A smart investor knows that determining the value of their investment is a crucial matter. The value that is drawn out will spell how every step of the investment process moves forward. But it’s easier said than done. Determining the real market value of a piece of land can be a difficult proposition, considering that accurate valuation data is hard to come by.
Luckily, there are real estate appraisers you can hire to determine the value of the land you’re acquiring or financing. But even so, it’s important that you, as the owner and investor, knows how land valuation works so that you can protect your interests and make the right decisions for your business.
Property Appraisal Approaches
It’s important to first understand the approaches taken by real estate appraisers to better understand how land value is determined. To find the value of a piece of property, real estate appraisers consider three approaches: the cost approach, the income approach, and the sales comparison approach.
The Cost Approach
The cost approach considers the expenses involved in building a structure from the ground up. What the appraiser does is break down the construction costs and come up with a close estimate to help determine the potential property value.
The numbers of construction costs will be based on the current prices on the day the cost approach is conducted. A lot of factors come into computing construction costs, including:
- Building materials
- Allocation for risk management.
Being that the cost approach only determines property value on the basis of construction costs, it’s not a very accurate measurement. Hence, appraisals never use this on its own. It’s often paired with one or all of the other property valuation approaches.
The Income Approach
In the income approach, the basis for computing the land’s value is the potential income that the property can be expected to produce. One of the most accurate determining factors is lease revenue, or how much the property owner can earn if the house or building was rented out.
To come up with a value, the appraiser will consider the market rent in the area surrounding the property. They will take a look at how much similar properties in the area are being rented or leased out. Similar properties will have the same size, amenities, condition, location, etc. as the property in subject.
The market rent of the land can be an accurate determinant of the property’s potential value and how much the owner or investor can receive as an ROI.
The Sales Comparison Approach
Pieces of property around the same area would relatively cost the same. That’s because the value comes from similar factors, such as the cost of living, location, access to amenities and transportation, and even crime rates and population demographics. With this, people will always expect similar costs for all properties in a surrounding area or neighborhood.
Putting that into consideration, the sales comparison approach requires the appraiser to dig through records and look at recent sales figures of similar properties. They determine how much similar properties were sold in the past and balance that value out with the current market value. The numbers of past sales histories can be retrieved from appraisal records, real estate agents who have worked in the area, public records and documents, etc.
The sales comparison approach is the most accurate measurement of property value because it takes a look at concrete sales history and purchasing values of properties around the neighboring areas.
The Problem With Vacant Land
The three aforementioned approaches, however, almost never become applicable in determining land value. Only the sales comparison approach can be a viable option, while the others can’t be an accurate basis because of the fact that there is no property in the first place.
Real estate experts will tell you that it’s impossible to determine a vacant land value that’s a hundred percent accurate. But there are ways to retrieve a ballpark value that can be a good basis to move forward with the process of selling or leasing a parcel of land.
The factors to consider to come up with a ballpark value and evaluate a potential land investment include:
- How is the property zoned and what can it be used for?
- How many similar properties are there in the market?
- Are there similar properties in the vicinity that can serve as a basis for the land value?
- How desirable is the property?
- What are all the holding costs involved?
- Is there road access?
- What are the specifications (size, shape, dimensions) of the property and the adjoining properties?
- Are local conveniences and amenities accessible from the property?
- Is the property situated in or near a flood zone?
Determining the value of a piece of property is one thing. But if the property in question is a parcel of vacant land, it’s a whole different story. Although it’s not virtually possible to come up with a 100% accurate valuation, these factors can predict a land’s value and help an investor evaluate if it will be a good investment.