Examples
Example: A property generates $10,000 net operating income ($15,000 rent less $5,000 operating expenses). The improvements cost $70,000 to construct and require a 12% rate of return (10% interest plus 2% depreciation), which is $8,400. The remaining $1,600 income is capitalized at a 10% rate (divided by 0.10) to result in a $16,000 land value using the land residual technique.
Table 28: Land Residual Technique Breakdown
| Property NOI | $10,000 |
|---|---|
| Income to improvement | -$8,400 |
| Income to land | $1,600 |
| Divided by required rate (10%) | $16,000 land value |
Frequently Asked Questions
What is Net Operating Income (NOI) in the context of the Land Residual Technique?
Net Operating Income (NOI) refers to the revenue generated from a property, minus operating expenses. It excludes costs such as depreciation, taxes, and interest payments.
How is the rate of return on improvements determined?
The rate of return on improvements is the sum of the interest required on investments and an allowance for depreciation on the improvements. It typically includes an estimate for both.
What is the ‘highest and best use’ in property valuation?
The highest and best use refers to the most profitable legal use of a property, considering all regulations and feasible improvements.
How does the Land Residual Technique assist in feasibility analysis?
By breaking down the potential revenues and costs, this technique helps determine whether a development project is financially feasible and if it would result in a profitable outcome.
What is the difference between the Land Residual Technique and the Building Residual Technique?
The Land Residual Technique focuses on valuing the land after accounting for the improvements, whereas the Building Residual Technique evaluates the value of improvements given the land value and income generated.
Related Terms
Net Operating Income (NOI)
The income generated from a property after deducting operating expenses but before accounting for taxes, interest, and depreciation.
Improvement Value
The monetary worth of any enhancements or upgrades made to a property, which can affect the property’s overall value and income-generating potential.
Feasibility Analysis
A study carried out to determine the viability of a project, considering financial, regulatory, and market conditions.
Highest and Best Use
A principle in real estate appraisal that dictates the most profitable, legally permissible, and physically possible use of a property.
Income Approach
A real estate valuation method that uses the income an investment property generates to estimate its value.
Building Residual Technique
An appraisal method similar to the land residual technique but focuses on deriving the value of improvements based on a given land value and net income.
Online Resources
- Investopedia on Property Valuation
- Appraisal Institute
- Real Estate Appraisers Directory
- American Society of Appraisers (ASA)
References
- Glickman, J. (2002). “Property Valuation Techniques: Understanding the Basics.” Real Estate Review, 32(4), 45-60.
- Appraisal Institute. (2008). “The Appraisal of Real Estate” (13th ed.). Chicago, IL: Appraisal Institute.
Suggested Books for Further Studies
- “Real Estate Appraisal: From Value to Worth” by Peter Wyatt
- “Income Property Appraisal” by Jeffrey D. Fisher and Dennis S. Tosh
- “Practical Applications in Appraisal Valuation Modeling” by Mark R. Rattermann
- “Investing in Income Properties: The Big Six Formula for Achieving Wealth in Real Estate” by Kenneth D. Rosen
- “Real Estate Principles: A Value Approach” by David C. Ling and Wayne R. Archer
