The Creative Investor - Part 2: Thinking like a Builder

How do you estimate the value of land for residential development? For starters, you should never price it by the acre or even think of it in terms of X$/AC. Why? Because the raw land value is not related to per AC values, but rather to what the property could yield, how it can be used, the projected sale value of the total package end product (the new home on its lot) and the estimated cost for installing site and off-site improvements required for the proposed development, such as streets, curbing, sidewalks, utilities and storm water management facilities. Value of residential development land is always relative to use and not to the number of acres. In a way, size doesn’t matter. Here’s an illustration:

Suppose there are two vacant 50 AC parcels you’re thinking about buying in the same municipality. Zoning for Parcel A requires a minimum lot size of 40,000 SF and width of 200 feet; Parcel B zoning requires 30,000 SF lots and 150 ft. widths. On average, the new homes would sell for $300,000 on Parcel A and $350,000 on Parcel B. Each parcel is fairly level with no remarkable physical constraints. Per-lot improvement costs are ball parked at $56,000 for A and $43,500 for B.

In this scenario, Parcel A would probably be worth around $760,000 (or $19,000 per lot raw) to a builder who was buying fully-contingent. Parcel B, however, would command a price of over $2.3 mil ($44,000/lot). The reason that there’s a big difference in the bottom-line value of these parcels is because there are differences in the lot yield, end product value and improvement cost.

If Parcel A were for sale at $19,000/AC, it would be for sale for a l-o-n-g time, given this example. On the other hand, if Parcel B were for sale at $44,000/AC, it would sell in a heartbeat. Change yield or new construction value or lot improvement costs, and it's a brand new ball game.

Nancy Chadwick has developed two books about developing land and conducting research as an investor.