We use the numbers put forth in “Land Valuation: Methods for coming up with the numbers”. If you are not sure how we came up with the numbers, please refer there.
First you take your estimated Value (e.g. $4,000,000), subtract the Estimated costs ($2,000,000) to arrive at the approx. Land Value, which is now evident to be $2,000,000 ($4,000,000-$2,000,000=$2,000,000). This is your breakeven point. If you pay over 2 Mil for the land, you are likely going to be in the red. If you purchase it for less, you are likely going to make some money. If you purchase the Land for $800,000, you are likely going to have $1,200,000 of profit built in.
Land Valuation: Making Money
As an investor/developer we are here to make money. This being said, we need to make sure that when placing an offer on a piece of land we take profit into consideration. For Residential ,20-30% is considered a decent rate and for Commercial (it depends on the type of commercial). But as a rule let’s say 20-30% Profit built in with this amount it causes less headaches when it comes to financing. If your cost to develop was $2,000,000 and you’re looking to make 30% on that, your margin would be approx. $600,000 ($2,000,000*30%=$600,000). This number is then subtracted from the Residual Value of $2,000,000. Which means you would not pay more than $1,400,000 for the Land ($6,000,000-$2,000,000=1,400,000).
Now I do not know about you, but I do know that if I were looking to develop a piece of land I would want to make money on the whole project and not just the costs. So we will use the 30% one more time. This time, you take 30% away from the remaining land purchase price ($1,400,000*30%= $420,000-1,400,000=$980,000).
So–how much is my max offer?
For this particular example my max price to pay for the Land would be $980,000. If I pay less, it is a bonus in my pocket.
Land Valuation: Checking your numbers
$980,000 Max Land Purchase Price
+$2,000,000 Development cost
2,980,000 Total Projected cost
4,000,000 Projected Revenue for the sale
-2,980,000 Total Projected cost
1,020,000 Profit/$2,980,000 Total Projected cost = 34.2%Profit Margin
We have not taken into account any taxes to be paid, but even so… 34% is a pretty good rate of return. Residential works the same way (just with smaller numbers). I hope this helps you get an idea of how to evaluate a piece of land for Development/ investment. If you have any questions, comments or concerns please leave me a message or send me an email and I respond as soon as I can.