Overview
The Building Residual Technique is a specialized appraisal method used to evaluate the value of a building separate from the land on which it sits. This technique is particularly useful in complex urban environments where land values can be substantially different from building values. By subtracting land income from the Net Operating Income (NOI), appraisers can isolate the income attributable to the building itself. This building income is then capitalized to determine the building’s value.
Examples
Example 1
Scenario:
- Net Operating Income (NOI): $200,000
- Land Income: $50,000
Calculation:
- Subtract the land income from the NOI: $200,000 - $50,000 = $150,000 (Building Income)
- Capitalize the building income: If the capitalization rate is 7%, the building value = $150,000 / 0.07 = $2,142,857.
Example 2
Scenario:
- Net Operating Income (NOI): $500,000
- Land Income: $100,000
Calculation:
- Subtract the land income from the NOI: $500,000 - $100,000 = $400,000 (Building Income)
- Capitalize the building income: If the capitalization rate is 6%, the building value = $400,000 / 0.06 = $6,666,667.
Frequently Asked Questions
-
What is Net Operating Income (NOI)?
- Answer: NOI is the total revenue generated from a property minus all reasonably necessary operating expenses.
-
How is land income determined?
- Answer: Land income can be estimated by analyzing comparable rents and sales of similar parcels of land in the area.
-
What is a capitalization rate?
- Answer: The capitalization rate is the rate of return on a real estate investment property based on the income that the property is expected to generate.
-
How does the Building Residual Technique differ from the Land Residual Technique?
- Answer: In the Building Residual Technique, the land value’s income is subtracted from NOI to find building income. In the Land Residual Technique, the building income is used to isolate the land’s income.
-
When is the Building Residual Technique most useful?
- Answer: This technique is most useful in urban areas where land values and building values can differ significantly.
Related Terms
Net Operating Income (NOI)
The total income from a property after operating expenses but before capital expenditures, taxes, and debt service.
Capitalization Rate
The ratio of Net Operating Income to property asset value, used to estimate the investor’s return on investment.
Land Residual Technique
An appraisal technique that aims to determine land value by isolating and removing the building’s income from the total NOI.
Online Resources
- Appraisal Institute
- The Appraisal Foundation
- Real Estate Appraisers Board
- Investopedia - Real Estate
- National Association of Realtors
References
- “Real Estate Finance and Investments” by William Brueggeman and Jeffrey Fisher, McGraw-Hill Education.
- “The Appraisal of Real Estate” by Appraisal Institute.
- “Investment Analysis for Real Estate Decisions” by Philip T. Kolbe, Gaylon E. Greer, and Henry D. Wurts, South-Western Educational Publishing.
Suggested Books for Further Studies
- “Real Estate Principles: A Value Approach” by David C. Ling and Wayne R Archer, McGraw-Hill Education.
- “Fundamentals of Real Estate Appraisal” by William L. Ventolo Jr. and Martha R. Williams, Dearborn Real Estate Education.
- “Real Estate Market Analysis: Methods and Applications” by Deborah L. Brett and Adrienne Schmitz, Urban Land Institute.
Real Estate Basics: Building Residual Technique Fundamentals Quiz
### What is subtracted from Net Operating Income (NOI) in the Building Residual Technique?
- [ ] Operating Expenses
- [x] Land Income
- [ ] Depreciation
- [ ] Mortgage Payments
> **Explanation:** In the Building Residual Technique, land income is subtracted from the Net Operating Income (NOI).
### What is capitalized into building value in the Building Residual Technique?
- [ ] Land Income
- [x] Building Income
- [ ] Total Revenue
- [ ] Operating Expenses
> **Explanation:** Building income, which is the remaining income after subtracting land income from NOI, is capitalized to determine the building's value.
### How is Net Operating Income (NOI) calculated?
- [ ] Total revenue minus taxes
- [ ] Total revenue minus mortgage payments
- [ ] Total revenue minus depreciation
- [x] Total revenue minus operating expenses
> **Explanation:** Net Operating Income (NOI) is calculated by subtracting all operating expenses from the total revenue generated by a property.
### Which aspect of property value does the Land Residual Technique primarily aim to isolate?
- [x] Land Income
- [ ] Building Value
- [ ] Total Revenue
- [ ] Operating Expenses
> **Explanation:** The Land Residual Technique aims to isolate the income attributable to the land by removing the building income from the NOI.
### In which type of area is the Building Residual Technique most useful?
- [x] Urban areas
- [ ] Rural areas
- [ ] Suburban areas
- [ ] Industrial areas
> **Explanation:** The Building Residual Technique is most useful in urban areas where the land and building values can have significant differences.
### What is used to estimate land income?
- [ ] Household income levels
- [ ] Historical sales data
- [ ] Comparable rents and sales of similar parcels
- [ ] Building height
> **Explanation:** Land income is often estimated by analyzing comparable rents and sales of similar parcels of land in the area.
### What type of rate is used to capitalize building income?
- [ ] Interest Rate
- [ ] Depreciation Rate
- [x] Capitalization Rate
- [ ] Gross Rent Multiplier
> **Explanation:** The capitalization rate is used to convert building income into building value.
### Which of the following is the typical outcome of using the Building Residual Technique?
- [ ] Evaluation of land price only
- [x] Determination of building value
- [ ] Assessment of operating expenses
- [ ] Calculation of NOI
> **Explanation:** The primary outcome of using the Building Residual Technique is to determine the value of the building by capitalizing the building income.
### Why would an appraiser use the Building Residual Technique?
- [ ] To find market trends
- [ ] To assess the environmental impact
- [ x] To separate building value from land value
- [ ] To estimate future sales prices
> **Explanation:** Appraisers use the Building Residual Technique to separate the building value from the land value in order to better understand each component's contribution to the total property value.
### What kind of property is this technique NOT generally used for?
- [ ] Commercial property
- [ ] Industrial property
- [x] Raw, undeveloped land
- [ ] Residential property
> **Explanation:** The Building Residual Technique is generally not used for raw, undeveloped land because it focuses on properties that generate income through both land and a built structure.
