If his estimated RLV is $340,500, he might start his offer at $250,000 and might be willing to pay up to $350,000. But if the seller demands $450,000, the builder will not make any money, so he’ll pass on this lot.
Mathematically, it’s really that simple. The hard part is accurately estimating the sales price the property will command and the actual amount that it will end up costing to build. If one misses the mark on those, that’s the difference between making a profit or losing one’s shirt!
However, there is one last item to note — and it’s the toughest part of all for builders when it comes to making a good estimate on profitability on a project: Finding a land owner who is willing to sell at a price where the developer can still make a profit. Many a builder or developer has overpaid for land.
To restate the process for anyone curious about determining the value of an empty building lot, here’s what you should ask yourself:
- What can be built and how much will be the estimated final product sales price?
- How much are the costs of sale, construction costs, and builder required profit?
- The net leftover is what a prudent developer can pay for the land and still earn a fair profit – the “Residual Land Value”.
Leonard Baron, MBA, CPA, is a San Diego State University Lecturer, a Zillow Blogger, the author of several books including “Real Estate Ownership, Investment and Due Diligence 101 – A Smarter Way to Buy Real Estate.” Read useful tips for real estate buyers in his blog, Making Smart and Safe Real Estate Decisions. See more at ProfessorBaron.com.
Note: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinion or position of Zillow.
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