Determining the value of improved property (upon which one or more commercial, residential, or other types of properties have been built) is a relatively straightforward process that includes comparing sales of similar properties in the area. But matters may not be as simple when the property is vacant and undeveloped. In this case, investors rely on professional appraisers experienced in determining the land’s potential use and value. Land buyers and investors should better understand this process and what’s involved, including:
- Why a vacant land appraisal needs to be performed
- Determining highest and best use of the property
- Steps involved in a vacant land appraisal
- Who orders and pays for the appraisal
An appraisal report with favorable results can provide peace of mind that the land you’re eyeing is a good investment. But lacking a preferable appraisal value, you may not obtain the financing you need or you might want to back out of the deal. Though the appraiser’s estimated appraisal value and final report may disappoint you, it could help you avoid buyer’s remorse and improve your ability to scout out worthy properties in the future.
Why a vacant land appraisal needs to be performed
No matter what kind of property you’re targeting for purchase, it’s crucial to determine its market value. This value can help guide your decision on making the right offer price and aid you in forecasting profit margins, property taxes, closing costs, and other significant metrics. Using an appraised value determined by an expert, you can make a more informed decision on whether or not the property is a good value and worth your investment dollars.
But vacant land appraisals are different from appraisals of built property.
"A vacant land appraisal is primarily concerned with the highest and best use of the property. If this is not determined before the sale, the appraised value could be incorrect," notes Mason Spurgeon, a certified general appraiser in Kirksville, Missouri.
Determining best and highest use of the property
To ascertain highest and best use, the appraiser must analyze the prospective value related to alternative uses of the property as well as the property’s current use. There are four tests that the Appraisal Institute recommends appraisers use to help determine the highest and best use of the property: Is the use (1) physically possible, (2) legally allowed, (3) feasible financially, and (4) maximally productive?
"Issues of physical possibility include size, shape, soil suitability, frontage, visibility, and access,” explains Robert Gagliano, president of Little Silver, New Jersey-headquartered Gagliano & Company, which provides real estate valuation assessments. “Legal issues include local zoning codes and can be regulatory in nature, with the presence of wetlands, endangered species, and stormwater management regulations being good examples. Legal issues related to residential development are often concerned with types of units permitted and the potential number of dwelling units. Commercial developers, on the other hand, are concerned with legal uses permitted and potential floor area.”
If the property passes the physically and legally possible tests, the next hurdle is to decide if the anticipated use will be financially feasible. This is demonstrated by gathering data, performing a market analysis, and creating proforma cash flow estimates.
"For example, a vacant parcel on a side street might be a poor location for a retail strip center, but it could be well suited for an office building," Gagliano continues. "Then the real drill down begins: Is there a market for new office space? Is there any new construction in the area? And how do values in the area compare to current construction costs?"
Lastly, it’s helpful to rank all of the viable anticipated uses that remain in order of return rate or value. Ultimately, the projected use that is considered maximally productive is the one demonstrating the highest net present value and internal rate of return.
"It’s the appraiser’s job to determine which use will bring the highest value to the land," says Gagliano.
Steps involved in a vacant land appraisal
There are many important stages involved in appraising a vacant lot, say the experts. Among them:
- Research. "We start the process by determining where the subject property is located using the legal description and maps, including geographic information system maps, aerial maps, and zoning maps," says Spurgeon.
- Inspection. "Next, we physically inspect the property," Spurgeon adds, “looking for access, terrain, other land uses, and other relevant characteristics.”
- Establish highest and best use of the property (as described above).
- Identify and analyze land sale comparables. "Here, it’s imperative that the appraiser understands that value follows use. A sale of land for the development of a three-story office building should not be used to value a parcel that has a highest and best use of industrial development, even if the permitted square footage is identical. Land sales must be carefully researched," Gagliano says. Spurgeon agrees, noting that "while the location of comparable sales is important, it’s even more vital that the sales have the same highest and best use."
- Select an appropriate unit of comparison. "Years ago, appraisers used a simple per acre or per square foot analysis. We’ve found that the minimum today is a per usable acre analysis, because the usable portion of the property -- the net of wetlands, slopes, and other physical encumbrances -- is isolated,” says Gagliano. He adds that the most precise analysis for residential development is per dwelling unit, while the most precise analysis for commercial property is per proposed building square foot.
- Organize the land sales and adjust for differences. Next, the comparable land sales are typically arrayed on an adjustment grid and amended for differences in property rights conveyed, financing, conditions of sale, and market conditions (time). "The next adjustments are at the discretion of the appraiser and can include location, physical characteristics, and size," Gagliano says.
- One of the most important adjustments in many areas relates to zoning. "For example, if the vacant lot is in a zone that permits single-family dwellings on 20,000-square-foot lots and the land sale comparable is in a zone that has a minimum lot size of 30,000 square feet, an adjustment is warranted," says Gagliano.
- Equally important is approval status, as fully approved parcels can garner significantly higher sales prices. "We recently performed an analysis for flipped residential land sales," Gagliano recalls. "The first sale was the purchase of raw land, and the second sale was for a fully approved parcel. The results, which showed premiums ranging between 39% and 572%, respectively, were eye-opening."
- Reconcile the adjusted sale prices to a single value. The net and gross adjustments are analyzed, and the appraiser determines how much weight will be given to each land sale in the final value estimate, according to Gagliano. Then, an opinion is reached on the vacant land’s value.
- Create the appraisal report. "This is how all the information collected in the process and the value of the subject property is transmitted to the client," says Spurgeon.
Who orders and pays for the appraisal
Rajeh Saadeh, a real estate attorney in Somerville, New Jersey, says "The buyer or buyer’s lender commonly orders the appraisal, the appraisal is typically conducted by an appraiser of the lender’s choosing, and the buyer foots the bill."
Gagliano notes that buyers, investors, and/or their attorneys also order land appraisals for estate settlement, partnership or family disputes, divorces, tax appeals, eminent domain actions, potential acquisitions or dispositions, donations, and several other reasons.
"Cost and time will vary, depending on the complexity of the assignment and type of report required," says Gagliano. He estimates that an appraisal for an empty lot targeted for a single-family home could cost $250 to $1,000 and take less than a week, while a complex valuation of a vacant parcel that requires reports from other professionals (such as engineers, planners, and cost experts) can tally $25,000 and up and span six months.
Additionally, be aware that if the property does not appraise favorably, "either the lender will not grant the loan or the lender will lend less than anticipated," Saadeh cautions. "Also, the loan terms, such as interest rate and loan costs, may become less attractive if the property doesn’t appraise as high as expected."
Lastly, note that "many lenders won’t offer vacant land financing unless the buyer provides a clear plan to develop the property and has a successful track record of developing similar properties," says Gagliano.
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