I am familiar with the residual land value technique and have been reading up on it however I'd like users to chime in on a real life example of how to get a good valuation on the price to pay for dirt or a development site.
Assuming you know the unit count and what can be built as well as the market rental rates and construction costs, what would be a more in depth way of calculating the land value?
Any initial tricks/back of the envelope math for an initial review to see if the deal would pencil out?
Any excel models or articles would be appreciated. Thanks!
Residual value. If we can be in the finished building for $700/sf and its going to cost $550/sf to get there, we can pay $150/FAR SF for the land. The "in depth" portion is refining the assumptions that get you to the $550/SF of cost and making sure you can actually build what you want there.
If there are couple of uses for the land, we may use some back of the envelope methods to get an idea of how others value (ie. multifamily land is worth $100K/unit, you can build 300 units, residential developer is going to pay $30mm) before we spend a lot of time refining our assumptions in the residual value approach.
Thanks man! When you say you can be in the finished building for 700 psf is that the market value? What it would fetch on the market?
Developer's profit within the cost? Otherwise project profit is zero based on that residual.
Multi guy here. Its a Return on Cost Equation for me. Try to pencil it to 125-150 bps above prevailing cap rates. Stabilized NOI / All in Basis (Land + Hard & Soft Costs).
Not adding in anything new here, just chiming into say that this is probably the most common approach. Untrended ROC at some spread above acquisition cap rates to compensate for development risk/incentivize an activity other than just buying a cash-flowing asset.
Out of interest, do you include growth on your NOI? And if the development yield is at prevailing cap rates, or slightly below - but greater with growth, would you do the deal?
Coming from a market where these spreads don't exist and some are underwriting non existent spreads, albeit without growth, but even with growth there's not much.
Makes it awfully difficult to be competitive.
You would determine your NOI at stabilization to solve for the yield on cost...which takes into consideration rents at that time. Does that answer your question?
Given the current cap rates for MF...there's no way a deal works if the yield on cost is lower than or equal to the cap rate.
The cap rates for senior housing are higher (often times much higher) than market rate MF. Those deals also throw off great cash flow. I've seen senior deals in which the yield on cost is nearly the same as the exit cap rate...but it includes a four or five year hold and factors in annual rent growth.
Solve for the land price. If you need a 6.5 yield or whatever, and the rest of your assumptions (rent, expenses, etc.) are pretty solid, then X is the land price that will allow you to achieve your target returns. You then compare X/units to what that type of land typically trades for in your market and if it's close, that's essentially your offer.
If these are just some random houses or old buildings that aren't being marketed, you can sometimes get it for much less. If this is land already being marketed, it may already be out of your price range, meaning you either have to pass or fudge some of your assumptions to make the deal work.
That's a solid response.
You'll generally want the land cost to always be a bit under 20% of the total development cost. But it all depends on rents and the other development costs. The yield on cost is the key metric overall.
Honestly...when you're in the MF space...you generally just know what you can pay for land. You'll know off-hand what the range in terms of cost per unit should be depending on the product type and market...etc. You just see enough pro-formas to form a quick judgement if the land cost seems to be in an acceptable ballpark.
>You'll generally want the land cost to always be a bit under 20% of the total development cost.
Thats a very arbitrary number. In NNJ or Inland Empire industrial land is going for 50%-66% of total development costs. My last MF development completed in which we refi'd out of completely land was 35%, the one before that (refi'd out in January this year) land was 12%.
The whole point of land value is its the filler position and not subject to arbitrary %'s of cost.
It should be - it's a true response.
Cashflow the project and solve the land price to the investor's required IRR (mid-teens IRR in our case).
As others have said, you're back-solving to the land price. Build to whatever your target development yield over exit cap spread is and goal seek the land cost that gets you there.
I understand that but how does that give you a land price number? can you run an example on a 15 unit rental property where you're building at $150 all in PSF with market rents of $20 PSF?
I'm not going to build a model and send it to you, but yes.
You are building to a yield on cost (which includes land) and you are making an assumption on your exit cap-rate. You back into a land price that gives you your target spread of development yield over exit cap.
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