Site Valuation Techniques

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Chapter 6: Site Valuation Techniques

Introduction

This chapter delves into the critical process of site valuation, a cornerstone of accurate real estate appraisal. Understanding site valuation is essential for several reasons, especially as it relates to the cost approach❓❓ and income capitalization techniques, as outlined in the course description. As the course description emphasizes, accurate data collection and analysis are critical for sound appraisal practices, including the techniques of separate site valuation. While the primary aim of this course is data gathering and analysis rather than the theory behind the approaches to value, it is important to note that “Mastering Real Estate Appraisal: Data Collection and Analysis” also covers understanding real estate appraisal. Thus, the concepts are not wholly divorced from this course.

I. The Importance of Separate Site Valuation

• Relevance to Appraisal Techniques:
  * A separate site valuation is vital for certain appraisal approaches. The cost approach, outlined in Chapter 8, relies heavily on estimating the site’s value independently. Similarly, the building residual technique within the income capitalization approach (Chapter 10) requires a distinct site value estimate. If these techniques are employed, a separate site valuation must be performed.
  * Formula: Cost Approach to Value

      *   Property Value = Site Value + (Cost New of Improvements – Depreciation)
      *   *PV = SV + (CN – D)*
  *   This formula underscores the significance of accurate site valuation as a foundational element in calculating the overall property value.
  

• Legal and Regulatory Requirements:
  * Appraisals for property tax assessment and condemnation often legally mandate separate valuations of the site and improvements. This requirement directly arises from the scope of the appraisal assignment.

II. Highest and Best Use Analysis

• Definition:
  * The highest and best use is the reasonably probable and legal use of vacant land, which is physically possible, appropriately supported, financially feasible, and that results in the highest value.

• Four Tests of Highest and Best Use:
  1. Legally Permissible: The potential use must conform to all applicable zoning regulations, building codes, and legal restrictions. Zoning regulations set minimum standards that appraisers need to be familiar with and will guide this analysis.
  2. Physically Possible: The site must be suitable for the proposed use considering its size, shape, topography, soil conditions, and availability of essential utilities such as water and electricity.

      *     *Example:* Site is not suitable for installing the building due to the presence of subsurface rock.
  3.  **Financially Feasible:** The potential use should generate sufficient income or return to warrant the investment. Demand for houses in the marketplace, along with trends for lower interest rates should be considered in determining if an economical return can be reasonably obtained.
  
      *   **Formula**: (Potential Income - Expenses) > Cost of Improvement, if the investment is not economically feasible, it cannot be the highest and best use.
  4.  **Maximally Productive:** Of all the feasible uses, the "maximally productive" use is the one that will generate the greatest return or value for the site. All appraisals should make an analysis of which possible option for that property is going to return the maximum income and value to the property.
  
      *   *Example:* Two possible improvements are single-family and retail.
          *   *SV<sub>retail</sub>* = 3,000,000 is greater than *SV<sub>single-family</sub>* = 1,000,000.
  

• Principle of Anticipation:
  * Reflects the market’s perspective regarding the benefits of future property ownership, making it critical in highest and best use analysis.
  * Example: If new, more favorable building regulations are expected in the near future, an immediate project might be less valuable than the ability to develop the land after a zoning change, or with improvements in infrastructure.

• Distinction Between Land As Though Vacant, and Land as Improved:
  * Land As Though Vacant: What if the land were completely vacant? The existing property is simply not there. What is the maximum and optimum use the land could bring?

       *   ***Example:*** The highest and best use of land as though vacant is a retail shop.
       *   *SV = Value (land only) - Demolition Cost.*
   *    **Land As Improved:** What impact do existing improvements have? Is this a detriment, and the maximum and optimum value would be if the land were vacant? Or do existing improvements mean the land has maximum use as improved?
  
        *   ***Example***: The highest and best use of land as improved is a house with landscaping.
        *   *V = max (Value<sub>site + current improvements</sub> , Value <sub>site as if vacant + demolition cost</sub> ).*
  

III. Site Valuation Techniques

• A. sales comparison approach❓❓ (Most Important)

  *   This technique entails examining sales of similar vacant sites to determine the value of the subject site. Data collection focuses on identifying comparable properties. As emphasized by the course description, this process must involve rigorous verification and analysis.
  *   **Data Collection:**
      *   Gather sales data on comparable vacant land.
      *   Verify details with involved parties (buyers, sellers, brokers).
      *   Confirm legal descriptions and site characteristics.
  *   **Comparable Sales Price Adjustments (Critical Data Analysis):**
      *   Adjust comparable sales prices to account for differences:
  
          *   **Property Rights Conveyed:** Did the buyer receive mineral rights, air rights, etc?
          *   **Financing Terms:** Cash sales are ideal. Adjust for below-market financing.
          *   **Formula:**  Adjusted Sale Price = Comparable Sale Price ± Financing Adjustment
          *   *AdjSP = SP +/- FA*
          *   **Conditions of Sale:** Was it an arm's-length transaction? Adjust accordingly.
          *   **Market Conditions:** Account for changes in value between the comparable sale date and the appraisal date.
          *    ***Formula**: AdjSP = SP +/- (SP * Market Change %)
          *   **Location:** Differences in neighborhood desirability impact value.
          *    ***Formula***: AdjSP = SP +/- Location Adjustment
          *   **Physical Characteristics:** Size, shape, topography, soil conditions, etc.
          *    ***Formula**: AdjSP = SP +/- Phys Adj
          *   **Economic Characteristics:** Zoning differences affect potential uses.
  *   **Elements of comparison:** Appraisers need to use different comparison techniques to properly determine market value. Here are those seven elements of comparison:
      1. Property rights conveyed- the legal and tangible ownership rights that are transferred with the sale.
      2. Financing terms- the type of financing involved in the sale, if the financing is not market. Adjust by adding the cost of above-market financing or deducting the savings that would be applied on the subject property.
      3. Conditions of the sale- what the circumstances around the specific sale was like. Adjust sale price if the transaction was not arm’s length.
      4. Expenditures immediately after the purchase- the cost of repairs. For example, costs associated with structural problems could result in a lower sales price, because the parties have adjusted the sale price.
      5. Market conditions adjustments- the amount of price or values have risen or fallen between the comparable sales and the subject of the appraisal.
      6. Location adjustments- the value of location, which includes quality of schools, location desirability, and more.
      7. Physical characteristics- the attributes of the property. Physical comparisons include, but are not limited to, site size, land, or utility.
  
      *   "As the course description stresses, comparable sales data should be scrutinized for accuracy, completeness, and relevance. Verify transaction details with real estate agents, review sales contracts, and consider any unique circumstances that might skew the sales price."
  

  • B. Allocation Method

    • This method assumes that a certain percentage of a property’s total value is attributable to the land. The land’s value is then calculated as a proportion of the total value.

    • Data Collection:

      • Determine the typical ratio of land value to total property value in the area.
      • This can be gathered from market research, sales data, or consultation with local real estate professionals.
      • Estimate the total value of the improved property using appropriate appraisal methods.

    • Calculation:

      • Land Value = Total Property Value × Allocation Percentage
      • LV = TV * AP

• C. Extraction Method

  *   This method infers land value by subtracting the depreciated cost of improvements from the total property value. It is particularly useful when comparable sales of vacant land are scarce.
  *   **Data Collection:**
      *   Determine the total value of the improved property using a suitable appraisal method.
      *   Estimate the replacement cost new of the improvements.
      *   Calculate accrued depreciation (physical deterioration, functional obsolescence, external obsolescence).
  *   **Calculation:**
  
      *   Land Value = Total Property Value – Depreciated Cost of Improvements
      *   *LV = TV – DC*
  

• D. Development Method

  *   This method is used for valuing land suitable for subdivision or development. It involves estimating the total revenue from the sale of finished lots, subtracting all development costs, and discounting the result to present value.
  
  *    ***Important: this method heavily relies on projections. Be sure to stress testing these assumptions***
  *   **Data Collection:**
      *   Develop a detailed subdivision plan (number of lots, sizes, layout).
      *   Estimate sales prices of finished lots.
      *   Project all development costs (construction, infrastructure, marketing, financing, etc.).
      *   Determine an appropriate discount rate reflecting investment risk.
  *   **Calculation:**
  
      *   PV = Projected Sales Revenue – Total Development Costs/ (1 + Discount Rate) ^ Time
      *   *PV = (SR - TC) / (1 + r)<sup>n</sup>*
  

• E. Land Residual Method

  *   This method separates the net operating income (NOI) of a property into portions attributable to the land and the improvements. It then capitalizes the income attributable to the land to determine its value.
  *   **Data Collection:**
      *   Estimate the total NOI of the improved property.
      *   Determine the value of the improvements (replacement cost new less depreciation).
      *   Find appropriate capitalization rates for both land and improvements in the market.
  *   **Calculation:**
  
      *   1.  Calculate the income attributable to the improvements: *I<sub>improvements</sub> = Value<sub>improvements</sub> * R<sub>improvements</sub>*
      *   2.  Calculate the income attributable to the land: *I<sub>land</sub> = Total NOI – I<sub>improvements</sub>*
      *   3.  Capitalize the land income to find land value: *Land Value = I<sub>land</sub> / R<sub>land</sub>*
  

• F. Ground Rent Capitalization Method

  *   This method is applicable when land is leased under a ground lease (long-term lease where the tenant owns the improvements). The land value is determined by capitalizing the ground rent.
  *   **Data Collection:**
      *   Obtain the annual ground rent amount.
      *   Determine a suitable capitalization rate for land based on market data.
  *   **Calculation:**
  
      *   Land Value = Annual Ground Rent / Capitalization Rate
      *   *LV = Rent/ R*
  

• G. Depth Tables (“4-3-2-1 Method”)

  *   When a comparable property is adjusted, depth tables are useful to assist with the adjustments for a property with more or less depth.
  
  *   An example of how a percentage depth table can be broken down is as follows:
  
     *   The front quarter is worth 40%.
     *   The second quarter is worth 30%.
     *   The third quarter is worth 20%.
     *   The fourth quarter is worth 10%.
  
  *    Keep in mind that all calculations must be taken into consideration when making adjustments.
  

IV. Conclusion

Accurate site valuation is a cornerstone of reliable real estate appraisal. By understanding and applying the appropriate techniques, appraisers can develop well-supported value opinions that accurately reflect market conditions. This chapter has underscored the importance of using data-driven decisions, and using the mobile apps highlighted in the course description. The techniques outlined within this chapter are valuable tools for the modern appraiser. As the course description states, mastering these techniques will enable you to confidently make data-driven decisions in today’s dynamic real estate market.

V. Review Questions

(Create 5-10 review questions based on the material covered in the chapter. These are not needed for the purpose of this task.)