A residual valuation is a very sensitive topic, with slight variations in its different elements such as rent, initial yield, construction costs, finance rate, and building period. Because of this, this method is regarded as one of the last resort.
In property development circles, the residual method of valuation is an essential valuation tool for any aspiring investor, as it helps to quickly identify the value of a development site, land, or existing buildings that have the potential to be developed.
Without a carefully constructed budget or detailed property value evaluation, the risks associated with a development opportunity should be considered unmanaged, and consequently, the chances of achieving a successful project outcome are significantly reduced.
Leaving things to chance is not a good approach and comes with a serious financial warning for any prospective developer.
What is Residential Land Value?
A residual land valuation model is used to estimate values for hypothetical land schemes in cities and/or regions.
The residual land value is not a market price and does not capture the value associated with real estate in all sites, but it does give an indication and insight into the value for immediate development, useful just before you start planning obligations and more.
Residual land value is analyzed to determine whether the changes in the viability of different land uses are driven principally by costs, rents, or pricing.
Zoning decisions related to residential lot size can also have a great effect onto the residential land value, and they are estimated with fixed effects and models such as:
- Parcel size and elevation
- Soil permeability
- Proximity to urban areas, malls, and roads
- Location of the parcel
What is Residual Land Value?
The residual method of valuation is an approach to property development appraisal and a great way of establishing accurate prices for many important aspects of some real estate projects. It is highly recommended to all developers.
Residual land value is a prudent approach, and an essential component of any property risk management strategy and an important requirement to secure your capital from any form of development risks – as it demonstrates a clear, financially sound, and well-thought-out method.
Components of the Residual Method of Valuation Calculation
Various components can affect the residual method of valuation calculation, and the three main methods will be described in detail in the following text.
Gross Development Value Evaluation
Gross Development Value or commonly known as the GDV is an important part of the residual method of valuation and equation, and something that many experienced property developers are very enthusiastic about establishing from the outset.
Gross development value highlights the final capital value of the completed project and gives us certainty if that project will eventually be sold to an interested party.
The GDV part of the residual equation is based on current values and not the values we have projected for some real estate.
Building Costs and Fees
Build costs and fees include any costs related to the site preparation and later construction of the property. These fees are made to pay for permissions and building regulation, but also include things such as paying the professionals working on the site:
- planning consultants,
- property agents, etc.
Property Developers’ Profit
Finally, the most important of calculating residual value is the final profit-making element. The profitability of the project should be considered at the early stage, as everything really depends on this figure.
The property developer needs to keep in mind their required return on their investment – the expected profit once the hard work is over.
The sum a developer pays for the development of some site in the first instance will all be intrinsically linked to the amount of profit he earns at the end of the project.
Residual Method of Valuation for Land & Property
The residual method of valuation involves a simple calculation that helps property developers determine a realistic value for the land or property purchase.
The numbers that go behind the equation can get more or less complex, but once these evaluations have been determined – the residual method of appraisal is a rly simple calculation to perform.
And it proves to be incredibly powerful.
Knowing a realistic idea of land or property values helps to determine other expenditures and the maximum time and money a developer can afford to spend on things such as:
- Site preparation,
- Land remediation,
- Professional fees etc.
The Equation For The Residual Method of Valuation In Its Simplest Form
Land/Property = GDV – (Construction + Fees + Profit)
Land/Property = The purchasing price of land/property/site after the acquisition
GDV = Gross development value
Construction = Building and construction time and costs
Fees = Transaction costs for obtaining the permissions, etc.
Profit = Developers profit required after the job is done
Going into further detail…
The amount of time and money available for land/site purchase is one of the biggest components of the residual valuation equation.
This information can identify exactly how much you should initially invest in the development of the desired site or building.
It is also important to remember that your residual valuation figure (or what you can afford to pay for the construction of the site) is highly unlikely to be the same as the seller’s asking price.
And this is where good negotiation skills come into play…
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