Residual Techniques
Residual techniques are a suite of appraisal methods used in real estate to estimate the value of a piece of property. These methods are particularly useful when one component of the property (either the land or the building) has a known value, and the value of the other component needs to be estimated. Essentially, residual techniques are based on the rate of return for the known component to infer the value of the unknown component.
Two primary types of residual techniques are frequently employed:
- Building Residual Technique: Used when the value of the land is known, and the goal is to determine the value of the building.
- Land Residual Technique: Applied when the value of the building is known, and the objective is to estimate the value of the land.
Examples
Example 1: Building Residual Technique
A developer knows that a particular plot of land is valued at $500,000. With a market rate of return of 10% on investments, the developer wants to estimate the value of the building that will generate a future net income of $75,000 per year.
Estimated Building Value = Net Income / Rate of Return
\[ \text{Building Value} = \frac{75,000}{0.10} = $750,000 \]
Therefore, the estimated value of the building is $750,000.
Example 2: Land Residual Technique
A commercial property generates a net income of $120,000 annually, and the building on that property is appraised at $1,000,000. The market rate of return for such properties is 8%.
Net Operating Income (NOI) contributed by the building:
Building NOI = Building Value * Rate of Return
\[ \text{Building NOI} = $1,000,000 * 0.08 = $80,000 \]
Total NOI from property:
\[ \text{Total NOI} = $120,000 \]
Remaining NOI attributed to the land:
\[ \text{Land NOI} = \text{Total NOI} - \text{Building NOI} = 120,000 - 80,000 = $40,000 \]
Estimated Land Value:
\[ \text{Land Value} = \frac{\text{Land NOI}}{\text{Rate of Return}} = \frac{40,000}{0.08} = $500,000 \]
Therefore, the estimated value of the land is $500,000.
Frequently Asked Questions
Q1: What are Residual Techniques used for?
Residual Techniques are primarily used to estimate the value of either a building or a piece of land when the value of one is known, and a specific rate of return is provided.
Q2: What is a rate of return in Residual Techniques?
The rate of return is a percentage that represents the return expected on investment. It is a critical factor in calculating the value of the unknown component (either land or building).
Q3: What is the Building Residual Technique?
The Building Residual Technique is used when the land value is known and the objective is to estimate the value of the building.
Q4: What is the Land Residual Technique?
The Land Residual Technique is used when the building’s value is known and aims to estimate the land’s value.
Q5: How do I determine the appropriate rate of return?
The appropriate rate of return is typically determined by examining market conditions, historical data, and investment benchmarks relevant to the specific property type and location.
Related Terms
Building Residual Technique
This method estimates the value of a building based on the known value of the land and the rate of return.
Land Residual Technique
This method estimates the value of the land based on the known value of the building and the rate of return.
Net Operating Income (NOI)
This is the income generated from a property after deducting operating expenses but before deducting taxes and financing costs.
Rate of Return
The gain or loss on an investment over a specified period, expressed as a percentage of the investment’s cost.
Online Resources
References
- Appraisal Institute, “The Appraisal of Real Estate,” 15th Edition.
- International Valuation Standards Council, “International Valuation Standards 2020.”
- Fisher, Jeffrey D., and Martin S. Smith. “Income Property Valuation.”
Suggested Books for Further Studies
- “Real Estate Valuation Theory and Application,” by Maury Seldin and Harlan W. Force.
- “Principles of Real Estate Practice,” by Stephen Mettling and David Cusic.
- “Investing in Income Properties: The Big Six Formula for Achieving Wealth in Real Estate,” by Kenneth D. Rosen.
