The subdivision development approach is one of the most polarizing aspects in appraisal theory. But why?
The single, largest contributor to the controversy is how and when it gets used: to estimate the fair market value (FMV) of undeveloped land. Because estimation and appraisal are usually the result of recent comparable sales, it can make people uncomfortable to use a different appraisal method. However, raw land is unique in the sense that it may be available for more than one use, and the variety of options then creates a wide range in value possibility.
Why People Are Skeptical about the Subdivision Development Approach
First and foremost, the term “subdivision development approach” isn’t the only term used to describe this theory. Across both Canada and the USA, there are at least thirteen different references, and none of them are the SDA. Here are a few of the examples:
1. Development cost or contractor’s approach
2. Development value approach
3. Residual approach
4. Lot method
5. Subdivision residual approach
6. And so on…
Clear as mud, right?
Now, let’s layer in the fact that using the subdivision development approach creates value estimates that are exponentially higher than the standard sales comparison. Depending on which side of a negotiation you’re on, you may have a vested interest in one approach being viewed as more accurate than another.
However, if BOTH valuations are performed correctly, they should be very close to one another; this is the crux of the problem.
How the Subdivision Development Approach Works
Here’s an overview of the eight steps that should go into the appraisal. They are not exhaustive, but they do give a good general idea of how things work.
1. How will the land be used? And what is the “best” opportunity? In other words, it looks at things like would the land be worth more if you built four speculative homes versus a shopping mall?
2. After you’ve ascertained best value, what is the actual development plan? Is it reasonable? Supportable?
3. Are there any timing factors to consider?
4. What will the price schedule look like over time? Will it remain constant, or will it vary the further into the project you go?
5. How will this fit into the community, and what is the likely purchase trajectory based on community demographics and information?
6. Estimate expenses related to the land development, as well any costs to stage or build a scale-model your potential customers need to view prior to purchase.
7. Estimate additional expenses:
b. Holding costs (loan interest, etc.)
c. Taxes and fees
8. Factor in any overhead for the developer/land owner, and determine net profitability
The bottom line is this type of valuation method for raw land is complex. It takes time. And it will definitely cost more than a standard appraisal. However, in a market with a dearth of comparable sales, it can be the best bet.
When SDA Should Be Applied
Again, there is no consensus amongst the appraisal community. However, here are a few examples where it would make good sense to use the subdivision development approach:
1. The land is already subdivided. No need to hypothesize about what the permitting and land use office will actually approve; it’s already been done. This makes the number of lots a constant and removes at least one high-level risk to creating an accurate valuation.
2. You need a good guess before you pin your business case on a specific piece of land. If you’re in the process of running the financials, it will help to have an SDA-based appraisal on hand so you can accurately forecast financial feasibility. Remember, the best ones include all sorts of financial costs and sales schedules; this is invaluable to creating an accurate business case and financial snapshot.
3. You need to secure a loan. Many loans associated with subdivision and build-out actually deliver the funds in phases. Your SDA-based report helps outline those phases, and alleviates some of the payback risk mortgage companies tend to focus on. As a result, they may be more likely to approve you for the full dollar amount.
The list could go on and on, but looking at these three examples clearly illustrates the value of a well-performed appraisal that’s executed using the subdivision development approach.
Ok I’m Sold….Who Can Help with My Appraisal?
The team here at Global Valuation Services are experts when it comes to the subdivision development approach. We’ve provided appraisals for all kinds of projects, and we’re here to help you with yours.
So, if you’re looking into subdivision or commercial land development, just call us at 772-215-5738, and let us put the SDA to work for you!