Site Valuation Methods

## Site Valuation Methods: A Scientific Introduction

In the dynamic landscape of real estate appraisal, accurate site valuation stands as a cornerstone for informed decision-making. Within the broader framework of the Cost Approach to Value, detailed in this training course, this chapter delves into the methodologies employed to determine the independent value of a site, divorced from the improvements upon it. This separation is crucial, not only for the Cost Approach itself, as highlighted in the accompanying book content, but also for legal and regulatory compliance in areas such as property tax assessment and condemnation proceedings. The scientific importance of site valuation stems from its role in providing a verifiable foundation for property value estimations, ensuring transparency and objectivity in the appraisal process. Accurately establishing the site value isolates the contribution of the land itself, facilitating a more precise understanding of the factors driving overall property value.

The application of the Cost Approach, a focal point of this course, necessitates a clear understanding of site valuation techniques. This approach operates on the principle that a property's value is the sum of the site's value and the depreciated cost of the improvements. As emphasized in the book content provided, the appraiser must arrive at an independent estimate of what it would cost to replace any existing structures, and adds this amount to the site value. Without a robust and scientifically sound method for determining site value, the Cost Approach becomes inherently subjective and prone to inaccuracies. By mastering site valuation, the appraiser can more accurately estimate depreciation and arrive at a more reliable final value indicator.

Furthermore, understanding site valuation is paramount for sound investment decisions. As this course aims to equip you with the ability to make informed investment decisions, knowledge of the fundamentals to estimate the site value is key. The book content emphasizes its role in specific techniques such as the building residual technique of income capitalization.

This chapter aims to provide a comprehensive understanding of several site valuation methods, empowering you to select and apply the most appropriate technique for a given appraisal assignment. Through this chapter, you will:

1.  **Understand the principles underpinning site valuation:** Delve into the concept of Highest and Best Use, a cornerstone of valuation theory that dictates how a site should be utilized to maximize its value.
2.  **Master various site valuation techniques:** Explore the Sales Comparison Method, Allocation Method, Extraction Method, Development Method, Land Residual Method, and Ground Rent Capitalization Method, gaining insights into their application, data requirements, and limitations.
3.  **Apply these methods effectively:** Develop the ability to critically evaluate the suitability of each method, considering the availability of data, the characteristics of the subject property, and the specific requirements of the appraisal assignment.
4.  **Accurately determine site value:** Gain confidence in your ability to independently and accurately determine site value, contributing to the overall reliability of the Cost Approach and supporting sound investment decisions within the real estate market.

By the end of this chapter, you will have acquired the knowledge and skills necessary to confidently navigate the complexities of site valuation, solidifying your expertise in the Cost Approach and positioning you for success in the competitive appraisal industry.

Chapter 6: Site Valuation Methods

Part of Training Course: Mastering the Cost Approach to Value

Description: Unlock the secrets of the cost approach to property valuation! This course provides a comprehensive understanding of cost estimation techniques, depreciation analysis, and their application in real estate appraisal. Learn to accurately determine property value by mastering replacement & reproduction costs, depreciation methods, and cost estimation techniques. Gain a competitive edge in the appraisal industry and make informed investment decisions.

I. Introduction: The Importance of Site Valuation

In the realm of real estate appraisal, particularly within the Cost Approach to Value, accurate site valuation is paramount. As the course description highlights, mastering cost estimation techniques is crucial, and this begins with a solid understanding of the land itself.

As the book content stresses, “Reason for a separate site valuation is to obtain data for certain valuation techniques. In particular, the cost approach to value… both require a separate estimate of site value.”
Therefore, this chapter delves into the scientific principles, methodologies, and practical applications involved in determining site value. This estimate is then integrated with the depreciated cost of improvements to arrive at the overall property value. Furthermore, as noted in Step 5 of the appraisal process in the provided content, “Valuing the Site” must be given due consideration.

The course description mentions replacement & reproduction costs, and depreciation methods. These are inextricably linked to the land value. Knowing the land value gives us an anchor point to then analyse the improvements and how they contribute (or detract) from the overall value. This is vital for informed investment decisions.

II. Highest and Best Use (HBU): The Foundation of Site Valuation

A. Definition:
* The Highest and Best Use (HBU) of a site is defined as the reasonably probable and legal use of vacant land or improved property that is physically possible, appropriately supported, financially feasible, and that results in the highest value. It is intrinsic to the Cost Approach to value.
* HBU analysis identifies the specific utilization that is the most profitable and optimizes the productivity of the land.

B. Scientific Principles:
* The concept of HBU is rooted in the economic principle of opportunity cost. It recognizes that a resource (land) has alternative uses, and its value is determined by the benefits derived from its most efficient and profitable deployment.
* The appraisal process aims to emulate the rational economic behavior of market participants who seek to maximize their returns on investment. This relates directly to making informed investment decisions, as per the course description.

C. The Four Tests of Highest and Best Use:

1. Legally Permissible:
   • This test considers the constraints imposed by zoning regulations, building codes, environmental regulations, historic district restrictions, and private deed restrictions (easements).
   • Example: A site may be physically suitable for a high-rise office building, but zoning regulations may limit building height to five stories. In that case, the high-rise is not a legally permissible use.
2. Physically Possible:
   • This test considers the site’s size, shape, topography, soil conditions, access, and availability of utilities.
   • Example: A steep slope might preclude certain types of construction, or poor soil conditions may require costly remediation.
   • Experiment: A soil percolation test can be conducted to determine the suitability of the site for septic systems, which directly affects the feasibility of residential development.
3. Financially Feasible:
   • This test examines whether a potential use can generate sufficient income to cover operating expenses, debt service (if any), and a reasonable return on investment. It needs to have a positive economic return.
   • Example: A proposed retail development might not be financially feasible if market demand is insufficient to support the required rents.
   • Mathematical Equation:
     * Profitability Index (PI) = Present Value of Future Cash Flows / Initial Investment
     * A PI greater than 1 indicates a financially feasible project.
4. Maximally Productive:
   • This test identifies the use that yields the highest net return or present value, considering all legally permissible, physically possible, and financially feasible alternatives.
   • Example: Two potential uses may both be feasible, but one might generate a higher income stream and, therefore, a higher land value.
   • Book Content: Each of these approaches results in an indication of value, also called a value indicator. HBU informs which approach is to be prioritized in the reconciliation step.

D. HBU as if Vacant vs. HBU as Improved:

• HBU as if Vacant: This analyzes the site as if it were unimproved, ignoring existing structures. This helps determine the site’s intrinsic value and potential for redevelopment.
• HBU as Improved: This analyzes the site considering the existing improvements. The cost to demolish existing improvements and any functional or economic obsolescence is considered.
• This distinction is crucial for the Cost Approach as it guides the appraiser on whether to value the property based on existing use or potential redevelopment. Book Content: For improved property, the appraiser must analyze highest and best use of the property as improved, and also of the property as if vacant.

E. Interim Use
* An Interim Use is a current use that is expected to change in the reasonably near future. This is a temporary use that can be considered during the HBU analysis.
* For example, an older commercial property may be operating as a car repair facility, but the highest and best use in the future is expected to change to retail. The car repair is the interim use, until market conditions and other factors make retail redevelopment financially feasible.
* This is a vital element to consider when using the Cost Approach. Is the current improvement temporary? What are the future plans for the site?

III. Methods of Site Valuation

A. Sales Comparison Approach (The Primary Method)

1. Description:

   • This approach is rooted in the economic principle of substitution, whereby a buyer will pay no more for a property than the cost of acquiring a comparable substitute.
   • Involves analyzing recent sales of comparable sites and adjusting their prices to reflect differences in characteristics compared to the subject site. This allows for accurate determination of property value, per the course description.

2. Elements of Comparison (adjustments):

   • Book Content: Sales prices of comparables must be adjusted to account for any differences between the comparables and the subject property, including physical differences, changes in market conditions, and differences in the terms of sale.

     • Property Rights Conveyed: Fee simple, leased fee, etc.
     • Financing Terms: Cash, seller financing, etc.
     • Conditions of Sale: Arm’s length transaction vs. a forced sale.
     • Market Conditions: Adjustments for changes in market value between the date of sale and the date of appraisal.
     • Location: Adjustments for differences in neighborhood characteristics, access, and proximity to amenities.
     • Physical Characteristics: Adjustments for site size, shape, topography, soil conditions, view, frontage, utility, etc.
     • Experiment: a Regression analysis can be performed on a large set of comparable sales data to quantify the impact of specific characteristics on property value, such as frontage on water or lot size. This relates directly to understanding depreciation methods, mentioned in the course description.
     • Zoning and Permitted Use: Crucial to ensure comparable uses allowed.
     • Economic Characteristics: Adjustments for variations of income generating uses.

   • Mathematical Equations:

     • Adjusted Sale Price = Comparable Sale Price +/- Adjustments
     • Percentage adjustments should be sequenced logically (e.g., financing before physical characteristics).

3. Data Sources:

   • Multiple Listing Services (MLS)
   • Public records (deeds, tax assessments)
   • Real estate professionals (brokers, developers)
   • Commercial data providers

B. Allocation Method

1. Description:
   • The book refers to Allocation, Direct Capitalization, and the Sales Comparison
   • This method derives the land value by applying a typical land-to-total value ratio observed in the market. It’s best used in conjunction with more reliable methods, as its precision is limited.
   • The extraction and allocation methods do not always guarantee a level of reliability to meet the requirements of USPAP, and therefore, should only be used if comparable sales cannot be obtained.
   • Example: if the value of a home in a specific area is typically 20% of the home value, one would use this percentage to value a similar lot.

2. Calculation:

   • Land Value = Total Property Value x Land-to-Value Ratio
   • Example: Property sells for $500,000 and land to value ratio is 20% = $100,000 for land value

3. Limitations:

   • Assumes a consistent relationship between land and improvement values, which may not hold true in all cases.
   • Limited accuracy, and best used as a supporting technique.

C. Extraction Method

1. Description:
   • This approach estimates land value by subtracting the depreciated cost of improvements from the total property value. This has relevance to depreciation analysis mentioned in the course description.
2. Calculation:
   • Land Value = Total Property Value - Depreciated Cost of Improvements
   • Example: A property sells for $600,000. Depreciated value of the house = $250,000. Land value is $350,000.
3. Relevance to Cost Approach: The book states that this approach requires a separate valuation of the site. The appraiser then estimates what it would cost to replace any existing structures, and adds this amount to the site value.

D. Subdivision Development Analysis (Land Development Method):

1. Description:
   • This method is used to value large tracts of land suitable for subdivision and development.
   • It involves projecting the revenues from the sale of finished lots, deducting development costs (construction, marketing, financing, and cost estimation techniques, all covered in the training course), and discounting the resulting cash flows back to a present value to estimate the land value.
2. Formula:
   • Land Value = (Present Value of Projected Sales - Present Value of Development Costs)
   • Uses Discounted Cash Flow (DCF) analysis.
3. DCF calculations are not simple, and are normally carried out with computers.

E. Land Residual Technique

1. Description:

   • The book content includes the building residual technique of income capitalization both require a separate estimate of site value. This is closely related to the land residual method.
   • This technique separates the income produced by a property into two components: the income attributable to the land and the income attributable to the improvements.
   • This method is applicable to income-producing properties such as retail stores and office buildings.

2. Calculation Steps:

   1. Determine the net operating income (NOI) of the property. NOI should be net of all operating expenses.
   2. Estimate the value of the improvements (the building).
   3. Determine an appropriate capitalization rate for the building (R_b).
   4. Calculate the income attributable to the building using the formula: Income_b = Building Value x R_b
   5. Calculate the income attributable to the land by subtracting the income attributable to the building from the total NOI: Income_land = NOI - Income_b
   6. Determine an appropriate capitalization rate for the land (R_land).
   7. Calculate the land value by dividing the income attributable to the land by the land capitalization rate: Land Value = Income_land / R_land

3. Example:
   * A building is projected to generate NOI of $100,000 per year.
   * Estimated value of the building is $800,000.
   * Capitalization rate for the building (R_b) is 10%.
   * Income attributable to the building = $800,000 x 0.10 = $80,000
   * Capitalization rate for the land (R_land) is 8%.
   * Income attributable to the land = $100,000 - $80,000 = $20,000
   * Land Value = $20,000 / 0.08 = $250,000

F. Ground Rent Capitalization:

1. Description:
   • This method capitalizes the ground rent paid under a long-term lease to estimate land value. Book Content: In a GROUND LEASE the tenant leases the land from the landlord, and constructs a building on the site.
2. Calculation:
   • Land Value = Ground Rent / Capitalization Rate
   • Example: Annual ground rent = $20,000, Market capitalization rate = 8%. Therefore, the value of the land is $250,000.

IV. Conclusion: Integrating Site Valuation into the Cost Approach

This chapter provides a foundational understanding of site valuation, crucial for mastering the Cost Approach to Value. Accurate site valuation, grounded in principles of HBU and employing appropriate methodologies, is fundamental for informed decision-making in real estate appraisal. Mastery of these techniques, as highlighted in the course description, gives you a competitive edge in the appraisal industry and enables accurate property valuation. This includes proper implementation of replacement & reproduction costs, depreciation methods, and cost estimation techniques.