How to Value a Vacant Home Building Lot

The market value of an individual lot is equal to the revenue it could generate when a residential housing unit is built on it minus the cost of creating that revenue (construction cost, marketing, profit, and other costs). Sales revenue will largely be determined by what can be built on the lot and how much that unit would sell for in the market. The dimensions of the lot, building codes, and the local zoning ordinances create constraints on what can be built. Most often there is some variety in choices available to construct on a given lot. Each of these options has a revenue potential and an estimated cost. Builders produce the combination which yields the greatest profit.

Imagine a 6,000 Square Foot (SF) lot that is 60' wide by 100' deep. A typical lot such as this would have a front setback of 20', side setbacks of 5', and a rear setback of 30' leaving a 50' wide by 50' deep building envelope for the house foundation. This site could comfortably accommodate a 2,000 SF single-story house (some area is lost by not making the house a perfect rectangle). For the sake of making the calculations easy to follow, assume this house could sell for $1,000,000 (peak prices in Irvine, California, were around $500 / SF).

An individual speculator would be paying retail prices for house construction. This would be upwards of $150 SF. The cost of construction would be around $300,000 (2000 * 150 = $300,000). There would be a 6% sales commission (1,000,000 * 0.06 = $60,000), plus financing costs, overhead costs, and other miscellaneous costs which will add up to about 10% of the project cost (1,000,000 * 0.1 = $100,000). Therefore, your revenue minus expenses would be $1,000,000 - $60,000 - $100,000 - $300,000 = $540,000. This is how much money would be available to pay for a lot at the breakeven point.

Since a speculator would want to make a profit, the lot is discounted from $540,000 until an amount is reached to compensate for the risk and the headaches that go along with the project. Perhaps the speculator would want to make $120,000 (approximately 12% of sales price) in order to do this work? If so, the speculator would be able to offer $420,000 ($540,000 - $120,000 = $420,000) for the lot. If they are the highest bidder, they get the lot, and the project is theirs. (This same basic calculation also works for tear-down projects known as "scrapers").

Most people have no idea how to value a vacant building lot. Looking around at similar lots is not an effective method, particularly since the value of a lot is so sensitive to the final selling price of a house built on it. Buying lots is a speculators game, and those who get lucky can reap huge windfalls. Those who are not so lucky can lose a great deal of money.

Lawrence Roberts is the author of The Great Housing Bubble: Why Did House Prices Fall? Learn more and get FREE eBooks at: www.thegreathousingbubble.com/ Read the author's daily dispatches at The Irvine Housing Blog: www.irvinehousingblog.com/ Visit How to Value a Vacant Home Building Lot.

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