What is the baker to do when the cost of flour exceeds the cost of the bread? What happens when the price of land or the price of developing, the main ingredient of the property world, exceeds the amount that can be supported by the income it will produce?
For example, if the price for a lot is $50,000 and the maximum value a finished lot will sell is $40,000 after taking into account the construction costs, taxes, and other expenses, pricing will need to increase in order for the developer to make a profit. Instead of overpaying, developers should do like the baker and stop making bread.
The real estate professional will use several methods to determine the value of a project. For example, appraisers use three methods of analysis – the cost approach, income approach, and sales comparisons. For investors and developers, the methods may include calculations on the back of a napkin, formal calculations in a spreadsheet, or a complete analysis using sophisticated software. Each method can be used conveniently, effectively, efficiently, and reliably at specific points in the analysis of a project. The results of the analysis may vary from an initial analysis to the more complex analysis based on the quality of the information used in the analysis.
Residual land value calculates the value of the property based on the productive value of the land. In most cases, the residual land value represents value of the land based on the highest and best use. This article provides the background information to understand the mathematics of residual land value using the direct capitalization approach.
Direct Capitalization + Residual Land Value Analysis
The following case studies will provide a working example to solve for Residual Land Value. One case study evaluates a residential property with two separate densities. The second case study calculates the land value based on a future commercial office development.
This assignment requires you to read Direct Capitalization + Residual Land Value, to complete the case study. This case study will provide application of Excel skills including entering information, writing formulas, organization and formatting of individual worksheets, and analyzing the results.