How to Calculate Land Residual Value?
Land Residual Value is one of the real estate valuation methods, specifically in valuing land. It is a simple yet valuable tool you can use to assess if you plan to buy land and build a property. Land Residual Value is a powerful mechanism, especially if you already have a project in mind.
Developer’s Revenue is deducted by Development Costs and Developer’s Required Profit to derive the Land Residual Value.
We will present below a sample scenario in computing Land Residual Value.
Sample Project:
Let’s say you are planning to buy five hectares of land. From those five hectares of land, one hectare is non-constructible while the other one and a half hectare are for infrastructure. You are now left with 2.5-hectare land.
1. Developer’s Revenues
Based on estimates, per condominium building will occupy 3,000 sq. meters. The 2.5 hectares of 25,000 sq meter land can accommodate eight condominium buildings. Given that the selling price per unit is $1,250,000, you have a revenue of $10,416,667 for the sale of condominium units. Add to that the other revenues of $1,100,000. The total developer’s revenues are $11,516,667.
2. Development Costs
The developer costs are all the necessary costs for the development up to the sale of the property. These costs include:
· Survey and Approvals
· Transaction Fees
· Infrastructure Costs
· Building Construction Costs
· Selling Costs
· Professional Fees
· Security
· Contingencies
· Interest Expenses
3. Expected Profit
In return for taking the risk, you expect a return to cover that risk and compensate for your time and effort. For this scenario, we assume a 15% rate of return. The Expected Profit is then further deducted from the Developer Revenues.
The developer may base his expected return on real estate with similar-risk investments and his project expectations.
4. Land Residual Value
After identifying all related accounts, we are now down to computing the Land Residual Value.
In our sample scenario, revenue from sales of units amounted to $11.2 million, while other revenues are $1.1 million, with a total of $12.3 million revenues. Development costs amounted to $8.5 million, and the Required Profit before Tax is $1.8 million. These figures result in a Land Residual Value of $2 million. The Land Residual Value is the maximum amount you are willing to pay for the land.
Land Residual Value is more useful when you already plan what property to build on the land, computed the expected revenue, identified the costs involved, and decided on the Required Profit. Otherwise, you will waste time using the Land Residual Value Method and won’t be used for your project evaluation.
Land Residual Value should be utilized alongside other real estate valuation methods such as Comparable Analysis, Discounted Cash Flow Valuation, and Capitalization Rate to provide a more accurate and reliable business valuation.
