Land Value Calculator

What Is Residual Land Value?

Residual land value is an estimate of what a developer can afford to pay for land while still achieving a target level of profit.

The calculation works backwards. You estimate what the finished project could be worth, subtract the costs required to develop it and the profit you need to earn. What is left over is the amount available to pay for the land.

In simple terms:

Project Value − Development Costs − Required Profit = Residual Land Value

Why Is It Called “Residual” Land Value?

The word residual simply means what remains after everything else has been accounted for.

In a real estate development analysis, you start with the expected value of the completed project. From that value, you deduct construction costs, soft costs and other development costs. You also deduct the developer’s required profit.

The residual, the amount remaining, is what the project can support in terms of a land price.

What Do You Need to Calculate Residual Land Value?

A residual land value calculation depends on four fundamental questions:

1. What can you build?
You need to first understand the development potential of the property. This will involve a review of zoning, easements, environmental features etc.

2. What will the finished development be worth?
For a for-sale development, this is typically based on the expected sale value of the completed units or space. For a rental property, the value may be estimated using projected net operating income and a capitalization rate. Check out the our Cap Rate Calculator for more information on this method.

One key step here is to incorporate the “building efficiency” rate. Efficiency, refers to the fact that what you sell will probably be less than what you build.

For example, if you’re building an apartment building, your per square foot sales rate will typically just be based on the size of the apartment units themselves. But, you will need to build more than just the units (i.e. the hallways, amenity areas etc.).

Play around with the efficiency rate in the calculator above to see how much this can impact the results.

Quick tip: Don’t be overly optimistic with this number to start. Find out the efficiency of similar completed projects and try to match that.

3. How much will it cost to develop?
Development costs include construction, consultants, municipal fees, financing, marketing, contingencies and other soft costs. A more detailed analysis may also account for timing, carrying costs and other project-specific expenses.

4. How much profit do you need?
Development involves risk, time and capital. The calculation therefore needs to account for the level of profit or return required to make the project worthwhile.

And just because you may accept less profit, doesn’t mean your investors or banks will. Everyone is taking risk on the investment and they need to be compensated for it. No one is going to risk vast sums of money for profit that could be achieved through a government bond of GIC. Maybe someone would, but you shouldn’t.

Change any of these assumptions and the amount you can afford to pay for the land will change. Play around with the calculator to see the impact of certain assumptions.

Is Residual Land Value the Same as Market Value?

No. Residual land value is not necessarily the market value of the property.

It represents the land price supported by your particular development scenario, assumptions and required profit. The property itself may ultimately sell for more or less.

Also, another developer may arrive at a completely different residual land value for the same property. They may believe they can achieve more density, sell the finished product for a higher price, build for less, obtain financing on different terms or accept a different level of profit.

This is why residual land value should not be treated as an appraisal or a definitive statement of what a property is worth.

Why Is Residual Land Value Useful?

Residual land value connects the price of the land to the economics of what can actually be developed on it.

It can help when evaluating a development site, determining a potential purchase price, comparing development concepts, testing different densities or assessing whether an asking price can be supported by a development pro forma.

Your Residual Land Value Is Only as Good as Your Assumptions

A residual land value calculation is not a prediction or an appraisal. It is the result of a set of assumptions.

If achievable density is lower than expected, construction costs increase, approvals take longer, financing costs rise or finished values decline, the amount that can be supported for the land may decrease. The opposite can also be true.

Theoretically, if a municipality increases fees substantially, and everything else stays equal, then the residual land value should drop.

Early in a project, high-level assumptions can be useful for determining whether a property is worth investigating further. As the project progresses, those assumptions should be tested and refined through planning and zoning review, market research, cost estimates, due diligence and a more detailed development pro forma.

Residual land value analysis is a fundamental exercise to land development analysis. If you need guidance with this analysis, contact our team at info@sitmentor.ca.