Implication of Debt Finance on Land Value: A Discussion
I'm trying to keep this high-level to encourage open discussion rather than bias it too early.
We're debating how the value of land for development changes as the level of development debt increases.
A traditional residual land valuation suggests that as debt levels rise, finance costs increase—reducing what can be paid for the land.
However, others argue that in real markets, the availability and cost of development debt can enhance the viability of schemes and ultimately increase land value.
I'd really like to hear how others view this?
This is a pretty nuanced topic but I'll try to keep my response short by arguing that the cost of perm debt ultimately has a bigger impact than the cost of development debt.
Assuming a 2 year construction timeline, 65% LTC and a 65% Average outstanding balance, if your interest rate was 10%, then your debt costs about 8.5% of total Cost. If your rate was 5%, then your construction debt would be 4.25% of cost.
To keep the same returns, a 1% increase in rate should increase cap rates by 60bp. However, from what we've seen it seems to alter assumptions, and rates increasing from 3% to 5.5%, increased cap rates by about 1%. A 1% increase in cap rates decreases value by about 20% for market rate multifamily in most markets. That is a much more significant hit to feasibility which impacts land values considerably.
Thanks for the reply.
If I’ve understood correctly though, in your scenario rates are changing but the amount of debt is static.
Is it your belief that, if the amount of leverage was to increase, say from 50% LtC to 65% LtC, all else being equal, the value of the land would or should go up (in reality) ?
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