The most common valuation method, used in the residential resale market, uses recent comparable sale transactions as a basis for value. Recent sales of similar properties are analyzed to find an average sale price per acre (or per square foot) and this is applied to the size of the subject property. This method looks like this:
In dynamic real estate markets like the Fraser Valley and Metro Vancouver there are 3 big challenges with using this method to calculate a development property’s value:
- Not all development land properties are the same. Property features like creeks, future roads, setbacks, and slopes are commonly overlooked when reviewing comparable sales. These factors significantly impact a property’s development potential.
- Development land transactions can have long timelines. Many development land transactions take 6-18 months to complete and since the sale price is negotiated at the beginning of that time, sale prices can be 6-18 months old by the time the transaction details become public.
- Land values are changing constantly so the “comparable” average price per acre derived from other transactions may not be accounting for a recent sudden shift in the market.
These challenges can lead to determining a value for the property that is incorrect. Because of this, it is critical to use the developer’s valuation method, whenever possible, to find what is known as the residual land value.
RESIDUAL LAND VALUE ANALYSIS
The more complex method of calculating land value, used by developers, involves running a development proforma. A development proforma is a financial projection of the project that could be built on a property and is a reverse calculation that concludes with the land value that can be paid after all costs have been subtracted from the total selling price of all of the future homes. This calculation determines the point at which the future project is financially viable. Simplified, the development proforma looks like this:
This method is more accurate than a comparable analysis because it uses current selling prices for the new homes to be built and current construction costs, rather than a potentially dated price per acre derived from other land transactions. Thus, the residual land value method represents the price a developer can afford to pay today, rather than what a developer paid in the past for similar properties.
Follow the links below for neighbourhood specific case studies showcasing how using the residual land value method assured a property was priced appropriately and helped maximize the ultimate sale price:
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