How to value vacant land

Title says it all. I know it's a simple question, I'm just curious to know what the bigger shops do. What should be considered?

Comments (21)

 
Most Helpful
Jan 8, 2021 - 2:19pm

Well, there are two most common approaches: sales comps (find similar transactions and adjust them to arrive at value) and residual value approach (calculate development value - development costs - developers profit = land value).  Something like multiples and DCF from company valuation.

Factors that should be considered: location (of course), zoning (what can be built, commercial, residential, industrial etc.), development potential (how much sq meters / sq feet you can build on the land), and other physical factors such as shape, slope etc.

Not sure what kind of answer you were looking for, hope this helps.

 
Jan 8, 2021 - 6:53pm

Np! Just to elaborate a bit. The method which will be used depends on the specific case. I would say that sales comparable (market approach) is more commonly used (at least from what I have seen), especially in active markets with many transactions. This is because the residual approach is very sensitive to inputs used in valuation (it's easier to massage the numbers).

However, if there is vacant land plot with specific project in preparation, e.g. multifamily with xy units will be built, there are permits obtained, cost estimate from construction company, conceptual design etc. Then it makes sense to use the residual approach.  On the other hand, if it comes to some (usually quite large) land plot owned by landbaking fund, which bought land just to re-sell it at higher price, and does not plan to develop anything, so no specific project is prepared, then sales comps method would probably be more appropriate.

 

 
Jan 8, 2021 - 7:52pm

Depends. A real estate appraiser will typically look at recent sales of similarly zoned sites in the area and make adjustments for things like development envelope, site configuration, commercial income potential, etc. You have to be familiar with the zoning and know what the allowable uses and total building square foot allowance is. 

If you're a developer, you'd probably do a discounted cash flow where you model out the development costs, rent levels upon completion, etc. You will basically be willing to pay for the land whatever value would allow for a good return to you.

 
Jan 8, 2021 - 10:59pm

The answer depends on what your role is and what side of the table you sit on.  If you ask a land owner, a banker, and an appraiser, you could get three different answers.

But from a developer's point of view, I take the profit approach already mentioned.  Using a real example, if a single family lot sells for $1,200 per frontage foot and I am delivering 40' lots, I know my gross revenue is $48,000 per finished lot.  I need a 20% gross margin for the project to be worthwhile to my investors and I.  So my all-in finished lot costs need to be $40,000.  If the soft and hard costs per lot are $30,000, I can pay $10,000 per lot for land.  I then calculate a density assumption, guided by civil engineers.  Let's assume 4.50 lots per gross acre.  So I could pay $45,000 per gross acre.

There are lots of variables in land development, so these numbers can move wildly.  It is one of the most difficult asset classes in many ways as there's so much risk in the dirt. 

Also, good luck working with the brokerage community and land owners, who don't know the first thing about land development.  The number of times I've heard, "but my neighbor got X per acre!"  Where their neighbor has a massive drainage outfall and the subject property has no outfall, requiring some absurdly high detention requirement.  Or whatever the case may be.

 
Jan 9, 2021 - 1:02am

Here is a really easy trick my boss taught me many years ago.

NOI of the completed project / completed project's cap rate = gross value of stabilized project.

Gross value - hard and soft costs of construction = gross land value.

Gross land value / (1+discount rate)^n (with n = years between today and time to construct) = land value today.

Example:

NOI: $500,000

Cap rate of completed project: 7%

Gross value of stabilized project: 500,0000 / .07 = $7,143,000

Construction costs: $6,000,000

Time to construct project: 2 years

Discount rate: 15%

Gross land value: $7,143,000 - 6,000,000 = $1,143,000

Land value: 1,143,000 / (1+1.15)^2 = $864,000

It's not perfectly mathematically precise, but it's close enough to allow you to run a really quick value. 

Array
  • 3
 
Jan 10, 2021 - 1:37am

Justman

If you're not trending your stabilized value and it's written as of today. Why do you need to discount it?

It's a back of the envelope, so don't read too much into the mathematical precision. In my example, you are getting a future stabilized value 2 years out, so you need to account for those 2 years. To get "perfect" precision you would need to layout the cash flows monthly and discount appropriately.  

Array
 
Jan 9, 2021 - 10:50am

Here's a simple back of the envelope method using fake numbers as examples:

1) Use the projected NOI / cap rate of highest and best use to estimate exit value of completed project (this depends on the market and zoning, for example if apartments are the best use the setbacks/zoning allow for 100 units generating $1mm in revenue, and the market typically has 50% opex/loss ratio and a 5% cap rate, the value is $10mm)

2) subtract ~15-20% as the developers profit (continuing example above, using 15% the profit margin on $10mm is $1.5mm)

3) subtract construction costs (continuing above... lets say the market/zoning analysis and step 1 assumes a 70k SF building that costs $100/SF to build, so $7mm)

4) $10mm - $1.5mm - $7mm = $1.5mm land value.  An apartment developer would pay $1.5mm for the land, $7mm on construction, and then hope to exit for $10mm paying themselves a $1.5mm profit (15%) for their efforts.

As you can see, the developers pro forma rents/expenses, cap rate assumptions, construction cost assumptions, desired profit margin, and interpretation of zoning/best use all impact the land value.  

Array
  • 2
 
Jan 10, 2021 - 11:07am

BobbybananamA

where do you guys find data for comps for this? 

where do you guys find info to make these assumptions? 

not a real estate guy, just curious. 

A lot of it is being in the game and having access to the data or having personal knowledge. Examples: construction cost inputs might be your knowledge that the last similar deal you saw in your market cost $300 psf, so you use that as the input in your model for construction costs. Your discount rate is taken from knowledge gained through experience of what investors would typically need to invest in a new construction project in, say, retail real estate, so you use that in your inputs. To construct your NOI of a completed project (in order to infer the land value) you'd find data using, say, CoStar (or use your own knowledge) for, say, retail rental rates and maybe your own knowledge of typical management fees, local taxes, etc. to construct the full financial statement. You'd get finished cap rate by looking to datasets from CoStar, et al to get a finished cap rate. 

A lot of it is piecing together the puzzle using your own experience and some helpful data. Also, just asking questions of knowledgeable people you know and/or work with--brokers, developers, lenders, etc. People are generally happy to share their insight when asked. When I used to work as an analyst for a principal owner of real estate, I kept the data folder--we'd sign up with a lot of brokers to receive their deal packages, and when we would get those deals from brokers, the deals would often come with financial statements, comparable cap rate data, and detailed tenant rental rates. We'd throw that data into a folder and when needed we'd use it to help construct our offers on other deals. The most helpful information from those deal packets was the tenant rental rates and terms since that's something that couldn't be fudged--they were what they were--and that data is not easy to come by in the public market.   

Array
 
Jan 11, 2021 - 1:01pm

This is very helpful 

How can someone with no industry knowledge invest in land without access to data like this? Is there any sub-par but OK source? Of course the data sources you mentioned would be the best, but I wonder if there's some just OK ones. 

The reason I asked is because I have wanted to invest in raw land in the past in remote areas, but I had a lot of difficulty getting reasonable data. 

 
  • Analyst 1 in IB - Ind
Jan 10, 2021 - 5:43pm

Anyone want to hop on a call with an aspiring RE analyst and give me some advice/mentorship? 1st year at BB with experience in ARGUS and can model water fall cash flows looking to switch industry.

 
Jan 12, 2021 - 4:24pm

I deal with a fair amount of vacant land and comparable analysis is usually used.  Most of what we look at is what has the land been historically used for or what it has the potential to be used for.  If land is used for cattle grazing that is a pretty small amount they're gaining per acre whereas if it has water and can be used to grow different types of crops that increases the value a lot.  Local real estate guys are usually the best ones to contact about that or if you can find a landman to talk to that will help as well.    

 
Jan 12, 2021 - 4:32pm

Definitely agree that good sales comps is the best way to go. Often in urban areas where use and FAR can be highly prospective (i.e., prospective buyers are making assumptions about what they can get from government approvals), land comps can be very difficult to use, if they are really available at all. But yes, definitely start with land comps; it's absolutely the best way to go if they are available. 

Array
Start Discussion

Popular Content See all

Girlfriend vs PE
+70PEby Investment Analyst in Private Equity - Growth Equity">Investment Analyst in PE - Growth
Life Hacks during WFH | How do you avoid burnout?
+58IBby 1st Year Analyst in Investment Banking - Mergers and Acquisitions">Analyst 1 in IB-M&A
Leaked EY Email
+53IBby 1st Year Analyst in Investment Banking - Industry/Coverage">Analyst 1 in IB - Ind
I’ll never take WSO for granted again
+50OFFby Principal in Venture Capital">Principal in VC
What's so good about Evercore?
+36IBby Prospective Monkey in Investment Banking - Mergers and Acquisitions">Prospect in IB-M&A
Have any 1st year analysts actually quit?
+33IBby 1st Year Analyst in Investment Banking - Mergers and Acquisitions">Analyst 1 in IB-M&A
I'm tired man
+26IBby Intern in Corporate Finance">Intern in CorpFin

Total Avg Compensation

January 2021 Investment Banking

  • Director/MD (9) $911
  • Vice President (31) $349
  • Associates (139) $232
  • 3rd+ Year Analyst (18) $155
  • 2nd Year Analyst (86) $151
  • Intern/Summer Associate (89) $144
  • 1st Year Analyst (344) $134
  • Intern/Summer Analyst (298) $83

Leaderboard See all

1
LonLonMilk's picture
LonLonMilk
98.5
2
Jamoldo's picture
Jamoldo
98.4
3
Secyh62's picture
Secyh62
98.3
4
CompBanker's picture
CompBanker
97.9
5
redever's picture
redever
97.8
6
frgna's picture
frgna
97.6
7
bolo up's picture
bolo up
97.5
8
NuckFuts's picture
NuckFuts
97.5
9
Edifice's picture
Edifice
97.5
10
Addinator's picture
Addinator
97.5