Cash Flowt / (1 + r)^t) – Initial Investment

      Where:
      * Net Cash Flowt = Projected cash flow in period t
      * r = Discount rate
      * t = Time period
      * Practical Application: A developer plans to subdivide a 10-acre parcel into 20 residential lots. The projected sale price per lot is \$200,000. Development costs are estimated at \$1 million. The developer expects to sell all lots within 2 years and uses a discount rate of 10%. The site value is calculated by discounting the projected cash flows back to their present value.
      * Limitations: This method is highly sensitive to the accuracy of the projected sales prices, development costs, absorption rate, and discount rate. Requires specialized knowledge and experience in real estate development.

• 6.3.5 Land Residual Technique: Income Attribution

  • Principle: Based on income capitalization, this method isolates the income attributable to the land and capitalizes it to determine site value.

  • Process:

    1. Estimate the total net operating income (NOI) of the property (land + improvements) using income capitalization techniques (Refer to the course description of income capitalization for more guidance).
    2. Estimate the value of the improvements using the cost approach or sales comparison approach.
    3. Select an appropriate capitalization rate for the improvements.
    4. Calculate the income attributable to the improvements by multiplying the improvement value by the improvement capitalization rate.
    5. Subtract the income attributable to the improvements from the total NOI to determine the income attributable to the land.
    6. Select an appropriate capitalization rate for the land (may differ from the improvement capitalization rate).
    7. Capitalize the income attributable to the land using the land capitalization rate to estimate the site value.
       • Mathematical Representation:
    • Site Value = (Total NOI - (Improvement Value × Improvement Cap Rate)) / Land Cap Rate

  • Practical Application: A commercial property generates an NOI of \$100,000. The value of the building is estimated to be \$800,000. The building cap rate is 8%. The land cap rate is 6%. The site value is calculated as: (\$100,000 - (\$800,000 * 0.08)) / 0.06 = \$600,000.

  • Limitations: Requires accurate estimates of NOI, building value, and capitalization rates. Highly sensitive to small changes in these variables.

• 6.3.6 Ground Rent Capitalization: Lease Analysis

  • Principle: Estimates site value by capitalizing the ground rent paid under a long-term land lease.
  • Process:
    1. Obtain information on the ground rent paid under a long-term land lease for the subject property or comparable sites.
    2. Analyze the terms of the lease, including the lease term, any rent escalation clauses, and any renewal options.
    3. Select an appropriate capitalization rate for the ground rent based on market data and the risk associated with the lease.
    4. Capitalize the ground rent using the capitalization rate to estimate the site value.

  • Mathematical Representation:

    • Site Value = Ground Rent / Capitalization Rate

  • Practical Application: A parcel of land is leased for \$20,000 per year. The appraiser estimates that the appropriate capitalization rate for the leased property is 8%. Site value is calculated as \$20,000 / 0.08 = \$250,000.

  • Limitations: Accuracy depends on the stability and reliability of the ground rent and the appropriateness of the capitalization rate.

• 6.3.7 Depth Tables: Allocation By Location within Site

  • Principle: The rear portion of the lot is less valuable than the front portion. These depth tables are often utilized to break out lot values.

  • Process: This method is normally employed in an absence of more direct market sales comparison support.

    1. Calculate “front foot” value using SCA (or another method)
    2. Determine what percentage of value is associated with each portion of the lot
    3. Multiply “front foot” value by percentages from step 2 to value the site.

  • Mathematical Representation:

    • 4-3-2-1 table allocation:
    • 1st ¼ = 40% of Value
    • 2nd ¼ = 30% of Value
    • 3rd ¼ = 20% of Value
    • 4th ¼ = 10% of Value

  • Practical Application:

    • Site is 100 feet in depth, and front-foot valuation is 100. Calculation of value per quarter lot section is:
    • 1st section (0-25 ft): $4,000
    • 2nd section (25-50ft): $3,000
    • 3rd section (50-75 ft): $2,000
    • 4th section (75-100 ft): $1,000

  • Limitations: Best suited for the most simple site valuations. As such, it should not be used if better information and methods are available

6.4 Reconciling Site Value Indicators

As with any appraisal process, multiple valuation methods often yield different value indicators. The final step is to reconcile these indicators, giving the most weight to the method that is most reliable and applicable to the specific property and market conditions. In many cases, this will be the sales comparison approach, especially when adequate comparable sales data exists.

6.5 Conclusion

accurate site valuation❓ is a critical skill for real estate professionals. By mastering the theoretical principles and practical methodologies outlined in this chapter, you can unlock the power of real estate valuation, make informed decisions, and maximize your investment potential, as highlighted in the course description. The thorough site valuation builds a strong foundation for residual techniques and yield analysis that will be explored in later chapters.
The key to success is to understand the limitations of each valuation method and to apply them judiciously, reconciling the results to arrive at a well-supported and defensible opinion of site value.

I hope this chapter is a useful and detailed addition to the course. Let me know if you’d like anything changed.