Is ‘Land Value’ an Oxymoron?

Perhaps the most difficult property type to determine value for today is vacant land or low rise properties which one would think have a highest and best use as a development site. The difficulty stems from a lack of transactions upon which to form an opinion.

Does land have value today? Sure it does, but calculating that value is not an easy task.  Interestingly, during the most challenging years in the recession of the early 1990’s, land actually had no value. Zero. Nada! During most of 1990 and 1991, there were development sites, which had been forclosed on by banks, which were on the market for $20 per buildable square foot and there were no takers. This was shortly after the development market hit a peak in 1987 thru 1989 when the best sites in Manhattan ( Metropolitian Tower, Cityspire, and the Blockfront on Second Avenue between 64th and 65th Street) hit a record of $125 per buildable square foot. Massey Knakal sold a site, which I believe was one of the first development sites coming out of that zero-land-value period, at 408 East 79th Street to RFR Holdings for about $30 per buildable square foot. I vividly remember the seller being thrilled to have achieved such a high price.

Today, land has value but the disconnect between buyers and sellers is significant. During this past cycle, land values routinely hit $400 or $500 per buildable square foot. The most prime sites reached approximately $700 and The Drake hotel site at 56th and Park achieved a price in excess of $1,000.

Since the peak of this most recent cycle and as the economy has deteriorated, the availability of financing for development projects has all but evaporated. Accessing debt for hotel or office construction is very challenging today and the properties with the best chance of obtaining financing are residential rental developments. We are working with several developeres who are looking to purchase sites for residential rental construction, however, the common opinion is that in order to make a residentail rental project work, a price of $150 to $200 is the maximum that can be paid for the land. Given that sellers could have obtained two or three times this amount 18 months ago, they are not presently willing to “hit the bid”.

Many developers who are interested in taking advantage of current market conditions are waiting on the sidelines for the failed projects of novice devolopers to hit the market via lenders who will likely take back many of these properties.

One thing to keep in mind is that there are always exceptions to the rule.  A hospital recently purchased a site at 1133 York Avenue for just under $300 per buildable square foot and they will probably sit on this site for a while before ultimately building a new facility for their own use. Users will always have needs and sites that are extraordinarily well located or have some strategic value are likely to achieve premium pricing.

This segment of the market is where I see the most opportunity today as, not only do you need capital to take advantage of the opportunities but, you need developoment expertise as well. As transactions start to occur, the question of what land value is, will be much easier to answer.

18 Responses to “Is ‘Land Value’ an Oxymoron?”

  1. 1 Elyssa February 12, 2009 at 9:25 am

    Mr. Knakal, How has the elimination of the 421a program affected land value and the development market?

  2. 2 rknakal February 12, 2009 at 12:39 pm

    Hi Elyssa, that is an interesting question. 421a was a vital instrument used to created affordable housing in NYC. Consumers view the value of residential real estate in accordance with what their monthly occupancy cost will be. Without these tax breaks, the monthly cost goes up and the price the consumer can pay goes down which has a direct impact on the price that a developer can pay for the land. Given so many other factors are changing in the marketplace, it is very difficult to isolate this factor and determine the exact impact on value.

    More importantly, the elimination of this importatnt program, which was intended to stimulate the construction of MORE affordable units through the 80/20 program and others, will actually result in LESS affordable units being created. Politicians thought they were taking a stand against “rich condo buyers” and have actually negatively impacted those who would be the biggest beneficiaries of affordable housing. A replacement program is needed as soon as possible to meet this significant need.

  3. 3 Marty Leith February 12, 2009 at 8:12 pm

    Mr. Knakal,

    You mentioned above that construction loans have “all but evaporated”. We’ve found a few lenders and everyone wants 100% guarantees. Do you know of any that would do partial for the right apartment project/developer?


  4. 4 rknakal February 13, 2009 at 9:23 am

    Hi Marty, you are correct that guarantees are required on the construction loans that are available. There are some lenders that are not requiring 100% guarantees for the right project. Your mortgage broker can probably fill you in on those lenders. Feel free to give me a call at 212-696-2500 and I can provide some insight.

  5. 5 Nick Coburn/GreenAcre Partners February 13, 2009 at 4:53 pm

    The question of the value of land today cannot be measured on a “by the pound” basis, but rather by looking deeply into the land assets themselves to determine the attributes of value that exist beyond the surface – elements such as potentially expired entitlements and development agreements, zoning and master plan considerations, partially completed horizontal and vertical developments, utility availability and neighborhood sentiment concerns, to name only a few of the critical components of value that often go un-analyzed by today’s opportunity purchaser. The issue is that the money is found on the macro scale, while the land value is determined on a very micro (local) level. We really believe “it’s all in the execution,” and extracting value from land that has recently suffered a significant value shift is only going to be accomplished by people with tried and true development expertise — not to mention, “boots on the ground” with local knowledge on an asset-by-asset basis. This local knowledge is critical to further analyzing and establishing the potential value of a parcel of land or project in some stage or another of development.

  6. 6 rknakal February 13, 2009 at 10:44 pm

    Hi Nick, you make some very good points here. In a macro sense, what you are saying is that local market expertise is a very important aspect of all real estate investing, not just in land. One of the things that Paul Massey and I realized when we started in the brokerage business in 1984, was that, while we were in the real estate business, we were really in the information business. The only way to have the best quality information is to be an expert in the local market. That expertise creates a significant competitive advantage and is commonly found in real estate professionals who are at the top of their game. If you follow this “boots on the ground” approach, I’m sure your developments will be very successful.

  7. 7 Jim C February 17, 2009 at 4:32 pm

    Great topic-
    The value today of the land (raw or otherwise) is in the creative eye of the opportunist. The very best investment going forward is acquiring land at opportunistic levels that will allow the purchaser to create the CRE plays of tomorrow. We got into this space due to malfeasence in the valuation process again. Use your vision to capitalize on the opportunity….Grow or go…

  8. 8 rknakal February 17, 2009 at 9:48 pm

    Hi Jim, I agree that we are in an opportunistic market for development sites in New York City. The opportunity has been created by the trickle of development financing available today and the uncertainty surrounding the future of all end user markets. This disconnect in the market is affording those with cash, patience and expertise with what are perceived to be great opportunities. We are presently working with several developers who have either been on the sidelines for many years or have taken on only a limited number of projects in this upcycle and are now aggressively looking for distressed sites to purchase. It is likely that many of these sites will stay on the shelf, at a low cost basis, until the market gets better.

  9. 9 Joshua Stein February 18, 2009 at 10:43 am

    Ultimately land value depends on completed-project value and the cost to get there. You need to look at what the project will cost (and will otherwise entail), and then see what the project “will” be worth at the end of the day (taking into account rental value or sales value), and then subtract something out for compensation to the entrepreneur, and then what’s left is the amount that the entrepreneur can afford to pay for the land (i.e., the maximum bid the entrepreneur would offer in an auction). So land value is ultimately a function of all the costs and benefits of the project as a whole, as estimated by each particular prospective developer, after taking into account their own vision and strategy (and brilliant insights about how best to execute the project). If completed-project values are dropping dramatically (thanks to dropping rents and condo values), but construction costs are not dropping as fast, and other costs are (let’s say) staying constant, then it is entirely possible that when you do the math the land value (the residual of what a developer would pay as the price of entry for the project) could approach or equal $0. That’s one analysis a prospective developer would perform in evaluating a site and may have more meaning than comparable sales. Of course, this approach also assumes no interest in land banking and no interest in speculating on a better world tomorrow.

  10. 10 rknakal February 18, 2009 at 6:42 pm

    Hi Joshua, I agree with your comments and would add that in order to figure out a residual value (which is the approach you illustrate) you also need to subract from the value of the finished product (or conversely add to the project costs) the profit that the developer needs to make in order to substantiate the investment in the land and going through the process of constructing the building. The example you used demonstrating how land could have zero value is completely representative of the New York City land market in the early 1990’s when land did have zero value for about two years.

  11. 11 Car Todd February 19, 2009 at 10:08 am

    Ever hear of the Land Residual Appraisal process? If not, look it up in any basic appraisal text book.

    In my 62 years of real estate practice every builder/developer I ever did a valuation study for always used the Land Residual values for his highest and final bid for the land in negotiation. The only use they had for the recent comparable sales was to insure that they were not leaving any money on the table in their price bargaining.

    Also remember that the developer’s and investor’s definition of Market Value is “the present worth of future benefits”. If no future benefits can be foreseen there would be no commercial value residual to the land. That does not mean there is no value to the land for public use such as a mini-park, community garden, children’s play ground, municipal parking lot, etc. An appraiser knowledgeable in valuing municipal land will know how to find a dollar value for the questioned land in municipal use. As a former Senior Appraiser for the City of NY. I and my colleagues in the Dept. of Real Estate’s Appraisal Division have valued many such parcels during their careers there. Federal and State funds were granted to the City based upon those values for the development of those sites for their designated planed and/or existing use.

    There is no such thing in a civilized society as $0.00 value uncontaminated land. Heavily contaminated land can have a cost to cure that will exceed and commercial or municipal value in future use, hence the Super Fund program was designed to eliminate the public health hazard of such sites when the contaminated owners can not afford to remove the toxicity.

  12. 12 rknakal February 19, 2009 at 10:43 am

    Car, clearly, we are familiar with land residual spproach to value. I do, frequently, have a different opinion of a propery’s value than an appraiser will. I know that appraisal value is done by the book and I have tremendous respect for the appraisal community. In fact, my firm publishes “Sales Data for Appraisers Only” which we make available only to the appraisal community on a complimentary basis. This data gives detailed income and expense information for sales that we have closed. In recent years this has totaled 400 to 600 sales per year and I am told by the appraisal community that no other brokerage firm does this for them.

    I do not beleive in the accuracy of the land residual approach to value. In theory, it seems reasonable, but in reality, if you change any of the dozens of assumptions in the approach by a few percentage points, the value can swing wildly up or down. We rely on comparable sales to determine value as we assume the developers who have purchased properties have run models that they are willing to stand behind financially. If every devolpment site in a neighborhood is selling for $300 per buildable square foot and the land residual value approach comes up with $100, is $100 the value? If you think so, I would purchase the property for $100 and sell it for $300, or the true “market value”.

    I believe a property’s value is what someone is willing to pay for it. If no one is willing to buy it, it has no value. You could argue that a property does have “value” to the community as a park or playground, but try telling that to the owner who wants to sell it and can’t find a buyer.

    Thank you for the thought provoking response.

  13. 13 Car Todd February 19, 2009 at 3:01 pm

    The land residual value is not a “Market Value” as legally defined but is a value to an individual (personal value). All sales are in reality based upon the buyer’s “personal value”. That explains the ranges in sales prices appraisers analyze to find “Market Value” (as defined in his report – in this case let’s assume its as legally defined).

    I’ve done many market and rental value studies in my career. For a time was in charge of site selection for a regional chain. The prices and rents we paid were “personal” to the chain’s business operation.

    To this day I still believe that an appraisal based upon comps alone is a fraud. It may be fine for litigation (because most judges lack of the nuances of real estate in the real world and want “proof” of your value – the comp adjustment process looks scientific even though it a messaged judgement call.).The last 35 years of my career was mostly in litigation. Just because 3+ comparable properties sold in close distance and time to your subject property that does not mean there is a buyer out there f for your subject property. It requires a market demand study to determine that and most buyers of an appraisal would not pay for the cost of such a study. I’ve appraised taxpayers that say had 6 stores 4 rented to successful tenants and studies have shown the remaining two are the results of over building and it is best to let the existing adjacent tenants use the vacant store windows for display until there is a change in the neighborhood to create a demand for the two vacant stores by new users or an existing tenant’s business expansion.

  14. 14 rknakal February 19, 2009 at 3:33 pm

    Car, the concept of “personal value” is difficult to justify as an approach to market value. As a broker, the only value I try to determine is the value that the most optimistic buyer will pay for the property. All other values are theoretical mental gymnastics that will not help me in determining how much I can sell a property for. To determine the market value of a property using “personal value”, wouldnt you have to determine who the optimal buyer would be for a property and then use all of the assumptions that this unique buyer would use in order to determine their unique “personal value”?

    Perhaps comps are heaviley weighted in New York City because it is reasonable to assume there will always be a reasonable level of demand here.

  15. 15 Paul R White February 19, 2009 at 10:23 pm

    I purchased a small vacant residential lot in an R7-1 area of the Bronx for twenty cents a square foot – land area, not buildable sq ft! – in 1984. Two and a half years ago I had an offer on the same vacant lot of $80 per land square foot.
    Yet, as you allude to Robert, I would have difficulty selling this lot today at one half or one third this price because of the climate for development and economic conditions.

    There are “values” that may be important to certain owners such as myself but they are non-market values. I am happy to bank land for several reasons only some of which are economic-driven. You cannot put a price on the enjoyment I get out of being able to visit and stand on actual NYC soil that I own, fee simple with no debt. Lots of exercise keeping it clean, too.

    Long term, for the patient and watchful some truly remarkable capital gains along with other benefits can be had with vacant land.

  16. 16 rknakal February 22, 2009 at 6:32 pm

    Hi Paul, you are correct that if you are patient, holding land pays off. If we look at the history of cycles of real estate values, each up cycle has brought us to new threshold pricing and it is likely, for a number of reasons, that this trend will continue. In the down part of the cycle, the “wealth effect” of owning real estate is negatively impacted but remember this: If you do not have to sell and you can afford to hold on throughout the down cycle you will realize tremendous capital gains.

    With regard to successful real estate investing, a lot has to do with when you get on the roller coaster and when you get off the roller coaster. If you do not have to get off during a down cycle, ultimately the value will rise.

  17. 17 Victor Weinberger February 22, 2010 at 4:30 pm

    I was marketing a property in a prime location of Flushing, Queens. it was nearly 200,000 SQ.Ft. Buildable (including community service incentive). I’ve had developers tell me in today’s market, “if you’ll give me that parcel for free, I wouldn’t built.”

    Why one might ask these builders feel this way?
    Well look at the numbers. If the construction is at $300 per SF (hard and soft cost); which means that project would cost $600 Per Sq.Ft to built.
    The resale value of condos in that location is maximum around $575 per SF. Hence, they wouldn’t built it, even if given the land is free. That’s the uphill battle that we as sales broker face. Imagine, even if it’s free, they still won’t built.

  18. 18 Carl Todd February 25, 2010 at 10:33 am

    Vivtor & RK
    The “toxic assets” that us taxpayers have bought via the TARP and other Goldmanfleece programs have no current non-government “willing buyer”, however we are told that the government will make a profit on them in the “Future”.

    Vick – would you pay $100 for the site and put the deed in trust for your grand kids as you file a tax-cert. to reduce the AV to your purchase price? If you wont I will, having spending the first 17 years of my RE career in Flushing when my dad moved his RE practice base from the Empire State Bld. to Flushing after WW II and can see a long range future for strategically located Flushing.

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