Land development is the process of preparing raw land for the construction of improvements.
Pricing land for development can be a difficult task for the untrained investor. As a niche subset of both residential and commercial real estate, using comparables for land can be as dangerous to a developer as it is mysterious, sometimes causing the failure of what was certain to be a great development.
There is one universally accepted land valuation method used by development professionals, corporations, and appraisers alike; the Land Residual Method. Using this method is to determine the current and future value of any piece of land, whether its use be residential or commercial.
The land residual method is a calculation that takes the highest and best use of a particular piece of property and subtracts out the total cost of development to arrive at the residual value: the land value.
Use and Utility
You’ve heard the term “Location, Location, Location” thrown around in many real estate circles. It is never more true than when developing land.
Property value is determined by its highest and best use. A piece of property that can be developed into a regional shopping mall will be more valuable than a property that can only be developed into a single family home. This is because the end use of the former has a much higher finished value than the latter. The value of the materials are more and the expected income from renting or owning the first is significantly more valuable than the second. It all comes down to profit and a return on investment. Generally speaking there is more profit to be made in larger commercial buildings than a single family home. However, the commercial property takes significantly more risk and money to develop.
As a developer/investor you’re here to make a profit. You want to work that into the equation before you price your land and make your offer. Most developers of residential property like to make between 25-35%. Anything below that will be hard to finance through a conventional lender, and would also be a risk on your part. Markets move up and down, sometimes as much as 10% in a few months. If your profit margin was only 20% and the market drops 10% you’re left with a 10% profit. For that kind of money you don’t need the risk of development you can just go out, buy a T-Bill, and sip iced tea on your front porch until retirement.
There are six steps in the process of development.
How to get Started
Determine your target market.
It could be your local neighborhood, a particular zip code, or the entire city.
Don’t make the mistake of thinking you need to develop in the high-end areas. That’s not always the case. There are many developers who profit in areas that are at median income levels or below. To figure out the best market in which you should develop you’ll perform a Feasibility Study, the first step in the process of Residential Land Development.
You have found a hot market, now all you need to do is find the available land to purchase and develop.
Remember, to have an professional at your site who performs all researches and planning, the better you’ll know your market the fewer surprises you’ll run into later. Many developers have gone broke thinking that they can develop a lot just because the home across the street sold for a certain amount. Market’s change, costs go up and down, and contractors can get busy.
Once you’ve find your site or your area, you’ll want to estimate the potential future profits. This is done by performing a highest and best use analysis.
Highest and Best Use
The highest and best use of a piece of land is determined by answering four questions in the following order:
- Is your proposed project legal?
- Can it be built practically on your site?
- Will your project generate the desired return?
- Does the proposed use represent the use that will deliver the maximum return?
When developing single family homes, find an area that allows that kind of home to be built. Determine the allowed sf to build on two stories, that style home must be able to be built practically on our site. The goal is to return a profit of 30% on the cost, to be able to sell the property for at least 30% more than what it will cost to build it.
As an experienced Florida State Certified General Contractor and as an Real Estate agent, I can help you with finding the right land and with developing the land.