Content of the material
- How to Calculate Land Value
- The Problem With Land Valuation
- Discover the REtipster Club
- Land appraisals: Tough to get right
- Understanding Land Value
- How much do vacant land appraisals cost?
- Shape, Topography, and Size
- 2. Usable land vs. unusable land
- Comps-Based Valuation
- Rural vs. residential
- How to Determine Property Value
How to Calculate Land Value
Before calculating land value for tax purposes, it’s important to keep couple of points in mind:
- The purchase price consists of the price of the land and the price of the improvements, such as for a house. This might not be listed on the sales and purchase agreement, because in practice, sellers and agents usually only list the final closing price on any real estate contracts.
- In terms of accounting, a property is eligible for depreciation while the land is not.
After taking these two things into consideration, you are ready to calculate the current market value of land in one of three ways:
Assessed value: In this method, the government is the appraiser of the official value land value for tax purposes. Put simply, assessed value is an approximation, but it should serve as a fair estimate of based on current market conditions. For example, suppose you paid $200,000 for a house, and the assessed value is $160,000 consisting of $40,000 for land and $120,000 for the improvements (the house), then the value of land is 25 percent of the total value, or $40,000. To calculate that figure, you would have:
$40,000 (the value of the land) / $200,000 (the value of the house and land) . = 0.25 (the value of the land as a percentage of the total). = 25 percent.
Remember also, as discussed above, the land value cannot depreciate, but the value of the improvements (the house, in this case) can.
Appraised value: In this case, appraisers, the people who make their living appraising, or valuing, assets, are the ones who place a value on the land. This is precisely why lenders usually order an appraisal conducted by a qualified appraiser or appraise the property themselves internally. Say, for example, you purchased a property that the bank’s appraisal says is worth $180,000 consisting of $50,000 for the land and $130,000 as replacement value of the house, then the land value is:
$50,000 (land value) / $130,000 (the value of the house) + $50,000 (the value of the land). = $50,000 / $180,000. = 33.33 percent
Replacement value: Insurers are well known to be meticulous in financial planning. After all, they are the ones who are legally required to pay for the “replacement cost” of a piece of property, if the insurance contract is written as such. For example, if you purchased a house for $250,000 and the replacement value for the house (improvements) is $175,000, this means that the land is valued at $75,000. To calculate the land value as a percentage of the total value of the property (land + improvements, such as a house), you would have:
$75,000 (the value of the land) / $250,000 (the value of the land and improvements). = 0.30 (the value of the land compared to the overall property expressed in decimal form). = 30 percent.
So, according to this appraisal, the land value is 30 percent of the total value of the property (the land and improvements, such as a house or buildings).
All three of these land-valuation methods can be justified in the eyes of the law. So, which one to use will then depend on your circumstances or objectives. If you would benefit by claiming as high a depreciation as possible, go with one that has the lowest land value (as a percentage of the overall property). If you would benefit by claiming a lower depreciation (on the “improvements” such as a house or buildings), you would use the method that yields the highest land value as a percentage of the property overall .
When determining land value for tax purposes, there is probably no better source for information than the government, which, after all, enforces the rules for all determinations as to land and property valuation for tax purposes.
The Problem With Land Valuation
These valuation approaches usually work fairly well for houses, apartments, commercial buildings, and the like, but vacant land is a completely different story.
In the vast majority of cases, the data needed to draw these conclusions for a vacant lot simply isn’t available.
The Income Approach typically doesn’t apply, because unless the property is being leased to a farmer or hunter, or is generating income by some other means, it is highly unusual for a vacant lot to generate any kind of regular income.
The Cost Approach doesn’t apply, because by nature of the fact that it’s vacant land, there are no improvements to take into consideration.
The Sales Comparison Approach may apply, but only if there are enough sold comps to take into consideration (and many times, there aren’t). In most cases, there are FAR fewer sales comps available for land than for houses and other improved properties… and even when the comps do exists, they are much harder to quantify than improved property. Looking at different vacant lots is hardly an “apples to apples” comparison, and it’s a very imperfect science at best.
It’s a frustrating dilemma for land investors because it’s extremely important for us to understand a property’s market value. This number drives everything else in the process (the offer price, the cost of property taxes, holding costs, closing costs, the profit margin when selling, etc.).
If we can’t be certain about a property’s market value, we’ll have to live with some level of ambiguity – and ambiguity is never ideal, especially when you’re investing a lot of money into a property you can’t afford to be wrong about.
Discover the REtipster Club
Learn what successful investors aren’t telling you. Become a member, achieve financial freedom and make your dream a reality!Join the Club!
Land appraisals: Tough to get right
Not all residential appraisers have the experience and expertise to appraise land. Choosing an appraiser who doesn’t specialize in this area can be a recipe for disaster.
In one example cited by LIA Administrators & Insurance Services, a land buyer used an Arizona appraiser to find out what a two-acre parcel was worth.
The appraisal pegged the value at $160,000 and the buyer secured funds from a lender to finance the land purchase. When the buyer later defaulted on the loan and a foreclosure was filed, the lender hired a different appraiser to give the land another look.
The new appraiser found that there was no access to the lot and assigned it a value of just $90,000 — $70,000 less than the first appraised amount. The lender then filed a lawsuit against the first appraiser, who should have recognized the fact that those two acres were land-locked.
To find a licensed and qualified land appraiser, you can ask a local real estate agent who regularly sells land for recommendations. An agent like Hunt, for example, will have a direct referral for you, saving you time in your search for an appraiser you can trust. You can also do a search on the American Society of Farm Managers and Rural Appraisers, where you can find the contact information of more than 2,100 of the country’s top land appraisal experts.
Understanding Land Value
Property owners use land value to determine how much to charge other parties for its use. For example, an individual who rents out several acres of farmland to ranchers for grazing cattle will determine an amount to charge by looking at the market value of the land compared to land taxes and the capitalization rate.
Land value may be determined by real estate appraisals conducted by third parties. An appraiser’s assessment can be crucial to a lender’s decisions on offering to finance a prospective buyer or refinancing for a property holder.
Appraisal of the land can include a comparison of its condition to similar real estate. This is not the same as comparative market analysis, wherein the prices of recently sold similar properties are compared.
It is always a good idea to use an appraiser, as they will also look into any flaws or defects with the property that may affect its value.
The position and location of the land can have a direct influence on its value. For example, a remote parcel of land may have limited value because it does not have access to amenities, utilities, transportation or other resources that could make the property useful. The value of the land might increase if the property is located near a popular destination such as a city, entertainment venue, or services that are in demand.
How much do vacant land appraisals cost?
Vacant land appraisals range in cost based on their complexity. If you’re buying a residential lot, the appraisal may only take a week and cost under $1,000.
However, commercial lots can take much longer to assess. If you’re doing environmental studies or market research to make sure there’s enough demand for your business, you may have to wait a month or more for the report to be finished. You can also expect to spend a few thousand dollars, as environmental studies alone range from $2,000 to $4,000. Depending on the piece of land, you may need to get a vacant land loan.
Shape, Topography, and Size
Shape and topography are both important considerations because they affect how the property can be developed. Oddly shaped lots may have less usable acreage and road frontage than standard square parcels, which makes them less desirable. A property that has rolling hills or a river running through it may also be harder to build on and appraise lower.
Size has an impact on the land’s value as well. Small lots typically sell at a higher price per acre than large parcels of land. The appraiser may also take into account how much demand there is for a parcel of that size and factor it into the calculations.
2. Usable land vs. unusable land
The more acreage the more a piece of land is worth, right? Well, not quite.Number of acres certainly factors in heavily when determining land value, but there’s a big difference in price potential between usable land and unusable land. Think of it this way: if a large piece of land is zoned for agriculture but only 40% of it can sustain crops, it’s going to be worth a lot less than a smaller piece of land where more acres are usable and productive. To make sure you get a fair price on a piece of land, always compare your intentions with the land to how much of the land is usable for those purposes.
Once you understand the physical nature of the parcel and what you can do with it, you can compare it with other pieces of land that have changed hands in the last year or so. Looking at the sale of other comparable properties – referred to as comps – will give you a good sense of where the market sits. The more recent your comps, the better, especially in fast-moving markets like San Francisco and surrounding area where prices move quickly. Compare the properties on the basis of their price per square foot, rather than on their total selling price.
Rural vs. residential
Many landowners possess vacant lots that will someday become the site of a house or building. But appraisers will treat rural tracts of land or farmland used for agricultural purposes differently than they do residential or commercial land.
“Rural appraisals can be more challenging due to the lack of sales data, which is naturally the result of having many fewer homes than suburban or urban markets,” explains Pogwist.
“In some rural counties, there may not be sales for many months or even years. The appraiser would need to expand his or her comparable sale search far beyond what is typical in order to find sales that could be utilized as value indicators for a property.”
The appraiser will consider some of the same factors — access, topography, configuration — but the size of rural land is often much larger, adding extra time and cost to the valuation process. The value will also hinge on things like the farm economy, the quality of the soil, irrigation and drainage, the local climate and rainfall, and any current farming regulations that might limit usage of the land.
The portion of usable space is one of the key factors in farmland appraisals. As Hunt explains: “If you have 100 acres of land, and 50 of it is usable and the other 50 is comprised of gullies and trees that can’t be plowed or cultivated or grazed, the value of the usable acres will be much higher than the rest.”
How to Determine Property Value
Beth Buczynski of Nerd Wallet recommends that you use online tools, such as a land value estimator or land value calculator, as well as comparable properties and appraisals to determine property valuation for tax purposes. She notes that there are five different ways to determine the property value:
Use online land valuation calculators and land value estimators. More than one in five of U.S. homeowners who determined their home’s value used an online estimator, Buczynski notes. The technical term for these tools is automated valuation model, or AVM, and they’re typically offered by lenders or real estate sites like Zillow and Redfin. Still, David Rasmussen, senior vice president of operations at Veros Real Estate Solutions, cautions:
“Most AVMs on real estate sites are generally for marketing and lead generation purposes. They’re tasked with returning a value for just about every property even when data is limited. And in doing so, they water down the accuracy.”
Get a comparative market analysis. You can ask a local real estate agent for a comparative market analysis, or CMA, which provides an agent’s evaluation of the home and market to provide an estimate of value, typically for listing purposes. You may even be able to get a local real estate agent to provide a CMA for free.
Use the FHFA House Price Index Calculator. This tool, which is a land value calculator, is easy to use. Simply enter the state where you the property you purchased is located, the purchase quarter (when you purchased the property, such as “2016 Quarter 4”), the valuation quarter (the quarter for which you want to determine the property’s valuation, such as “2018 Quarter 4), and the purchase price (such as $200,000). Then hit “Calculate,” and you will receive a quick answer giving you the value of the property, in this case $228,832. This means the property is valued at $228,832 as of the fourth quarter of 2018.
Hire a professional appraiser. As previously discussed, this is a great option. Lenders use appraisers to estimate property values because that is what these professionals do for a living. More than one-fourth of U.S. homeowners determined their home’s value through an appraisal, Buczynski says.
Among other things, appraisers evaluate:
- Market: The region, city and neighborhood in which a home or other property is located.
- Property: Characteristics of the house or other property, including improvements and the land it sits on.
- Comparable properties: Sales, listings, vacancies, cost, depreciation and other factors for similar houses or other properties in the same market.
They then combine this information to create a final opinion of value for the home or other properties and deliver in an official report.
Evaluate comparable properties. Speaking of comparable properties, using this metric is also a great way to find the value of a property, even without paying for a professional appraiser. Appraisers and AVMs both rely on recent sale value of comparable properties, often called “comps.”
Speaking to the popularity of using comparable properties, well over 50 percent of homeowners estimated their home’s value by looking at comparable properties, Buczynski says. “Pulling comps is one way to determine market value without paying an appraiser, but use good judgment. Just because the property next door sold doesn’t mean it’s a comp,” says Ryan Lundquist, owner of an appraisal company based in Carmichael, California.
When using comps to determine the value of a property, make sure to employ an “apples to apples” approach: Look for similar size, location, condition and upgrades. To get started browse Multiple Listing Service listings, particularly for recent sales and look for recent listing prices of similar properties if needed. Make sure you view at least three similar properties before using the comps method to value your property.