How to Value Land + Teardown SFR

Question

Hello BP,

I recently came across some derelict properties in the Delridge neighborhood of Seattle and was able to (with the help of the owner of a nearby shop) track down the owner, who said that they were actually selling 3 adjacent lots. The total land square footage of the lot is 13,772, and the owner is asking $1.1 million for all 3. Is that a fair price? I've never done a tear-down deal before, so I'm not 100% sure how to value land and take into account the price of the demo and rebuild.

Thanks!

Scott Choppin · Answer

@Taylor Herman I was writing my first response as you posted your last.

Given that you've checked the zoning and determined "multi-story" complex, what was the dwelling unit/per acre that the zoning allowed? That will tell you how many units you can build on the site.

Next, do a full underwriting or proforma analysis of the project, of which the build costs, are one component in the model. You'll need to check rents, operating expenses, soft costs (architecture/engineering), development impact fees, and financing costs.

Getting land comparables is good, but you only have what other sites sold for, not necessarily that those sites sold with your zoning, land use, and density. What if all the land comps were for high rise office? You are best served when land comps match your type of project, even then, if someone does buy land and builds your exact same project, their build cost structure can be different. Example: many larger apartments complexes built by the major REIT's even in the Seattle market, can buy much better PSF build cost efficiency than a smaller developer can. It's amazing what discounts you can negotiate when you have a 500 unit project to dangle in front of a GC. That REIT can then pay more for the same piece of land just through lower build cost. Another example: a developer working on a smaller MF with a 20 year relationship with a local GC, that local GC can give preferential pricing because that developer had given him multiple projects in the past, or may have multiple projects going now, such that each projects total prices can be discounted. Again, but lowering the build cost, you can increase the amount you can pay for land.

We would very rarely make an offer on a site that we did not already do a proforma analysis on, to be sure we really know the deals works. On occasion, if we know the exact market well, and have build something recently, we might offer for land without a proforma, but that's a very specific situation with our having prior knowledge of projects that we've done recently.

Given what I see here, can I make the suggestion that you use your BP network to find someone with the knowledge that is needed here to partner up with? Find a developer partner locally who has done this a bunch, and make them an offer to partner up to bring their skill set to the table. Then you can use that project partnership to learn in detail this process and the underlying skill set for yourself.

I know a local Seattle based developer who does these types of projects, I would be happy to make in introduction. DM me if interested.

Thanks.

Scott Choppin · Answer

Hi @Taylor Herman, the best approach really starts from the perspective of a real estate developer. Ultimately, per @Christopher Phillips link, the residual land value analysis is the preferred methodology. Basically it looks like this:

Revenue from sale (sale of house or apartment project) - build costs, soft costs, financing -  developer profit = residual land value (amount you can pay for land)

But before you can know what to build you first must ask yourself these questions related to this opportunity:

1. What can go on the land from a zoning standpoint? See my post for how to do this:

Lifecyle of a CA MF Development Deal

2. Does the market demand support what the zoning allows and vice versa?

Check the zoning and see what is allowed.

Then as the developer (that's what you are now) you need to determine the match between the zoning and the market. Many time they are coherent, sometime they are not. Zoning changes much slower than real estate markets, meaning markets may start to demand units that zoning does not yet allow (that's why developers apply for zone changes).

Then do a basic underwriting of the deal to determine what can go there, how many units, what size units, etc. You can utilize an architect for this, but as I say in my Lifecycle post, you should learn this for yourself ultimately.

This will then determine your revenue per the formula residual land analysis above.

Sometimes, you may find that the market demands something other than what you zoning allows. In the post from @Ted Lanzaro, he outlined that spec single family residential (SFR) are not in high demand in his area. If your zoning allows SFR, and there's low demand for those, either you negotiate a lower price to be in line with market demand, or the deal is a pass (BTW, you will and should pass on many many sites).

Other times you may find a positive mismatch, meaning the zoning allows a use that produces higher value than it's present use. Example: your site zoning may allow higher density, maybe duplex, triplex, or higher multi-family densities, but it's not obvious that's what's allowed, surrounding sites are all SFR or commercial. In the example from our Lifecycle post link above, the site is an SFR, yet we can build a multi-unit project on same site. When this happens, the land value goes up (obviously the market demand is higher, therefore the value is higher).

So all land had some value, if lower number of units, or lower value units, it means lower land residual. If higher number of units, or higher value of units, than higher land value. So both density (how many units you can fit on the land) and the price of each unit, will influence the land value (BTW, build costs, soft cost, etc also influence, but I leave them out in this example for simplicity)

3. Does the price the seller wants match what you need to/want to pay for the land based on your underwriting of the deal and the residual land value?

Most times in our experience, sellers have a much more aggressive view of pricing than the market. Our running joke: land sellers are the first to raise prices and keep raising AHEAD of the market in a market up cycle, and the last to lower prices (and maybe never) in a down cycle. So be cautious with the seller's pricing guidance.

I am an offer of help. Please feel free to reach out if needed.

Scott

Jason Hsiao · Answer

It's not easy b/c there's not as much data point or comparable sales for land @Taylor Herman. Similar to what @Christopher Phillips said, it'll come down to the development. If there's no similar properties sold somewhat recently a rough rule of thumb is to keep land acquisition to 20% of your overall development cost or negotiate even lower.

Demo like build cost varies by area and not knowing what kind of house it is it's hard to say. Best to call up a few guys and get quotes.

Sean Walton · Answer

I would ask the owner what he wants for all the properties? Then do some of the due diligence to see if it is reasonable. If he is looking at it as lots for single family homes and a developer can do multifamily, you may be able to get a good deal you can shop around. Try and get it under contract and shop it around to developers I know one that does large multi families in Seattle if you want to PM me.

Charles Burnett · Answer

Hi Taylor. I was actually the listing agent on these properties last time they were on the market. And I own a rental property right behind them. It actually doesn't pencil at $1.1. I took the overpriced listing in hopes that I that the owner would come to his senses and that nearby developments would possible justify the price, but it didn't happen.

Albert Bui · Answer

HI Taylor,

It may help to ask a seasoned local investor to help give you a take on these 3 lots.

@Dima Suslikov - What are you thoughts on these three lots in Delridge ?

Since Im mainly involved on the financing end I would look at the after repair value (ARV) of the construction, permits/softcosts, holding costs, land acquisition costs, and etc to make sure you have sufficient margin or safety for profit if you need to sell or equity if you need to refinance or take out that construction loan so you can hold.

I would always recommend multiple exit strategies prepared in advance so you arent forced to take any specific route.

Generally Land acquisition costs are 10-20% of project cost but in areas where the ARV is 300-400 persqft or higher you can pay a higher cost for land and still make your intended equity creation (if you intend to refi) or profit margin (if you intend to sell).

Taylor Herman · Answer

Thanks so much @Scott Choppin!

Scott Choppin · Answer

Thanks @Taylor Herman. Use me as a resource if needed.

Take care.

Taylor Herman · Answer

Thanks for all the great info and tips @Scott Choppin! It sounds like this kind of property is a bit out of my wheelhouse. I currently only deal with SFR or smaller MFR, but just wanted to get an idea of everything involved in bigger development projects. I guess I'd be better served by getting a bit more experience before trying to take on the big builds.

How to Value Land + Teardown SFR

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