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Valuing Land When There Are Few
or No Vacant Land Sales
by Philip G. Spool, ASA
For those of you who have read my articles in Working RE magazine in the past, I have already written an article about land extraction, also referred to as land abstraction (Land Value: Extraction Method—published Summer 2012). This is an extension to that article with a revision.
This article is geared for both residential and commercial properties that have a land component and a building component. While most everyone uses the term “land,” technically we are valuing the “site,” which is the land that is cleared and ready for construction. For the purpose of this article, we will consider the word “land” interchangeably with “site.”
Why value the land when appraising a property? There are two reasons why you would need to value the property site (land) in an appraisal report. A very important reason is to determine the highest and best use of the property. If the value of the land is equal or greater than the property with the existing improvements (utilizing the Sales Comparison Approach and/or the Income Capitalization Approach), then the highest and best use of the property would be to either demolish the existing improvements and construct a building consistent with the immediate area or to consider the existing improvements as an interim use. In either case, that should give you the maximally productive (most profitable) use. A prime example where the land value is greater than the existing property would be an under-utilization of the site whereby the land-to-building ratio is much larger than normal or if the land zoning permits a better use than what exists on the land.
Another reason to value the land is if a lender (for loan purposes) requires the appraiser to value the land component of the whole property. For the most part, there are three components in a property: the building component, the land component, and the site improvements (also referred to as extra features, such as the parking area, fencing, swimming pool and landscaping). The lender might want to know how much of the total property value is the land portion and determine if they want to make the loan. After all, the lender is not making a land loan but a loan with viable existing improvements. This is not the concern of the appraiser.
Calculating Land (site) Value
The two most common methods in determining the land value are by the sales comparison method and the extraction (abstraction) method. By the way, you can call it either land extraction or land abstraction as some appraisal books refer to the extraction method while other appraisal books refer to the abstraction method. For the purpose of this article, I will call it the extraction method. A third method is called the allocation method.
Sales Comparison Method
The Sales Comparison Method is probably the most preferred and reliable method for estimating land value. This method is similar to valuing an existing house or commercial property, comparing the subject to recently closed sales of vacant lots with similar zoning. As no two houses or commercial buildings are typically the same, no two vacant lots are the same. The most common differences include the size, width and depth of lot, location, and if the comparable lot is cleared or in need of clearing trees, shrubs, and leveling the land. All of these differences must be taken into consideration. It is important that the sales price of the land sale be converted into a sales price per square foot of the lot. This is the unit of comparison that the opinion of value will be based on, after adjustments for the differences mentioned above.
Once the sales price per square foot is determined for each comparable sale, the reconciliation process starts. Probably the most important comparison is the lot size differential. Basic appraisal theory indicates that smaller lots tend to sell for a higher price per square foot than larger lots, just as larger lots tend to sell for a lower price per square foot than smaller lots. However, one should consider the most ideal lot size for the end use, in this case, a single-family residence or the type of commercial property on the site.
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For example, if the average lot size is 15,000 square feet, would a 10,000 square foot site be worth more per square foot than the 15,000 square foot site? Not in all cases. One has to consider the demand for the 10,000 square foot site versus the 15,000 square foot site, just as one has to consider the demand for a 20,000 square foot site. If the ideal house size or commercial building size is best reflected on a 15,000 square foot lot in the area, then perhaps a 10,000 square foot lot size would reflect an inferior designed house or commercial building, representing less demand for the smaller lot. If the lot size is 20,000 square feet, then the extra 5,000 square feet of land could represent surplus land.
Many appraisers confuse the difference between surplus land and excess land. Surplus land is land that cannot be sold off separately, while excess land can be. In many cases, a large lot that is considered to have excess land more likely is worth more than a large lot that has surplus land, due the fact that two buildable lots are worth more than one buildable lot. The shape of the lot also has to be taken into consideration. All of these situations have to be taken into consideration when reconciling the value of the subject’s lot.
Extraction Method and Not Deducting Building Component
In a time when there is strong demand for new construction, whether it be a stable market or an increasing market, and when demand is greater than supply, there is no need to select a sale, whether being a residential property or commercial property, and deduct the existing improvements. A test of reasonableness would be whether the sales price per square foot (without deducting the building component) is in line with pure vacant land sales and if the sales price per square foot appears to be consistent. The economy, particularly demand and supply for land for construction of a building, helps to determine whether or not to include the improvements in your analysis.
Extraction Method and Deducting Building Component
In a nutshell, site value is the difference between the sale price of a property and the contributory value of its improvements. So how do you determine the contributory value of the improvements? There are several ways to do this. The contributory value of the improvements is the same as the depreciated value of the improvements as observed in the market. In other words, it can be construed as cost new, less the accrued depreciation. Accrued depreciation is calculated as the effective age divided by the total economic life of the improvements. If you still have your appraisal books from your basic appraising course, look up Accrued Depreciation. An excellent reference book you should always have is The Appraisal of Real Estate, currently the Fifteenth Edition, by the Appraisal Institute.
When valuing the subject property, the appraiser calculates the effective age by an onsite visit to the property and observes any physical deterioration in order to arrive at the effective age. However, the appraiser does not have the luxury of visiting the interior of a comparable sale or even walking around the outside of the comparable sale that is a good candidate for the site value by the Extraction method. But if the property is listed on the Multiple Listing Service, there is a possibility that there are photographs of the interior and exterior of the property. You can also contact the listing agent to get additional information regarding the physical condition of the improvements to arrive at a more supportable effective age. Remember, effective age of a property is based on the appraiser’s judgment and observation.
Therefore, the proper procedure would be for the appraiser to calculate the replacement cost new of the improvements first and then subtract the depreciated value (contributory value) of the improvements from the sale price of the property used for comparison. But what about the residential site improvements such as the swimming pool, driveway, landscaping, etc.? And what about the commercial site improvements such as the parking pavement? Yes, those too have to be subtracted from the replacement cost new of the improvements.
Where do you get your replacement cost figures? There are several sources. For residential and commercial properties, use Marshall & Swift (also referred to as Marshall Valuation Service. For residential properties only use either www.Building-Cost.net (they now charge for their use) or www.CostToBuild.net (free service).
Extraction Method Using the Property Assessor’s Building Component
Another method, though one that is not supportable, is to obtain the Property Assessor’s estimate of the depreciated value of the improvements of a recently closed sale. The land value would be the sales price less the property assessor’s estimate of the depreciated value of the improvements. This is not supportable because an owner can have their property assessment successfully appealed resulting in a reduction in the improvement portion of the assessment, while another recently sold house may not have had their property assessment appealed or not successfully appealed, resulting in no reduction. Just remember, assessments are based on the mass appraisal system and not looked at individually.
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The Allocation method is more applicable for valuing residential land but not commonly used. However, if a newly constructed house is built on a site that was purchased recently, it can be effective. The Allocation Method can be applied as a percentage or proportion of the building to the total value of an improved property. For a comparable improved sale, either the land or building portion must be determined. If the house is relatively new, estimating the cost of improvements and dividing the costs by the sales price of the property will give you the percentage of the improvements to the purchase price of the comparable.
The remaining percentage difference will be the land portion and the percentage of the land portion times the sales price would result in the land value. The Allocation method is not as reliable to apply on an older house because estimating accrued depreciation is too subjective. If new developments are being constructed nearby, consultation with the developers is helpful if the developers can provide the building costs associated with the houses being sold. This would include the site improvements, such as landscaping, driveway, open patios and swimming pools.
In conclusion, the next time you explain how you arrived at your site value in your appraisal report and you state that you utilized the Extraction or Abstraction Method, be sure you use the correct procedure in addition to having your support in your workfile. Or better yet, have it indicated in detail within the text addendum of your appraisal report.
About the Author
Philip G. Spool, ASA, is a State-Certified General Real Estate Appraiser in Florida, appraising since 1973. Formerly the Chief Appraiser of Flagler Federal Savings and Loan Association, he has been self-employed since 1992. In addition to appraising, he is an instructor with Miami Dade College, teaching continuing education classes. He is also the Vice President and Chairman of the real estate division with the Greater Miami Chapter of the American Society of Appraisers. He can be reached at email@example.com.
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