3 Tips For Maximizing Land Value When It's Time to Sell
As a real estate asset class, land is often the most misunderstood. What makes one piece of raw land worth more than another similar-looking property?
Location is an obvious answer. But citing location alone doesn't begin to scratch the surface of articulating all the factors impacting how a piece of land is valued.
And that poses several challenges for landowners as they look to capture the most value for their real estate. Because if you don’t have a solid understanding of what impacts a property’s value, you can’t begin to take steps to maximize its value when it’s time to sell.
First, you'll need to throw out everything you think you know about pricing land. This article will deconstruct how homebuilders and real estate developers value property, explaining why some land is more valuable than others. Then we'll cover 3 tips that landowners should consider if they're looking to maximize the value of their property. For a deep dive into everything land, check out our landowner's resources page here.
If you missed the first article in our landowner series – “When is the right time to sell your land as a landowner” - you can check it out here. That should offer some additional context as we dive into a discussion about maximizing your land value.
So, let’s jump right in.
The wrong way to value raw land
If you ask a real estate agent, most will tell you that the comparable sales (or “comp”) approach is the most effective means of valuing a property.
Essentially, properties with similar features in corresponding geographic regions are compared against each other. Depending on the size of the comparable property, many agents and landowners will then extrapolate a $/acre figure and use that as a benchmark to infer a land value.
That approach works well for a few homes in the same submarket but misses the mark regarding land valuation. Because no two pieces of land are the same, countless surface and subsurface conditions will impact the site's feasibility and value.
But what are those variables, and how do they impact land value? To unpack this, let's look at how real estate developers value land and why that’s important to landowners.
How real estate developers and builders value raw land
Despite how they're portrayed, most real estate developers aren't greedy capitalists solely focused on maximizing profits. Most developers aren't in the business of strong-arming unsuspecting landowners into selling their properties below market value.
But they are driven by making money; otherwise, they wouldn't develop a property.
Profit is one of several important metrics quantified during a real estate development feasibility study that guide whether a developer will move forward with a project. Because with all the additional fees, bureaucratic headaches, and challenges municipalities present developers nowadays, a project needs to offer developers an adequate return, or they won’t pursue it.
So that means that at its core, land value is based on the future income generated from a property. Because to make money, a developer needs to understand what the property can yield and back out their fees and development costs into a “land value” or a purchase price.
But what conditions impact the potential development of a site?
The short answer is everything. And estimating sitework and land development costs and the extent of work required for development is often a considerable challenge.
When it comes to a potential project, most real estate developers are concerned with how dense and what types of allowed development a site will yield. And this creates a situation where the surface and subsurface conditions of an individual property substantially dictate what can be built and, ultimately, the value of a property.
Consider it this way:
A site's topography impacts the amount of grading required and site engineering work, influencing the size and cost of retaining walls if required.
A property's access or proximity to public utilities is a significant variable, impacting both the cost and development density that a developer can achieve on a site.
A property may or may not require off-site improvements – that’s often dictated by the type of project you’re proposing and the municipalities development requirements.
The presence of streams or wetlands on a property can impact development yield and the value of the land. A stream & wetland delineation would be required to determine the extent to which a property is encumbered.
Even things that aren't evident on the surface – like floodplains and watersheds, environmentally protected areas, and impervious surface allowances.
The land comparison approach doesn’t adequately consider all the different variables that impact how much can be built on a property and how expensive it will be for a developer to develop the land.
Each property needs to be investigated for its unique characteristics, and all potential associated development costs must be accounted for. Then those costs are weighed against the probable future value of a completed project.
But understanding how to value land is only the first step. Let’s discuss a couple of tips landowners should consider for maximizing the value of their land.
1. Consider who is the end user or potential buyer
Anyone that’s spent time in sales understands that you need to know your target buyer before you can effectively market and sell your product.
Selling a property at the highest value is no different.
Consider how different builders and developers specialize in various types of real estate. For example, national home builders typically focus on large, moderately dense residential subdivisions, frequently with hundreds of potential lots. While local and regional builders may instead focus on projects with a slightly smaller lot count or may deal with land that does not have access to public utilities.
Some developers strictly focus on high-density infill development or may specialize in apartment and multifamily construction. Other developers are experts in strip mall construction or warehouse development.
A property’s zoning and land use will govern what can be built on a property. Additionally, a municipality's future land use plan may offer insight into what sorts of projects may be approved.
So, by understanding the type of land and allowed land use, you’ll know what kinds of buyers may be interested in purchasing the property. That will help you to more effectively market and target the right potential buyers to maximize the sales price.
2. Consider using land entitlements to increase its value (highest & best use)
Land entitlements are the legal permits and approvals required before you’re allowed to develop or build on a piece of land.
Depending on the proposed project or development, the land entitlement process can be time-consuming, costly, and risky.
Consider a single-family residential subdivision development – before a homebuilder can begin building houses, a property must be subdivided into separate legal parcels. To subdivide the land, specific conditions must be met under the allowed land use regulations – characteristics like adequate lot sizes, proper rights-of-way and property setbacks, adequate greenspace, sidewalks, and landscaping, and a comprehensive stormwater plan.
Once the plan has been drafted, reviewed, and shown to meet the standards, it's signed off on by the proper regulatory authorities and recorded as an official subdivision plat. After final engineering, that recorded plat serves as the guiding plan for a builder to develop homes on the newly divided lots.
Depending on the size or complexity of the proposed land subdivision, the entitlement process may be as simple as an administrative approval of conceptual design after some minor feasibility work. That feasibility work will broadly differ by municipality but offers a lower risk entitlement alternative to more complex projects.
The land entitlement process for a commercial real estate development project can differ significantly but offers a landowner the same potential benefit of added value.
One of the biggest indicators of a property's value is the allowed density of development. Land that accommodates apartment construction will generally command a higher price per acre than land that only allows for one single-family unit per acre, for instance.
To achieve the land's highest and best use or maximize the value of your property, rezoning may be required to change what can be developed and increase the allowed density. A rezoning adds significant risk to the entitlement process but will often result in a higher sales price.
3. Consider several exit strategies
Because real estate is illiquid, it's vital to contemplate possible exit opportunities to give yourself the maximum ability to pivot with changing market conditions.
Land often transacts even more slowly than an improved property, which challenges landowners in timing their sales.
But as a landowner, you have several options for when it might make sense to exit your project: "as-is," after light feasibility and investigative work, fully entitled "paper lots," developed lots or a joint venture with a builder.
Each strategy offers a distinct risk profile to the landowner and requires a different amount of time and capital. Additionally, because different builders buy projects at various stages of the investment cycle, it's important to engage potential buyers early to understand how they'd like the property delivered. That way, landowners can create an exit strategy that makes sense based on their goals and the goals of the real estate developer.
When crafting an exit strategy, a landowner's desired timeline is an important consideration. Selling a property "as-is" normally carries the lowest risk and is the quickest exit, but will yield the lowest sales price. Light feasibility and due diligence may take several months to complete and require some capital outlay, but will garner a higher sales price. As more entitlement work is completed to convert the property into a higher and better use, the project becomes riskier and more time intensive, requires a more substantial capital outlay, but maximizes the land value.
How can a landowner determine how much to invest in land entitlements?
Let’s think back to the discussion above about how real estate developers and builders value raw land. Land value is the future income that can be derived from a property – but what exactly does that mean?
Consider a residential subdivision from a homebuilder's perspective.
Let's assume a homebuilder finds a property that will support the construction of 30 single-family homes. Comparable homes in the area sell for $500,000 each and typically sell within 2-3 months of a completed building.
To arrive at a land value, a homebuilder will work backward from the sales price of a finished home. Then the builder will subtract all the costs associated with building the house – real estate agent commissions, construction materials, labor, land development costs, entitlement costs, carrying costs, financing fees, etc. Finally, after accounting for the builder's desired profit, the remaining number is the price a builder can pay for the land, also known as residual land value.
Depending on the quality and type of home being built, a good rule of thumb is the finished lot cost should not exceed 20-25% of the home price. So, on a $500,000 home, the value of the land should be $100,000. Let's assume site work and land development costs are $45,000 for the property, which leaves a remaining value of $55,000 per lot. But this $55,000 value fails to account for any of the costs, time, and risks associated with entitling and approving the lots for development.
A developer would need to hire various outside consultants on a typical residential subdivision to assist with the entitlement – civil engineers, environmental consultants, utility consultants, architects, landscape consultants, etc. Those consultants incur costs, and the municipality typically has its processing and application fees as well.
And if the project requires a rezoning or special use permit, attorney fees can quickly add up and the time needed and the project risk increases dramatically.
Most home builders aren't land development experts and are not interested in navigating the entitlement and approval process. But that's why there is an opportunity - landowners shoulder the land entitlement risks and capture the upside as a result.
Let’s assume that to entitle the 30-lot single-family development project, engineering, consulting, and application fees total $150,000. That equates to $5,000 of costs on a per-lot basis. Subtracting that from the $55,000 per lot figure after netting development costs, we arrive at a residual land value of $50,000 per lot.
A profit opportunity exists assuming the landowner's "basis" in the land is less than $50,000 per lot. In other words, if they paid less than $1,500,000 ($50,000 x 30 lots) for the land, it may be worthwhile to pursue adding value through land entitlements.
What potential risks exist in pursuing land entitlements?
Although land ownership is generally low maintenance, it doesn’t generate inbound cash flows. So, one of the challenges during the land entitlement process is there is no income to pay engineers, consultants, and attorneys or land carrying costs while a project is awaiting approval. That may create a challenge for landowners that are illiquid.
Additionally, builders and developers may or may not be building homes or commercial properties depending on market conditions. If a property owner has capital tied up in land entitlements, they may run into a problem if the land doesn't sell as quickly as anticipated.
Understanding where we are in the real estate cycle is critical to determine whether it makes sense to entitle a property speculatively. Investing in real estate during a recession requires a deliberate approach to navigating the short and long-term conditions created by market downturns and potentially creates a risk to pursuing land entitlements.
Another potential land entitlement risk to consider is political uncertainty. There is no guarantee that the municipal approval authorities will sign off on a project, and that risk grows exponentially if rezoning or special use permits are required.
It's critical to consider what is feasible on a piece of land given market, political, and development considerations to minimize risk.
How a real estate development consultant can help you maximize land value
As development becomes more complex and municipalities introduce added friction into the process, landowners are faced with more challenges than ever if they’re eager to maximize land value.
And at the same time, the real estate industry has evolved into a series of disjointed functions that deliver services according to their priorities – landowners lack a "one-stop-shop" when assessing a property's feasibility, navigating the land entitlement process, or maximizing a property's value.
And those misaligned incentives between a real estate service provider and landowner create a situation where property owners often spend too much money on bad advice.
And the mistakes can add up quickly.
Landowners can quickly spend tens of thousands of dollars on entitlement work that doesn't increase the property's value.
A real estate development consultant offers an alternative to this outdated model. Their expertise crosses over traditional real estate functions to provide landowners with a resource to help them navigate the complexities of land ownership.
Marsh & Partners offers real estate consulting services to help landowners answer these questions.
If you’re interested in maximizing the value of your property, or you want to kick around ideas, you can book some time on our calendar – we’ll have a quick conversation to get you headed in the right direction.