Site Valuation Techniques

Okay, here’s the content for your chapter, aiming for a scientific and practical approach, incorporating the PDF information where relevant. I’ve added some mathematical formulas where applicable and attempted to organize it well for training purposes.

Chapter 6: Site Valuation Techniques

Introduction

Site valuation is a crucial aspect of real estate appraisal. It involves determining the value of the land component of a property, independent of any improvements that may exist upon it. This separate valuation is necessary for various reasons, including cost approach valuations, income capitalization techniques (building residual technique), property tax assessments, and condemnation proceedings. This chapter provides a detailed exploration of site valuation techniques, covering relevant scientific theories, practical applications, and mathematical models. Understanding these techniques is essential for accurate and reliable property appraisals.

I. The Importance of Separate Site Valuation

• Data for Valuation Techniques: The cost approach and building residual technique heavily rely on a separate estimate of site value. This is explicitly mentioned in the provided PDF.
• Legal Requirements: Property tax assessment and condemnation often legally mandate separate site valuations.
• Highest and Best Use Analysis: Site valuation is intrinsically linked to determining the highest and best use of the property. The land’s potential independent value contributes to this analysis.

II. Understanding Highest and Best Use

• Definition: Highest and best use is defined as the reasonably probable and legal use of vacant land or an improved property, which is physically possible, appropriately supported, financially feasible, and that results in the highest value.

• Four Tests: To find Highest and Best Use, four questions must be asked, in order:
  1. Legally permissible? If not, reject.
  2. Physically possible? If not, reject.
  3. Financially feasible? If not, reject.
  4. Maximally productive? The remaining possible use is the highest and best use.

• Importance of Highest and Best Use:

  • Value Determination: It drives the overall property value.
  • Comparable Selection: It guides the selection of appropriate comparable properties.
  • Consistent Use: It enforces that both land and improvements are valued based on the same use.

III. Site Valuation Techniques: A Detailed Examination

A. Sales Comparison Approach (Market Data Approach)

*   **Principle:**  This is the most reliable and commonly used approach.  It involves comparing the subject site to similar vacant sites that have recently sold in the same market area.

*   **Process:**
    1.  **Data Collection:**  Gather data on recent sales of comparable vacant sites. Data includes sale price, date of sale, location, zoning, physical characteristics (size, shape, topography), and any restrictions.  Real estate brokers, <a data-bs-toggle="modal" data-bs-target="#questionModal-329709" role="button" aria-label="Open Question" class="keyword-wrapper question-trigger"><span class="keyword-container">appraisers</span><span class="flag-trigger">❓</span></a>, lenders and title companies are commonly used to verify data.

    2.  **Comparable Selection:**  Choose comparable sales that are most similar to the subject site. Similarity is assessed based on factors like location, size, zoning, and physical characteristics.
    3.  **Adjustments:**  Adjust the sale prices of the comparable properties to account for any differences between them and the subject site. Adjustments are made for factors such as:
        *   **Property Rights Conveyed:** Differences in fee simple versus leased fee interests.
        *   **Financing Terms:** Adjustments to account for atypical financing arrangements.
        *   **Conditions of Sale:** Adjustments for sales influenced by duress, foreclosures, or related-party transactions.
        *   **Market Conditions:** Account for changes in the market from the date of the comparable sale to the date of the appraisal.
        *   **Location:**  Adjust for differences in neighborhood desirability, access to amenities, or proximity to nuisances.
        *   **Physical Characteristics:** Adjust for differences in size, shape, topography, soil conditions, or view.

    4.  **Value Indication:**  After making all necessary adjustments, the adjusted sale prices of the comparable properties provide an indication of the value of the subject site.

*   **Mathematical Representation:**
    ```
    Subject Value = Comparable Sales Price +/- Adjustments
    ```

*   **Example:**

    | Comparable | Sale Price | Date of Sale | Location Adj. | Size Adj. | Adjusted Price |
    |------------|------------|--------------|---------------|-----------|----------------|
    | 1          | \$150,000  | 3 months ago | +\$5,000     | -\$2,000   | \$153,000      |
    | 2          | \$160,000  | 6 months ago | -\$3,000     | +\$1,000   | \$158,000      |
    | 3          | \$145,000  | 2 months ago | +\$2,000     | \$0        | \$147,000      |

    Based on these adjusted prices, the appraiser would reconcile the data to arrive at an estimated value for the subject site.

B. Allocation Method

*   **Principle:** This method is used to separate land value when comparable land is not available. It assumes that land value is a certain percentage of the total property value. The value assigned will also be adjusted to compare to properties for an accurate estimate.

*   **Process:**

    1.  **Determine Total Property Value:** Estimate the <a data-bs-toggle="modal" data-bs-target="#questionModal-329705" role="button" aria-label="Open Question" class="keyword-wrapper question-trigger"><span class="keyword-container">market value</span><span class="flag-trigger">❓</span></a> of the improved property using other appraisal approaches (e.g., sales comparison, income capitalization).

    2.  **Establish Land-to-Value Ratio:** Research typical land-to-value ratios for similar properties in the area. This can be derived from sales of comparable properties where both land and improvement values are known.

    3.  **Calculate Land Value:** Multiply the total property value by the established land-to-value ratio.

*   **Mathematical Representation:**

    ```
    Land Value = Total Property Value * Land Ratio
    ```

*   **Example:** A property with total value of $500,000 in an area where land accounts for 20% of the total value suggests a land value of \$500,000 * 0.20 = \$100,000.

C. Extraction Method

*   **Principle:** This method also separates land value from an improved sale by removing the depreciated cost of the structure from the total.

*   **Process:**

    1.  **Determine Total Property Value:** Estimate the market value of the improved property.

    2.  **Estimate Depreciated Cost of Improvements:** Estimate the cost to replace the existing improvements, then deduct accrued depreciation (physical deterioration, functional obsolescence, and external obsolescence).

    3.  **Calculate Land Value:** Subtract the depreciated cost of the improvements from the total property value.

*   **Mathematical Representation:**

    ```
    Land Value = Total Property Value - Depreciated Cost of Improvements
    ```

*   **Example:** If a property sells for $400,000 and the depreciated cost of the improvements is \$250,000, then the estimated land value is \$400,000 - \$250,000 = \$150,000.

D. Development Method (Subdivision Analysis)

*   **Principle:** The development method estimates the value of raw land based on its potential for subdivision and development.

*   **Process:**

    1.  **Determine Highest and Best Use:** Identify the most profitable and legally permissible use for the land (e.g., residential subdivision, commercial development).

    2.  **Develop a Subdivision Plan:** Create a detailed plan for subdividing the land, including the number of lots, sizes, street layout, and infrastructure.

    3.  **Estimate Development Costs:** Estimate all costs associated with developing the subdivision, including land preparation, infrastructure installation, construction, marketing, and financing.

    4.  **Estimate Gross Revenue:** Project the total revenue from the sale of all lots in the subdivision, considering market demand and absorption rates.

    5.  **Calculate <a data-bs-toggle="modal" data-bs-target="#questionModal-88174" role="button" aria-label="Open Question" class="keyword-wrapper question-trigger"><span class="keyword-container"><a data-bs-toggle="modal" data-bs-target="#questionModal-329695" role="button" aria-label="Open Question" class="keyword-wrapper question-trigger"><span class="keyword-container">net revenue</span><span class="flag-trigger">❓</span></a></span><span class="flag-trigger">❓</span></a>:** Subtract the total development costs from the projected gross revenue to arrive at the net revenue.

    6.  **Discount to Present Value:** Discount the net revenue back to its present value using an appropriate discount rate to account for the time value of money and the risk associated with the development project.

*   **Mathematical Representation:**

    ```
    Land Value = Present Value of (Total Revenue - Development Costs)
    ```
    ```
    PV = FV / (1 + r)^n
    ```
    Where:
    *   PV = Present Value
    *   FV = Future Value (Net Revenue)
    *   r = Discount Rate
    *   n = Number of Years

*   **Example:**  A subdivision project is projected to generate net revenue of $1,000,000 after 5 years. Using a discount rate of 10%, the present value of the land is \$1,000,000 / (1 + 0.10)^5 = \$620,921.

E. Land Residual Method

*   **Principle:**  This method estimates the land value based on the income attributable to the land after accounting for the income required to support the improvements.

*   **Process:**

    1.  **Estimate Total Net Operating Income (NOI):**  Project the total net operating income that the property is expected to generate.

    2.  **Determine Improvement Value:** Estimate the replacement cost (depreciated) of the improvements, (V_i).

    3.  **Determine the Capitalization Rate for Improvements (R_i):** Find a market-derived capitalization rate for similar improvements.

    4.  **Calculate the Income Attributable to the Improvements (I_i):** Multiply V_i * R_i = I_i

    5.  **Find the Income Attributable to the Land (I_L):** Subtract the Income Attributable to the Improvements from the Total Net Operating Income: NOI - I_i = I_L

    6.  **Determine the Capitalization Rate for Land (R_L):** Find a market-derived capitalization rate for similar land.

    7.  **Value the Land:** V_L = I_L / R_L
*   **Mathematical Representation:**

    ```
        V_L = (NOI - (V_i * R_i)) / R_L
    ```

    Where:
        *   V_L = Value of Land
        *   NOI = Net Operating Income
        *   V_i = Value of the Improvements (Depreciated)
        *   R_i = Capitalization Rate of the Improvements
        *   R_L = Capitalization Rate of the Land
        *   I_L = Income Attributable to the Land

*   **Example:**

    A small office building is projected to have a Net Operating Income (NOI) of $80,000 per year. The Improvements are depreciated, at $500,000. Market Capitalization Rates for this type of improvements are at 8%. Market Capitalization Rates for the land are at 7%.

    1. Find the Improvement Income
        *   $500,000 (Improvement Value) * .08 (Improvement Cap Rate) = $40,000

    2. Isolate the Land Income
        *   $80,000 (Total Income) - $40,000 (Improvement Income) = $40,000

    3. Capitalize Land Income
        *   $40,000 / .07 (Land Cap Rate) = **$571,428 (Value of the Land)**

F. Ground Rent Capitalization

*   **Principle:** This method is used when land is leased under a ground lease, where the tenant owns the improvements and pays rent for the land.

*   **Process:**

    1.  **Determine Annual Ground Rent:** Identify the annual rent being paid for the use of the land.

    2.  **Select a Capitalization Rate:** Research market-derived capitalization rates for ground leases in the area.

    3.  **Capitalize the Ground Rent:** Divide the annual ground rent by the capitalization rate to arrive at the estimated land value.

*   **Mathematical Representation:**

    ```
    Land Value = Annual Ground Rent / Capitalization Rate
    ```

*   **Example:** If the annual ground rent for a property is $20,000 and the capitalization rate is 8%, then the estimated land value is \$20,000 / 0.08 = \$250,000.

IV. Depth Tables

• Concept: Depth tables (e.g., 4-3-2-1 method) are rules of thumb that suggest that the front portion of a lot is typically more valuable than the rear. These are highly simplistic and should be used with caution, if at all.

• Process: Assign percentages to the front, middle, and rear sections of the lot. Multiply the total land value by the respective percentages to allocate value.

• Caveats: These tables ignore the specific use of the property. They are rarely defensible as a primary valuation tool but can be used to provide a rough estimate.

  • There are also depth tables that are more mathematically complex.

V. Factors Affecting Site Value
Many characteristics will determine the worth of a location. The following are some of these characteristics:

• Zoning
  • Permitted and potential uses
• Location
  • Accessibility to desired places
  • Safety
  • Beauty
• Shape/Size
  • A usable lot
• Utilities
  • Are they established? Are hookups available?

V1. Reconciliation and Final Value Estimate

• Reconciliation: After applying multiple site valuation techniques, the appraiser must reconcile the different value indications to arrive at a final value estimate for the site.

• Considerations in Reconciliation:

  • Reliability of Data: Give more weight to techniques that rely on the most reliable and verifiable data.
  • Appropriateness of Technique: Give more weight to techniques that are most appropriate for the specific property and market conditions.
  • Consistency of Results: Consider the consistency of the value indications across different techniques.

• Final Value Estimate: The final value estimate should be supported by clear and concise reasoning, taking into account all relevant factors.

VII. Conclusion

Site valuation is a complex process that requires a thorough understanding of market conditions, appraisal principles, and various valuation techniques. By applying the appropriate techniques and carefully analyzing all relevant factors, appraisers can arrive at accurate and reliable estimates of site value, which are essential for informed decision-making in the real estate market.