By Leonard Baron
In even the most developed neighborhoods, there’s usually an empty lot sitting idle that begs the question: How much is that “piece of dirt” worth? Compared to the values of the existing homes nearby, it’s not readily apparent what the value of that empty lot might be. But it’s got to be worth something, right?
The fact is, valuing a vacant lot, in concept, is pretty simple under a commercially recognized valuation technique called Residual Land Valuation (RLV).
Residual Land Valuation is simple and straightforward for single-unit development. It becomes vastly more complex as other kinds of development options are introduced (apartments, condos retail, office, industrial) and when city, state, local planning group’s constraints are factored in, as well as other economic variables, like zoning laws, average daily traffic count (ADT), costs of construction, NIMBYism, floor area ratio (FAR).
But for an experienced, prudent developer who is considering buying a single-family-zoned lot to build a house upon, there is a formula that helps determine the kind of profit such a deal could yield.
First, the developer needs to determine the “product” or kind of house they are going to build and for how much the finished product will sell. They review the immediate housing marketplace, talk to real estate agents, review comps, and determine that in order to maximize their profit, they should build a 2,600-square foot house on the lot (Note: Different developers may see a different market, size, luxury fixtures, sales price, cost to build).
That house, based on real estate market conditions, will sell for an estimated $850,000. The builder estimates “all in” that it will cost $400,000 to build the house – sticks, bricks, permits, architectural, loan interest, fees, everything, except land, plus 7% in sales costs (commission, escrow, title, etc.).
Now we can figure out the RLV, which equates to how much a developer might offer for the lot and the maximum he should pay.
If the developer starts with the $850,000 sales price, he then subtracts the sales costs to arrive at a net sales price of $790,500. Then he subtracts the cost to build, and builder-required profit that he hopes to earn, and what is left over is what he can pay for the land. That’s estimated at $340,500 in this example, which is the RLV.