One of the biggest obstacles every land investor has to wrestle with is finding the “market value” of vacant land.
It may seem like an odd dilemma to a conventional real estate investor but trust me – if you've ever tried to find comps or relevant valuation data for a parcel of raw land, you know how challenging it can be to nail down a concrete value for this type of real estate.
Especially for those in the land flipping business, it presents a MAJOR challenge because the conclusions we draw about this number will affect everything else in the process. Most of the data we need simply isn't there.
How Real Estate Appraisals Work
Before we get into the complexities of valuing land, let's establish a fundamental understanding of how real estate appraisals work.
In most real estate transactions (especially when they involve financing), buyers and lenders will hire a professional appraiser to verify the value of the real estate being purchased and/or financed. The appraiser will put together a comprehensive report that considers three key valuation approaches:
These are widely considered to be the most reliable methods of determining a property's market value. In most cases, an appraiser will use at least two (if not all three) of these methods to come up with their conclusion. Here's a quick overview of how each of them works:
The idea behind this approach is to determine the amount of ongoing income (i.e. – rent or lease revenue) the subject property can be expected to produce. To determine this number, an appraiser will look at the “market rent” in the area. In other words, what are similar properties currently rented or leased for in the same market? The appraiser will look at several similar properties (while also considering their size, location, condition, amenities, etc.) to get an idea of how much revenue the subject property could feasibly produce.
With this approach, the appraiser will determine what it would cost to rebuild the same structure from the ground up. The appraiser will determine an estimated construction cost based on today's prices (minus depreciation, plus land) and use this to calculate the property's value.
There are a lot of big assumptions that live inside this approach (namely, the cost of building materials and the assumption that nobody will ever pay more for a property than the cost of the improvements). The cost approach is an important consideration, but it's rarely sufficient to use this approach all by itself to determine a property's fair market value.
Sales Comparison Approach
With this valuation method, the appraiser will look at the recent sales figures of similar properties in the area (i.e. – the prices that similar properties have sold for in recent history), otherwise known as “comps.” With this approach, the appraiser assumes that a normal buyer will not pay more for the subject property than others have recently paid for similar properties in the same area.
Appraisers will only consider the data from properties that have actually been sold because these are concrete numbers and (in theory) represent real purchase prices that have been paid. Appraisers usually find this data from various public records, real estate agents, other appraisers, etc.
The Problem With Land Valuation
These valuation approaches usually work fairly well for houses, apartments, commercial buildings, and the like, but vacant land is completely different.
In most cases, the data needed to draw these conclusions for a vacant lot simply isn't available.
The Income Approach typically doesn't apply, because unless the property is being leased to a farmer or hunter, or is generating income by some other means, it is highly unusual for a vacant lot to generate any kind of regular income.
The Cost Approach doesn't apply, because by nature of the fact that it's vacant land, there are no improvements to take into consideration.
The Sales Comparison Approach may apply, but only if there are enough sold comps to take into consideration (and many times, there aren't). In most cases, there are FAR fewer sales comps available for land than for houses and other improved properties… and even when the comps do exists, they are much harder to quantify than improved property. Looking at different vacant lots is hardly an “apples to apples” comparison, and it's a very imperfect science at best.
It's a frustrating dilemma for land investors because we need to understand a property's market value. This number drives everything else in the process (the offer price, the cost of property taxes, holding costs, closing costs, the profit margin when selling, etc.).
If we can't be certain about a property's market value, we'll have to live with some ambiguity. Ambiguity is never ideal, especially when you're investing a lot of money into a property you can't afford to be wrong about.
What Determines Land Value?
Unfortunately, there is no “magic bullet” in valuing land. As any real estate appraiser can tell you, it's virtually impossible to reach the point of 100% certainty about any property's market value, and that's especially true for unimproved land.
The good news is, there is almost always a way to get reasonably comfortable with a “ballpark value” on a property, even with raw land.
While it's not a black and white valuation approach by any stretch, there are several reliable measurements you can use to get confident with the value of a prospective property before you sink any of your own money into it.
When I'm seriously evaluating a potential land investment, I start by looking at several different factors and asking myself, “How important will these factors be to my end buyer?”
How is the property zoned?
What can this land be used for?
Can someone use it to build a house? Office Building? Factory?
Is it best suited for farming? Hunting? Mining?
Make sure you understand what you (or your future buyer) will be allowed to do with the property in accordance with the local zoning and planning department.
In many cases, a property may be useful for more than one purpose, which is another important thing to consider.
How much inventory is available on the market?
Is this a one-of-a-kind property, or are hundreds of others exactly like it on the market right now?
If you own land with an incredible location (or view, access, or resources, etc.) unlike any other area, that's probably worth something.
However, if your property is one of a hundred others exactly like it, all of which are currently listed for sale – that will make it much harder to sell your property at a premium price.
What prices are the similar properties listed in the near vicinity?
Pretend for a moment that you are the owner of this property you're evaluating.
If you listed this property for sale today, what kind of “selling competition” would you have to deal with in the immediate vicinity?
If you're able to acquire the subject property for the price you want, will you be able to re-list it, and list it at a price that is significantly higher than what you paid for it, AND exceedingly lower than all the other properties in the area? This is how you make money as a land flipper, and it's another key consideration in determining what you should be willing to pay for a parcel of vacant land.
How desirable is the property?
Think of this as the “common sense” approach.
What was your first impression the first time you saw this parcel of land? Did anything about it look interesting, desirable, appealing, or attractive? Be honest with yourself – was there anything sexy about it? Is it likely to catch anyone else's interest? Are you looking at a gorgeous, wooded, mountainside lot – or is it a dry, barren, hostile wasteland?
If you go through the effort of creating a great property listing, how beautiful will you be able to make this property look? Can you give buyers an offer they can't refuse?
What are the holding costs associated with the property?
Suppose you buy a parcel of land and cannot re-sell it immediately.
What if you have to hang onto it for six months? Twelve months? Two years?
If you're forced to hold onto this property for longer than you want to, how much will it cost you (e.g. – property taxes, association fees, assessments, etc.)? Can you afford it? Is it worth the risk?
Luckily, the holding costs on vacant land are usually pretty cheap… but if you find that a property has unusually high property taxes or HOA fees, you'll want to factor that small bit of risk into the equation.
Does the property have road access?
When you're dealing with vacant land, this one is a biggie and has huge implications for what a property is worth.
It's always important to verify that a vacant lot has road access (or some kind of legal easement) so the owner (be it you or your future buyer) can actually get to it.
If it doesn't have any legal access points (and believe me, there are a surprising number of vacant lots that don't), your property might as well be on the moon. Make sure the property has legal access, and if you decide to roll the dice on a landlocked property, make sure you're paying almost nothing for it.
What is the size, shape & dimensions of the property?
Think about what this property might be used for someday. Is the parcel big enough? Does it have an odd shape? Is it located next to anything that would significantly decrease its desirability? Take a mental note of any red flags that you run into… these can be serious issues that will influence the property's value.
How close is this property to the local conveniences and amenities?
Consider what amenities or local attractions will be available to the property owner. Will they have a grocery store across the street or will they have to drive 3 hours to get there? Will you be able to market the property's location as a good thing?
This one is closely related to the property's desirability and its highest and best use. If the property's most obvious use is to build a single-family house, park a mobile home or hold any kind of residence, then this metric becomes even more important to consider.
What do the adjoining properties look like?
The properties next door can have major implications for the value and “sale-ability” of a parcel of land (e.g. – Think about it, would you rather live/work next to Glacier National Park or a Meth Lab?).
Most people care a great deal about who their neighbors are, so try to get a good idea for how the surrounding properties could impact the desirability of your property. If the adjoining properties have any obvious issues beyond your control, you'll want to think carefully about what this means for the property's value.
Is the property situated in a flood zone?
When properties are located within a flood zone, the cost of flood insurance can be very expensive. This added cost of property ownership can have a BIG negative impact on the feasibility of building improvements on the property.
To get an idea for whether a property is situated within a flood zone, check out the FEMA website or the Obie Risk Map and do a property search to see if your property is situated within or nearby a flood zone.
Land Valuation Hacks
Even though the data for vacant land appraisals is sparse in most areas, there are still some alternative approaches that can help you zero in on a realistic value of the property you're evaluating. Here are a couple of tricks I use regularly…
Research Public Listing Websites
This approach is far from perfect (for obvious reasons), but it does do one thing quite well, it will inform you of what kind of competition you're dealing with (and what those sellers are hoping to get out of their property). In other words – if you were to list your subject property for sale in this market TODAY, what other listings would you have to compete against?
Take a minute and do the math. Once you understand what price your property will have to be listed for to look like the best deal on the market, this will give you a better perspective of the property's potential value in contrast to what's currently available on the market (because if you're offering the best deal and advertising it well, it will theoretically be the first one to sell).
As mentioned in the video above, if you're looking for a faster, more streamlined way to handle much of this manual research, be sure to investigate PRYCD and Price Boss. These two different software options handle the process a bit differently, but they can both help save you a ton of time if you understand how to work within the limitations of each one.
Contact Local Real Estate Agents
Again, this is far from a foolproof method, but it does help to “tell the story” of what the subject property may be likely to sell for.
It's certainly helpful to look at market data on your computer, but there's another level of value that comes from picking up the phone and calling a few local real estate agents.
When I find a local agent with experience selling vacant lots in the area, I ask them something like this…
“Suppose I owned this property free and clear and I wanted to list it for sale with you today. What price would I have to list it for in order to sell it within 3 – 6 months?”
This kind of statement tells the agent a couple of things:
- I'm looking for a realistic idea of what it will take to sell this property quickly. I'm serious about getting it sold and I want some honest answers.
- If this agent turns out to be legitimately helpful, I may hire them for the job! This will encourage them to give me their time and offer up some legitimate answers.
As I'm having these conversations, I pay close attention to the prices they suggest. If they throw out some numbers that aren't going to work for me, now is the time to figure that out (instead of after I've already bought the thing).
Another thing I try to keep in mind that I may want to hire one of these people to list this property in the future. It doesn't hurt to start reaching out and making connections with agents on the front end like this because their services may actually come in handy.
Warning: Don't put too much faith in any ONE agent's opinion. There are a lot of clueless real estate agents out there, especially when it comes to vacant land. When I go through this exercise, I get input from at least 2 or 3 agents.
Recognizing Hidden Value
In some cases, the value of a property is a little harder to recognize.
Keep an eye out for any value that can be yielded by harvesting timber. If you notice that a property is situated in a densely wooded area, this may be worth investigating further. A professional forestry consultant can help you understand what timber on a piece of land is worth.
Also, keep in mind, depending on several factors, that removing trees has the potential to enhance or detract from a property's value and usefulness. In some cases, clearing the land (or choosing the right areas to clear) can make a property more readily usable for development. In other cases, dense tree coverage can foster wildlife and make a property more useful for recreational purposes.
Another potential point of value is the property's mineral rights (which aren't always automatically transferred to a new owner with the surface rights).
Surface rights are exactly like they sound – they are your rights to own and use the land's surface. Depending on your property type, the surface rights allow you to develop the land following the local zoning and planning ordinance.
Mineral rights apply to anything that exists beneath the surface. This includes coal, natural gas, oil, or any other commodity that can be mined. If your land is situated in an area with these energy resources, and if you own the mineral rights to your land, you can sell them or lease them to an interested party. Both options have pros and cons, and you can make money by collecting royalty or working interest. It will be up to you to decide which one you prefer.
When a property has value to offer in the form of timber or untapped minerals, this added value oftentimes isn't accounted for simply by looking at the basics like size, shape, location, zoning, and similar listed properties in the area. There can be real value at stake when a parcel has rich natural resources, which can present great opportunities that many other land investors will overlook.
An Appraiser's Perspective
I reached out to Ryan Lundquist (founder of the Sacramento Appraisal Blog and a certified appraiser in the State of California) to get his input on how he would approach the task of valuing land.
When it comes to real estate valuations, this guy's word carries a lot of weight because he is working in this world every day. As a professional appraiser, he understands how to approach this process using the conventional standards that are well-established in the real estate industry.
Here is a summary of a Q&A interview we put together on this topic…
What are the most important factors in determining the value of a vacant land property?
It’s honestly not easy to determine a ballpark value for a piece of land because there are so many factors to consider (as we'll get to below). Plus, since I hold a state license to appraise property, I have to actually support the values I give – whether I'm giving a verbal “ballpark” value or a full, written appraisal. I am essentially liable for any value I give, so that is why it can be challenging when people call me and say, “I don’t need a full appraisal, but just a quick value.” I get what people are asking, but since I actually have to support the value I give, it is more involved on my end.
Let's talk about location, zoning, and topography. Why are these things important? What about these three factors would cause a property's value to go up or down?
Everyone knows real estate is about location. A site next to a toxic dump, for example, probably isn't going to fetch high dollars, but a vacant lot in an upscale neighborhood is going to be worth much more.
That beings said, not all vacant lots are created equal and this is where zoning comes in to play. Zoning helps tell us what the site can be used for legally. This means if a vacant lot was zoned for residential housing and it could be split into four buildable lots, that might carry much more weight than a lot that isn't buildable at all (for whatever reason). On the other hand, if zoning would only permit a property for industrial use, it’s worth considering whether that use can be fully realized in the current market. In other words, is it a good market to improve an industrial lot?
Lastly, the topography is crucial. Two separate lots might have the same exact size on paper, but if one of them is on a steep incline and has very little buildable space, the lot that is actually useable could be worth much more.
In your opinion, is vacant land a difficult type of real estate to value? If so, why?
It sometimes feels difficult because there are definitely fewer comps. Sparse data always makes for more challenging valuations. Since the bulk of my work involves lots that have already been improved, that is definitely part of why it takes me longer.
(Note: When the data is available, this is the kind of visual context that Ryan likes to provide for his clients)
When an appraiser nails down the value of a vacant parcel of land, how much deviation (or “lack of reliability”) do you think there is on this number and why?
It honestly depends on the appraiser and how good the report is. There is no real “standard” end-all answer to this question. The reader of an appraisal report will have to sniff out whether it seems legitimate or not. Does the report tell a compelling story of value so that the value makes reasonable sense?
How much weight and importance would you give to the following factors?
The property's assessed value:
I suppose it really depends on how good the assessment is. Some areas may be better than others. However, one important consideration is that assessments in my area at least are based on when the property was purchased instead of the current market value. This means an assessment for a piece of land purchased 15 years ago might show a profoundly lower value than what the current market is willing to pay. Personally, I pay almost no attention to the assessment for this reason.
The listed prices of similar lots in the area:
I think the list price for similar properties can say something about value, though sometimes listings are out-of-sync with the market. I do pay attention to them (as well as pending and withdrawn transactions), but it’s always important to judge each one on its own – and determine whether it says something about the market or not. I do want to know how much interest similar properties have had from buyers when exposed to the open market and [it also helps to know] how many days they spent on the market too. It can be telling if listings aren’t selling at a certain level or if they’re fetching a lot of interest at a certain price.
The amount of inventory (of similar properties) on the market:
This is important because when there is more inventory in a market, it tends to water down the price (due to the increased competition). This is basic economics. When there is more supply than demand, prices will inevitably come down.
For the typical land investor who is trying to nail down a “ballpark value” of a vacant lot (WITHOUT ordering an appraisal), are there any common valuation mistakes or dangerous misconceptions they should watch out for?
I would say to make sure you are comparing apples to apples. One lot might look very competitive on paper, but when driving by or at least viewing it on Google “Street View”, differences can become apparent. I would also recommend talking with the city to ensure the land use and zoning are understood. I say this because sometimes information provided in Tax Records may not be accurate. The definitive word should come from the planning department instead of published records that may not have been updated in years.
Land Valuation is an Art, Not a Science
Believe me, I would LOVE to give you a crystal clear approach to valuing land that will always work, every time – but it's just not that simple (and if anyone tries to tell you otherwise, I'd be highly suspicious of whatever they're trying to sell you). The fact is – even an appraiser's opinion should be taken with a grain of salt. When we're talking about real estate (or any other product or service, for that matter), the final rule is this:
It's worth whatever someone is willing to pay for it.
The data (when available) can give us a halfway decent idea on this, but that isn't something you should bet your life on. The value is mostly contingent on finding the right buyer, for the right property, at the right time. Extracting the most value from any piece of real estate is an art, not a science.
When determining land value, the best you can do is perform a reasonable amount of research. Take the time you need to carefully consider the items listed above. Dig up whatever data you can find with tools like DataTree or PropStream, look at other locally listed properties on Zillow and use the best, most unbiased judgment you can manage.
At the end of the day, if you're making low enough offers, you should be able to protect yourself from most of the risks of land investing.
Due to the difficulty of getting perfect valuations, you should be giving yourself a healthy buffer to help offset any judgment errors you might be making along the way. This is the way I've been doing it for years, and even though I haven't always done it perfectly, I've never gotten in over my head – and that's something most real estate investors can't say for themselves.