How do you calculate Residual Land Value? Ricky Prota June 19, 2024

How do you calculate Residual Land Value?

In economic terms, land is worth what someone is willing to pay for it. As a finite resource, land goes to the highest bidder. The method used to determine land prices differs significantly between housing associations and private developers.

Residual Valuation for Private Developers

Private developers trade in land, while housing associations invest in property. This fundamental difference leads to varying criteria for assessing land value, sometimes favouring private developers and other times benefiting housing associations.

Historically, the agility of private developers has often worked to their advantage, providing more freedom for land buyers and a simpler valuation process. Speed is not the only factor; vendors aim to maximise sale value. In some cases, housing associations have an advantage because their assessment methods can lead to higher land values than those of private developers. Let’s delve into the typical private developer valuation process.

Private developers start by thoroughly researching the market to choose a mix of properties with the highest value and most marketable configuration, considering planning constraints. This detailed analysis results in the gross development value (GDV), or the total sales receipts from selling those properties.

Next, developers calculate the costs of building the properties, which include work costs, technical fees, abnormal costs, marketing, etc. Every expense is scrutinised to ensure nothing unnecessary is spent. Additionally, an allowance is made for an acceptable profit margin, usually around 20%, but varying with risk.

The residual land value is what remains after deducting costs and profit margins from the gross development value.

For private developers, residual land valuation is straightforward: sales income minus expenditure equals residual land value. Once the properties are sold, they move on to the next development.

Residual Valuation for Housing Associations

Housing associations consider additional factors, such as future rental income and shared ownership, along with grants from funding bodies.

The future incomes and costs are valued using the concept of net present value (NPV), which assesses the future value of net rent as if all income were received on day one. Read our blog on NPV calculations. A housing association can convert 30+ years of future net rental income into a single present-day value. The NPV of net rent, combined with grant income and initial sales tranche (for shared ownership), produces a proxy gross development value (GDV):

Gross Development Value = NPV of Net Rent + Grant + Initial Sales Tranche

From this point onward, the calculation mirrors that of private developers: costs are subtracted from GDV to establish the residual land value:

Residual Land Value = Gross Development Value – Build Costs – Professional Fees – Interest

Comparing Approaches

The different valuation approaches make some sites more suitable for private development and others for social development. Sites with high potential sales value typically favour the private model, while those with lower house prices look better for housing associations due to future rental streams and possible grants. For private developers, high sales value usually exceeds the value of future income streams.

The science of this is straightforward; the art lies in determining the optimal mix of units for a site. This task falls to the land buyer, not the architect, and is crucial for maximising residual land value, enhancing the housing association’s chances of a successful bid.

Many housing providers are increasing land-led and partnership approaches, making these schemes fundamental to the social sector. While beneficial, these approaches carry greater risk.

Landval Cloud: Your Partner in Minimising Risk

Landval Cloud is here to help you minimise risk and make informed commercial decisions when appraising land values. With our cloud-based solution, you can confidently navigate the complexities of land valuation and secure the best possible outcomes.

At SDS, we offer market leading software for developers, including viability, land valuation and project management solutions. We also offer consultancy services on appraisals, viability, and more. To enquire or request a demo, contact us today. 

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