1) Figure out how much the future value of the property will be worth.
There are quite a few ways to come up with this…
a) Direct Comparison – This type of analysis is done by looking at recent sales of similar properties/projects (not the land, but the property after everything has been built), in similar neighborhoods to come up with an estimated value. This method has both good and bad aspects to it.
- Pros: Gives you a good idea of current market value based on real numbers, and can be done by most real estate agents (for simple projects).
- Cons:Can be hard to find adequate comparable property, especially for commercial or unique properties. Many agents may be able to get comparables but not help to do the analysis.
b) Income Approach – This approach is used for income-producing properties such as malls, apartment buildings, and multi-unit residential houses. With this method, you take what you are expected to make per sqft net based on market (or expected) rents- Vacancy Rate. Calculate the value based on the Return on Investment (ROI) you expect to see.
- Pros: This is a good way to proceedif you do not plan on selling but instead wish to lease the property out.
- Cons: Vacancy rates can vary depending on the market, not to mention that it can take time to bring any property up to optimal occupancy.
c) Per sqft.– This method is similar to the direct comparison approach in that you need to figure out what the market value is of a similar properties per sqft. In other words, if current similar properties are selling for approx. $200 /sqft for a Retail Plaza ,then a 20,000 sqft building would be worth approx. $4,000,000.00.
- Pros: This method is the easiest to calculate in your head while giving you a rough estimate.
- Cons: This method is a good place to start for estimating approximate value but should be confirmed using other methods. In various markets there are bands as the bigger the property generally the less per sqft a property is worth.
There are other ways to determine future value, but these are the most common for valuating for a Development property. But how do you determine the cost of development?
2) In Determining the Cost of Development
You need to consider both the “Hard Costs” and the “Soft Costs”. Hard costs are anything that is needed for the actual construction of the building (think of it as anything needed to build it up). Soft Costs are things like the brokerage fees, financing fees, running utilities to all sections of the property, demolition of anything currently on the site, and grading (or anything you need to build horizontally).
There are 2 different ways to calculate these costs:
- Approx. Per/sqft – This approach is an estimation only.
- Pros: the fastest way to estimate costs quickly
- Con: it is also the least accurate.
- Itemized list – Breaking it down on a spreadsheet, where all actual costs, Hard and Soft, are Itemized.
- Pros: This one is very accurate (barring any surprises)
- Cons: It is difficult to find someone who can do this calculation in their head or otherwise quickly.
These approaches can work well together. First, approximate to see if a deal seems to make sense, then Itemize to confirm or debunk your initial thoughts.
Ways to find what numbers to use:
- Ask your contractors/project manager
- Local Building Association
- Other local investors/ builders
- You may instead (as before) do an itemized list getting quotes for each portion. If you have taken on the role of the Project manager, this is going to be something you will definitely end up doing.
A company may give you an average for hard and soft costs to build the Plaza. Let’s say it is approx. $100/sqft, so if you are looking at building a 20,000 sqft Plaza the building cost are going to be approx $2,000,000.