Determining the Value of Residential Land

Determining the Value of Residential Land

As the real estate market continues to change quickly, properly assessing the value of land is becoming more critical to a bank’s success.  For purchasers of large tracts of residential lots and land, having the ability to determine the value of land is an important skill.  Developers almost never rely on appraisers. In fact, most see the appraisal as nothing more than an item that is necessary to satisfy their bank.  The reason for this is that an appraisal is unable to account for the details that go into properly estimating the value of a parcel of land.  

Bankers would be best served to act and think like buyers of land, not owners.  It is much easier and more accurate to determine the value of land prior to purchasing it.  Once the land is owned, most real estate professionals have a paradigm shift in that they seek to justify their investment value rather than challenge it.  Prior to purchasing the property, prudent professionals will seek the best deal possible and look for ways to devalue the property so that they can invest less on the front end. 

 

Vacant Land
Today (August, 2008) single-family land in Southeastern Wisconsin is trading for anywhere between $20,000 per acre to $100,000 per acre.  So what is your tract worth?  Here are a few simple questions to get you started:

1.       What is the zoning and attendant density?

2.       What is the actual lot yield?

3.       Are there any off site utility costs and required grading?

4.       What are the municipal construction requirements?

5.       What are new homes selling for in the target area?

Answer these five questions and you should have the basic information needed to determine what a lot is worth.

Density and Yield:
Always start here.  Zoning and density are the two simple factors to start with; if the zoning allows for three units to the acre versus two, the difference can be substantial.  At $60,000 per acre in land cost, three units to the acre amounts to $20,000 per lot in land cost whereas two units to the acre is $30,000 per lot.  That’s a 50% increase in actual land cost.  If you are a banker taking back property, the zoning will be on the plat.  If the plat is not yet prepared or recorded, you can obtain the zoning from the municipal zoning official.

Once you determine the zoning, it is best to figure the actual yield.  Zoning may allow for three units to the acre but you may only get two units to the acre after figuring out how much land is truly developable.  Many parcels in Wisconsin have wetlands or other environmentally sensitive areas that will reduce the actual lot yield.

Understanding how the municipality defines density is critically important.  Some municipalities define density to be the aggregate acreage divided by the total number of units – irrespective of land lost to wetlands or other environmentally sensitive areas.  Yet other municipalities define a target for units to the acre while imposing stricter minimum lots sizes.

For example, consider a 100 acre parcel that has 10 acres of wetlands and environmentally sensitive area. We must also factor in “non-lot” land.  In the real estate industry, we use the rule of 3rds. That is to say that 1/3 of the property will be used for Park, Storm water, and/or Right of way (roads).  To keep the example simple we are going to assume that the wetlands cannot be used for storm water management (this is not always the case).

This leaves approximately 60 acres of land for actual lots.  At two units to the acre, you should yield 120 lots (60 X 2).  If the zoning is based on the entire 100 acres (this is the norm), we could yield 200 total lots (100 X 2).  But what about minimum lots sizes?

Assume that this same municipality has a strict minimum lots size of 15,000 square feet.  At 60 acres of developable land with a yield of 120 lots, you would arrive at 21,780 square feet per lot (60X 43,560/120) – or about 1/2 acre lots.  On the same parcel with a 200 lot yield you would arrive at 13,068 square feet per lot – or about 1/3 acre lots (60X43,560/200).

If the municipality enforced the minimum lot size of 15,000 square foot the best you could get on this parcel would be 174 lots (43,560X60/15,000). 

 

Off-Site Utility Costs:
Off-sites can be the one area that causes extreme variances.  In fact, a developer can spend hundreds of thousands of dollars in upfront off-site utility costs that will have a substantial impact on the actual lot cost.  It will also materially affect the proforma from an interest carry standpoint because, for the most part, off-site construction is a large front end cost.  A call to the municipal engineer will determine if there is any off-site utility construction needed.  If off-site utilities are necessary, it is best to retain a reputable engineering firm or other professional to determine the actual costs.

Grading is another (if not the biggest) wild card and is generally the issue that causes the most problems from a cost overrun perspective.  Understanding a site and its grading challenges makes all the difference when trying to determine what the property is worth.  On a 100 acre parcel the grading cost could range anywhere from $100,000 to $1,000,000.  If a grading plan is not yet complete, hire a qualified engineering firm to examine this issue.

When determining the actual value of a parcel of land, developers factor these costs into their equation prior to making a purchase decision.  Appraisals by their nature are not equipped to adjust value for development costs.

 

Municipal Construction Standards:
Obtain the municipal construction standards and pay close attention to anything that falls outside the normally acceptable standards.  For example, road standards can have a big impact on costs.  Roads can change the cost of your lots substantially by increases in depth and/or width.  Also worthy of examination are the storm water requirements and water service requirements, as these factors can cause large swings in cost.  Besides the size of the water mains, which typically range from 6” to 12” in diameter, some municipalities may require the water service to be in ductile iron rather than plastic.  This can add as much as 50% to the cost of the water service.

 

Similar Home Sales in Area:
At the end of the day, a lot needs to have a home built on it to realize its full value.  New home values are driven as much by the land costs as by the bricks and sticks.  As a homebuilder, we apply certain standard to lot values that we do not exceed.  The most basic fundamental is the 25% rule:  if the retail lot price is greater than 25% of the total house and lot purchase price, then there is a problem.  For example, for a home/lot package priced at $225,000, your lot should not exceed $56,250.  In fact, the closer you can get to 20% for the lot price the better.

 

Case Study:
Let’s put everything we’ve learned together in a practical case study.  As a banker, let’s say you are forced to foreclose on a 100 acre parcel that is zoned residential with a zoning density of two units to the acre.

Before getting into the details of the parcel, we need to start with a snapshot of the market.  A qualified market study that determines which homes are selling and at what price is the best starting point.  If there is a limited active market or an excess supply of homes, then your values will be severely depressed.

Let’s assume that, based on the market research, you feel a market exists for homes in the $200K – $250K segment.  So what is that 100 acres worth on the open market?

First we determine that at two units to the acre the parcel could yield 200 lots (100 X 2).  The municipality has a strict minimum lot size of 1/2 acre (21,780 sq ft).  However, we have only 60 acres of developable land after we account for streets, parks, and storm water facilties.  At 60 acres, each lot would be about 13,068 square feet, which is smaller than the 1/2 acre minimum of 21,780 sq. ft.  As a result, our yield is reduced to 120 lots (60X43,560/21,780).

We were also able to determine that sewer service must be extended to the site.  The sewer is about 1,500 feet away and requires an 8” line.  This will cost about $50 to $60 per foot.  At $60 per foot the extension will cost $90,000 for the entire site.

We determined that there was nothing out of the ordinary with the municipal construction standards and, other than the sewer off-site costs, normal conditions should apply.  Generally speaking, we use about $30,000-$35,000 per lot in construction costs provided the grading costs appear to be in line.  On a project this size, a normal (or good) grading cost would be about $450,000 – or $3,000 per lot.  This site has some issues with grade and some potential soil problems.  We assume that an additional $300,000 in grading costs will be necessary to complete the construction so we add $2,500 per lot ($300,000/120) to our normal $30,000 per lot for construction costs.

Accounting for the off-site utilities and the grading issues, we will use a factor of $35,000 per lot in site construction costs.

The remainder is as simple as backing into the value of the vacant land.  At $35,000 per lot in construction costs and 12% for soft costs, we are left with a lot cost of $39,200 ((35,000X120)+12%/120) before land.  Earlier we determined that there was a market for homes between $200,000 and $250,000.  Assuming a $225,000 average total house & lot price, a retail lot price at 25% equates to a value of $56,250.  Simply deducting the $39,200 from the $56,250 will determine that the land is worth approximately $17,050 per lot or $2,046,000 for the entire site.  Translating this to a fair market appraisal, it is worth about $20,046 per acre before developer profit.  Depending on what type of profit is sought, we would seek to add between $6,000 and $10,000 per lot at a minimum.

 

The value of residential land is most significantly impacted by the value of homes that are selling in the market area and the specific site conditions that drive the construction cost.  Using comparables from land sales in adjoining municipalities that occurred months ago is not always the most accurate way to determine a parcel’s worth.  This method does not correctly reflect the costs that may or may not be necessary to develop the property.

For more information on valuation methods and development costs, contact Scott B. Thistle at Provident Real Estate Services ( sthistle@providentres.com ) or visit our website at www.providentres.com.

Mr. Thistle is a Managing Member of Provident Real Estate Services LLC and has seventeen years experience in real estate development.   Provident Real Estate Services, LLC is a real estate consulting group specializing in bank workouts and real estate disposition.

 

 

 

 

 

Foreclosing Improved Property

If your bank is taking back real estate assets (REO/OREO), make sure you are aware of what you are getting….

Banks these days are busy owning more real estate than ever.  But going through the process of foreclosing improved property and taking title is a small piece of the real work. The value analysis and disposition of those REO/OREO assets is the difficult part. 

Once you have taken the asset back you should have a very specific checklist to follow to ensure that you understand exactly what you own – especially in the case of improved property.  Knowing exactly what you have will help you better understand what the property is worth, and ultimately what price it might command on the open market.

When foreclosing improved property or unimproved land, it is important to understand the distinctions between the two.  With land or lots that are fully improved (meaning all infrastructure is installed), the risks can sometimes be greater for you during the bank workout for the reasons that we will explore in this article.  Vacant, unimproved property has its own set of issues (to be covered in a future article).

Fully Improved Land:

When taking back real estate assets (REO/OREO), the real risks are in the outstanding agreements and/or fees due to the municipality, and any potential environmental considerations.  The aforementioned fees generally do not show up in a title commitment and cannot be insured over, even with a Special Assessments binder.  Unfortunately, they could materially affect the value of the land.  Foreclosing improved property that has some type of environmental problem could lead to another set of challenges.   Below you will find a checklist of things to consider before you foreclose, finalize the bank workout, and take ownership of the improved property.

1.       Title Insurance:                This seems like an obvious piece to the puzzle, however many people take the actual policy and consider it nothing more than just insurance.  Make sure to understand the items on the various schedules and how they might impact the actual value of the parcel.  We suggest that you have your real estate attorney or qualified real estate expert examine the schedule “A” for accuracy and the schedule “B” for potential problems.  This is your best starting point to fully understanding the property and the real estate assets (REO/OREOs). The schedule “B” is chock full of material facts regarding the property and may give you insight into why your debtor client walked away from the property.

 

2.       Appraisal:                           Appraisals are not what they used to be, however they do provide insightful information and certainly help determine the value of a parcel of land.  The information NOT included in the appraisal is what should concern you.  For example, outstanding tax liens with penalties and interest will impact your cost basis on the property.  Appraisers are also not qualified to render opinions on environmental conditions and the corresponding diminishment of value.  Likewise, topography can play a big role in what it will cost to construct a new home or building on the land and will factor into an offer that a builder or contractor may make on the property.  We advise all of our clients to have a qualified construction expert look at the land prior to determining what the parcel is worth.

 

3.       Recorded Plat:                  Having a final recorded plat will give you many of the important details you need to adequately understand the parcel during the bank workout of the real estate assets (REO/OREOs).  If it is a residential or commercial parcel, the plat will include information such as exact lot dimensions, building setbacks, zoning, easements, survey monument locations, and critical notes.  Obtaining a copy of the plat can be as easy as visiting the municipality’s engineering or planning department and requesting a copy.

 

4.       Real Estate Tax Records:               If your bank is foreclosing improved property, it is a pretty safe bet to assume that the real estate taxes have not been paid.  More often than not, you will find that the taxes for past years (including interest and penalties) are due.  Be sure to check with the municipality’s tax assessor or the clerk regarding back taxes.  If your parcel is in an unincorporated town, it is advised to also check with the county. 

 

5.       Zoning Code:                     Make sure you understand the actual zoning on the parcel prior to determining a value during the bank workout.  Often, a parcel may have multiple zonings.  It is best not to assume anything when it comes to zoning and to talk directly to the zoning official at the municipality.  You may think your debtor client had the final zoning in place on the entire parcel, but that is often not the case.

 

6.       Recorded Deed Restrictions:      If recorded deed restrictions exist, they should (but don’t always) show up on the schedule “B” of the title commitment.  Understanding what is in the Deed Restrictions and their potential impact will greatly affect the value of the parcel and the real estate assets (REO/OREOs).  If you have assumed the declarant rights while foreclosing improved property, you may have the ability to amend the deed restrictions.

 

7.       Environmental Conditions:         Prior to foreclosing improved property we would strongly recommend you conduct, at a minimum, an environmental screening.  An environmental screening can be done for a few hundred dollars (usually around $500).  The environmental screening is different from a phase one environmental assessment in that the screening only searches the major environmental database for issues.  We would also recommend that someone from the bank or a bank representative walk the property for visible signs of dumping or the like.  If you are not comfortable walking the property, we recommend that you pay an engineering firm to walk the property as part of the screening process.  Foreclosing on a property that has environmental problems may open up the door for major expenses and responsibilities associated with clean up.  It is not unheard of for a debtor who may be in trouble to accept payment for dumping on a property they plan to give back to the bank.

 

8.       Developers Agreement:               Also referred to as a subdividers agreement, this is the contract between the developer and municipality that outlines what must be done for the developer to be released from obligations to the municipality.  If your debtor was the property developer, this becomes a very important document to understand during the bank workout of the real estate assets (REO/OREOs).  It will outline all of the contractual obligations the developer (now you) has to the municipality. The agreement will also talk about what has to be done to release letters of credit, which as the lender you have more than likely posted.  There may be outstanding warranties on the infrastructure as well as other improvements that must be made before the municipality will allow any building permits to be issued.  We strongly urge all of our clients to consult with the municipality’s engineer concerning the developer’s agreement as well as any outstanding issues that may be in play regarding the parcel while foreclosing improved property.

 

9.       Impact Fees:                      Whether we like it or not, impact fees are a major expense on any parcel and, depending on the timing of the payments, may be outstanding on your parcel.  In the state of Wisconsin, the impact fee law compels the municipality to collect impact fees at the time the building permit is pulled.  If the impact fees are due at the time the building permit is issued, most customers (builders, contractors, or individuals) will factor this into their offer on the property.  Impact fees in the state of Wisconsin can vary greatly so don’t assume the fees to be any specific amount.  In the municipalities in which we have experience, we have seen fees differ as much as $15,000.  The impact fee law has changed substantially over the last five years so if you are foreclosing improved property and obtaining real estate that was platted several years ago there may be some rights to recover impact fees that were paid up front.

 

10.   Status of Infrastructure Installation:                       Don’t assume that the installation of infrastructure is complete.  When dealing with a developer that is having financial trouble it is not uncommon to find they have taken short cuts in the construction of the infrastructure and real estate assets (REO/OREOs).  To verify that you have adequately reserved for the cost of the remaining infrastructure, you should (a) interview the municipality’s inspecting engineer for known outstanding items, (b) analyze the contractor’s draws for unbilled items that need to be completed, and (c) work with the municipality’s staff to return any outstanding letters of credit.

Cover these ten basic items when foreclosing improved property and taking back real estate assets and you will, at the very least, protect your assets by better understanding the challenges and opportunities that exist.

The key to determining the value of REO/OREOs is to value the property as if you were a purchaser of real estate, not the owner.  Examine the costs associated with owning and/or building on the property and you will be better educated on the real value.

For more information on pre-foreclosure consulting and foreclosing improved property, contact Scott B. Thistle at Provident Real Estate Services (sthistle@providentres.com ) or visit our website at www.providentres.com

Mr. Thistle is a Managing Member of Provident Real Estate Services, LLC and President of Brookstone Homes, Inc.  He has 17 years experience in real estate development.  Provident Real Estate Services, LLC is a real estate consulting group specializing in bank workouts and real estate disposition.