Analyzing Land Development Value – Part 1
The value of land for residential development is related to income and expense. This means that what the land is worth is determined by the following factors: (a) how the parcel can be used; (b) the number of lots; (c) the potential sale (resale) value of the finished product; and (d) the expense necessary to transform the property into something that you can sell for a profit.
The items included in the last factor (d) may consist of vertical and horizontal improvements, consultant fees (eg, legal or engineering), and other expenses, such as municipal fees. It all depends on what your intended development scenario is. So, for instance, if you want to change the land parcel (developing it) only by obtaining zoning approvals, your category (d) would probably include municipal and consultant fees but not costs for installing improvements. On the other hand, if you are subdividing the parcel and then putting in the horizontal improvements (eg, excavation, grading, landscaping, streets, curbs, sidewalks) in order to sell vacant building lots, your expenses would have to reflect the cost of those improvements in addition to the other expenses you incurred. If you intended to subdivide, put in site improvements, construct homes on the lots and then sell a finished package (ie, new house on its lot), you would have to add your costs for building the houses to the other items of expense.
Since real estate developers do all of their income and expenditure projections of a land parcel on a per-lot basis, they do not use the number of acres in the property to determine its value and analyze the economic feasibility of a deal. This makes sense because for example, a 50 acre vacant land parcel zoned for lots of 43,560 square feet (one acre) will likely not produce 50 lots of one acre each. Land area is typically lost or wasted due to proposed roads, irregular shape and other physical characteristics restricting or prohibiting development, such as land areas having steep slopes, floodplain or certain soil classifications. Suppose this hypothetical 50 acre parcel could produce only 37 building lots and was for sale at $ 1.5 mil. Developers would show the planned land cost in their pro formas or spreadsheets at $ 40,541 per lot ($ 1.5 mil divided by 37 lots) and not as $ 30,000 per acre. So the first step in the land buyer's value analysis is estimating the number of potential lots that the parcel can produce. This is usually referred to as the "yield."
The starting point is reviewing the current zoning ordinance and map. This would tell you the zoning classification of the property, as well as other contractual facts: minimum lot size and width, minimum or maximum depth, allowable density or method of calculating the yield, and requirements relating flag or lane lots. Flag lots have a narrow strip fronting on a street and then the lot increases in size. Picture a flag on a pole, and you can get a pretty good idea of what a typical flag lot would look like.
The yield of any land development at best is approximate until the municipality grants approval of a specific subdivision plan. (And where public water and sewer are not available, the number of building lots can be even more speculative.) People interested in buying land use different ways of estimating the parcel yield. Sometimes the zoning ordinance spells out the method to be used, including the "obligations" that must be made from the gross square feet of land area for various reasons, including portions of the parcel containing "protected natural resources" like woodlands, floodplain, slopes , wetlands and prime agricultural soils.
The yield of a proposed land development can also be estimated by hiring an engineer to draw a sketch plan that would show a possible layout of the property. But this method is time consuming (and not free), and certainly is not the most efficient way to approximate a rough yield if you're looking at dozens of land parcels. So developers interested in buying land would use some rule of thumb they've created over time and tested from their experience. This enables them to estimate the parcel yield very quickly, and it's a great tool to use in the initial stages of their investigation when they have to screen many parcels.