The document discusses the land residual method for valuing land for development purposes. It begins by explaining that the land residual method takes the highest and best use of a property and subtracts the total development costs to arrive at the residual land value. It then walks through a hypothetical example of valuing a piece of land for single-family home development. It estimates development costs, projected home value, and calculates the maximum offer price for the land that would still allow for a profitable development.

1. Mel FellerTalks DevelopingReal Estate- How To Make Moneyby Mel Feller
Pricinglandfordevelopmentcanbe a dauntingtaskfor the untrainedinvestor.Asaniche subsetof both
residentialandcommercial real estate,usingcomparables forlandcanbe as dangeroustoa developer
as it ismysterious,sometimescausingthe failure of whatwascertaintobe a fantasticdevelopment.
However,forthe shrewdinvestor,there isone universallyacceptedlandvaluationmethodusedby
developmentprofessionals,corporations,andappraisersalike;the LandResidual Method.Byusingthis
method,youwill be able todeterminethe currentandfuture value of anypiece of land,whetheritsuse
be residential orcommercial.Youwillalsobe able toprice land,suchthat any developmentyoupropose
will have builtinprofit.Withsome practice,youwillbe able toemploythe landresidual methodinjusta
fewmoments,summingupthe value of almostanypropertyjuston sight.
The land residual methodhasafancysoundingname,buttouse itall you needisanunderstandingof
some simple math.The landresidual methodisacalculationthattakesthe highestandbestuse of a
particularpiece of propertyandsubtractsout the total costof developmentto arrive at the residual
value:the landvalue.Once youhave the numbers,it’sthateasy.“How do youget the numbers?”You
ask.It takessome research,butevena novice investorcanfigure itoutrelativelyquickly.
For the sake of thisarticle,I’ll be speakingtoresidential singlefamilydevelopmentorsingle familylot
land.Restassured,commercial developmentusesthe same principles,thoughthe calculationsare a
little more indepth.
Use and Utility
You have heardthe term “Location,Location,Location”thrownaroundin manyreal estate circles. Itis
nevertruerthan whendevelopingland. WhileIdonot recommendusinganytype of comparablesfor
valuingland,it’sgenerallyacceptedthatlandnearthe ocean,orany otherhighpricedcorridor, has a
higherintrinsicvalue thatlandbasedfurtherawayfromahub or commercial center. Itboilsdownto
use and utility. Forinstance,a100-unitoffice buildingindowntownSeattle will probablybe worthmore
than the same buildinginrural Arkansas. The landthose propertiessitonwill be valuedaccordingly. It
isone thingto accept that, butanotherto understandwhy.
Propertyvalue isdeterminedbyitshighestandbestuse.A piece of propertythatcan be developedinto
a regional shoppingmall will be more valuable thanapropertythatcan onlybe developedintoasingle
familyhome.Thisisbecause the enduse of the formerhasa much higherfinishedvalue thanthe latter.
The value of the materialsare more andthe expectedincome fromrentingorowningthe firstis
significantlymore valuable thanthe second.Itall comesdowntoprofitanda returnon investment.
There ismore profittobe made inlargercommercial buildingsthanasingle familyhome.However,the
commercial propertytakes significantlymore riskandmoneytodevelop.Hence,the largerlandvalue.

2. The firstpart of the landresidual methodistoestimate the final orfuture value of the proposed
property. Thiscan be done by several approaches. Inthe case of a single-familyhomedevelopment,it
can be quicklyestimatedbyusingrecentsalescompsfromalocal real estate brokeror agent. Make
sure you are dealingwithtrue comps;similarinstyle,size,amenities,andage. Youshouldnotbe using
a 10 yearoldsale as a comp for an aboutto be builthome.
For our example,letusassume youare buildinga3 bedroom, 2 bath home,and1,500 sf in size,witha
lotsize of 1/2 acre. Let us alsoassume yourcomparable reportshowsthe medianhome salesprice in
the last 6 monthsfor thistype of home to be $500,000.
Once you have arrivedatan estimate forthe final orcompletedvalue of yourpropertyyoumove onto
figure outwhatit will costto buildyourproposedproperty.
DevelopmentCosts
Developmentcostscanvary wildlyfromstate tostate andcity to city,dependentonthingslike the
amountof workinthe areaand the cost to delivermaterialstoyoursite. Whenestimating
developmentcostsIcounsel investorstoresearchtheirmarketbycallinglocal developers. Findout
whattheypaid. Talk to contractors and findoutwhatthe goingrate for material andlaboris. Talk to
local builders’associations. Theyoftenkeepdataonhome buildingcostsinthe area.
There are twowaysto estimate costs. You can use a $/sf method,oractuallygo line itembyline item.
The secondmethodcan onlybe done if youhave a listof all the line itemsrequiredtobuildyourhome.
The $/sf methodiseasiertoobtain,butnot as accurate as the line itemmethod.Yourgoal is to
determine the total softandharddevelopmentcosts. Softandhardcosts breakdownas follows:
A hard cost isanythingthatcontributestothe directconstructionof the structure itself. These are
usuallylimitedtothe coststo go vertical.Soft costsare anythingthatdo not fitintothat category. Some
softcosts are broker’sfees,financingfees,horizontal developmentlike runningof utilities,demolitionof
existingstructures,clearingandgradingof the land,curbs,roads,and driveways,amongothers.
If your local contractor tellsyouthe average hardand softcost to buildyourhome wouldbe $100/sf,
thenyouknowyour total developmentcostwouldbe $150,000 ($100/sf X 1,500 sf = $150,000).
Do the Math

3. Nowit is time to resolve yournumbers. The value of the completedhome isestimatedat$500,000,
whichishopefullythe amountitwillfetchwhenyouare readytosell. Yourdevelopmentcostsare
$150,000. The residual landvalue isthe difference betweenfinishedvalue anddevelopmentcosts. In
our example,the residual landvalue of the proposedpropertyis$350,000 ($500,000 – $150,000 =
$350,000).
What thismeans,isthat for youto buildahome that wouldcost$150,000 and have a value of $500,000
inthe openmarket,youcouldpayup to $350,000 for that piece of land. Thisisthe breakevenpoint. If
youpay more for the land,there isa great potential foryoutolose money. If youpay lessforthe land
you’re potentiallybuildinginprofit. Inaddition,thatisexactlyhow aprofessional developerwoulddo
it. Theydo notstop at the residual landvalue. Theygoone-stepfurtherbyworkingintheirprofit.
Work in your profit
As a developer/investoryou’re here tomake aprofit. You wantto work that intothe equationbefore
youprice your landand make youroffer. Most developersof residential propertylike tomake between
20-30%. Anythingbelow thatwill be hardtofinance throughaconventional lender,andwouldbe arisk
on yourpart. Markets move upand down,sometimesasmuchas 10% ina few months. If yourprofit
marginwas only15% and the marketdrops 10%, youare leftwitha 5% profit. Forthat kindof money,
youdo not needthe riskof developmentyoucanjustgo out,buya T-Bill, andsipicedteaon yourfront
porch until retirement.
If you are cost to developwasestimatedat$150,000 and youwouldlike tomake a 30% profiton costs,
your profitmarginwouldbe $45,000 ($150,000 X 30% = $45,000). This numberisthensubtractedfrom
the residual landvalue of $350,000 for a maximumofferprice of $305,000 ($350,000 – $45,000 =
$305,000). That means,tomake a 30% profiton yourdevelopmentcosts,youwouldnotpaymore than
$305,000 for the land.
Well thatis fine andgood,but most developerswanttomake profitontheirentire project,notjustthe
costs. Thus,we do thiscalculationone more time;thistime onthe landpurchase portionaswell.
Assumingyouwouldwanttomake 30% onthe landportionto,how much wouldyouhave to back out?
You wouldbackout approximately$90,000 ($305,000 X 30% = $91,500).
Max OfferPrice

4. Take your residual landvalue minusyourprofitoncostandyour estimatedprofitonthe landcostand
youcan determineyourmaximumlandofferprice. Forourexample,the final landvalue andmax offer
price wouldbe $215,000 ($305,000 – 90,000 = $215,000).
For the propertycitedinthe example Iwouldofferthe sellernomore than$215,000 to purchase their
piece of land. ThisensuresIcan get the developmentdone andmake anice profitformyself. Justto
checkmy numbers,Irun the math one more time.
Check the math
To check yourfinal expectedprofit,simplyrunthe numbersforwardfromthe start. Here is how it
wouldlook:
$215,000 Land Purchase
+ $150,000 DevelopmentandConstructionCosts
$365,000 Total ProjectCost
$500,000 ProjectedRevenue fromSale
– $365,000 Total ProjectCost
$135,000 Profit
$135,000 profit/ $365,000 total projectcost = 37% total profitMargin
Keepinmindwe have notaccountedfor taxesof any kind. That will of course reduce yourprofit
margin,butstill,thisisnotbad for a developmentthatprobablytooklessthanayearfrom start to
finish.

5. For evenhigherreturns,yourlandofferwouldbe made atanevenlowernumberthanyourmax offer
price,incase youendup negotiatingthe price higherwithyourseller.
You can see that the residual landvalue methodof obtaininglandvalueisaneasyand efficientwayto
make sure you are payingthe true marketvalue of the land,while workinginprofitforyourpotential
development.
Like you,leadershipexpertandbusinessauthorMel Fellerhasseenthe wordleadershipdefined
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differentstory?
Withoverthree decadesof executivecoaching,speaking,andmostimportantly,real-life,in-the-
trenches businessexperience,hisview isradicallydifferent. Mel Fellerappreciates,andshareswith
listeners,thatleadershipisamoment-to-momentchoice andnotabouttitle,tenure orposition.
Leadershipisforeveryone,everyday.Itishow we shouldlive ourlife.
Mel Fellersometimesreferredtoasthe “Provocateur”forhisabilitytostir upa groupor as the “People
Whisperer”forhiscoachingskill thatbringsoutthe bestin people,isknownforhispractical,street-
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audience atan intimate,intense andindividual level.