Why this article is important: This article explains how an agent tasked with valuing a vacant parcel produces the most informed valuation according to its size, use, location, the presence of natural resources, the regulations governing the land and more.
Land value is in the right to use it
Consider an agent tasked with creating a BPO for a vacant parcel. Surrounded by other vacant parcels, its potential uses — and thus value — are not immediately apparent.
The agent is tempted to simply assign a value for the parcel equal to sales prices for other land of similar acreage and topography. But before performing a comparative market analysis (CMA) or other land valuation technique, they research the many other aspects of the land and how they each impact its value.
Land is more than just a shape located on a map. Even when no structures are present, land conveys with it various rights, uses and often natural features/hazards and easements.
The agent developing their broker price opinion (BPO) on vacant land accesses various reports and documents from different agencies to confirm the land’s permitted uses, and thus its potential value.
These include:
- surveys;
- engineering plans;
- zoning maps;
- soil reports;
- any existing ALTA (American Land Title Association) reports;
- any existing subdivision maps; and
- other plans made to develop the property for use.
The agent also needs to order (or perform their own) land use feasibility study to determine the availability of public utilities and services, including:
- sewage;
- sanitation;
- water;
- power;
- gas;
- phone;
- internet; and
- fire and police services.
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Affixed to the land as its use and value
Real estate includes improvements as they are affixed to the land.
Improvements may be affixed to the land by:
- roots (e.g., shrubs and trees);
- embedment (e.g., walls);
- permanently resting (e.g., fixed structures); or
- physically attached (e.g., by cement or nails). [Calif. Civil Code §660]
Things naturally attached to the earth within a parcel are real estate. Natural fixtures to the land, called fructus naturals, include:
- trees;
- shrubs; and
- grass.
However, natural items humans plant and cultivate for consumption and use are fruits of labor, called fructus industriales, also known as emblements.
Fructus industriales include such things as crops and standing timber. Crops and timber are ordinarily considered real estate. However, industrial crops and standing timber sold under a purchase agreement and scheduled to be removed are considered personal property with value separate from the value of the land. [Calif. Commercial Code §9102(a)(44)]
When valuing a property with crops or natural features meant to generate revenue for the owner (such as a farm or vineyard), the agent needs to order and review a(n):
- land survey to confirm the location of the parcel’s boundaries;
- environmental assessment from a California Environmental Quality Act (CEQA) consultant;
- soil study to confirm the suitability of the land for growing; and
- water quality test.
Further, the agent needs to conduct a physical inspection of any irrigation system to ensure it is in good working order.
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Natural and environmental hazards, externals affecting use of a parcel
The existence of a hazard due to the geographic location of a property affects its usefulness or desirability, and thus its pricing for prospective buyers. To unify and streamline the disclosure of natural hazards to a prospective buyer of any type of property, a statutory form was created entitled the Natural Hazard Disclosure Statement (NHD). [See RPI Form 314]
Natural hazards within the region of a parcel’s location likely to subject its land to reduced or more costly use include:
- special flood hazard areas, a federal FEMA designation;
- potential flooding and inundation areas;
- very high fire hazard severity zones;
- wildland fire areas;
- earthquake fault zones; and
- seismic hazard zones. [CC §1103(c)]
Environmental hazards, as distinguished from natural hazards, are human-made noxious or annoying conditions which are hazardous or a nuisance for humans, whether the source is internal or external. Environmental hazards have an adverse effect on a property’s usefulness and worth to its occupants. As an interference with the use of a property, they are considered defects and thus material facts the seller agent must disclose to prospective buyers before they enter into a purchase agreement.
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Land use regulations enhance or reduce value
The agent investigates and determines whether title to the subject property is encumbered by any recorded Covenants, Conditions and Restrictions (CC&Rs) addressing the use of similar parcels also subject to the same CC&Rs.
CC&Rs by design limit how an owner may use their property. The CC&Rs bind all future owners since use restrictions run with the land and thus its value.
A prospective buyer of a parcel of real estate, particularly in a subdivision, obtains a preliminary title report (prelim) to determine whether the property is burdened with unwanted restrictions. The prelim is reviewed with their agent for defects prior to closing escrow to acquire title to a property.
A prelim discloses the results of a search of the property’s title history by a title company. However, it functions for the very limited purpose of constituting the title company’s revocable offer to issue a title policy. As a separate customer service, title companies supply a property profile with copies of any CC&Rs of record to agents on request.
CC&Rs are often unenforceable
For a covenant to affect title and thus ownership, it must run with the land. To do so, the restriction needs to directly benefit the subject property as against other properties. To benefit one lot as against other lots, the title to all lots within the subdivision must be encumbered by the same covenant. [Calif. Civil Code §1462]
Further, CC&R restrictions limiting an owner from freely selling, leasing or encumbering real estate, called restraints on alienation, may not unreasonably restrict the marketability of title to the property. This reasonableness rule also applies when the restraint is contained in a trust deed or lease agreement. [CC §711]
For example, CC&Rs addressing the installation or use of a solar energy system are unenforceable when the restrictions increase the cost of the system or decrease its efficiency by:
- increasing in the installation cost of the system by more than 20%; or
- decreasing the operating efficiency of the solar system by more than 20%. [CC §714]
Zoning regulations are set by the local and state government and govern the owner’s use of the property.
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One of the first steps for an agent gathering information to work up a BPO on a parcel of vacant land is to document the parcel’s allowed and prohibited uses by consulting a zoning information map from the local planning agency.
As well as examining the uses permitted by the zoning of the subject property, it is helpful in an evaluation to look at the zoning for adjoining and nearby properties to analyze the effect of uses permitted in the area of the subject property.
For example, a residential parcel’s location adjacent to a parcel zoned for industrial use likely has a negative impact on the residential parcel’s value. This is because industrial sites often produce noxious sounds, fumes or other adverse effects for nearby property.
On the other hand, a residential parcel located adjacent to a designated nature preserve will likely see a positive impact on the value since homeowners prefer the guaranteed quiet.
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Water is land and has value
Water in its natural state is considered land as water is part of the material comprising the earth.
While water is real estate, the right to access and use water is an appurtenant (incidental) right to the ownership of real estate.
Three key beneficial rights of ownership in water, over which the state is trustee, include:
- the right to use water;
- the right to take water by appropriation; and
- the right to take water by prescription.
The beneficial right of a parcel’s ownership to use water is called a riparian right.
Riparian rights refer to the owner’s rights in a parcel of real estate to take surface water from a source of running water contiguous to their land, such as a river or stream. [Calif. Water Code §101]
Here, the presence — or absence — of a water source on the land influences the agent’s valuation.
For example, consider an agent retained to complete a BPO on a vacant residential parcel located in a rural area. The agent locates similar nearby properties which recently sold and works up a CMA to arrive at a valuation on the subject property for the client.
The agent locates three similar properties at prices ranging from $120,000 – $140,000. Based on the agent’s initial analysis, the agent temporarily values the subject property at $130,000.
While gathering property information, the agent consults the local utility provider and discovers the subject property has no access to the public water supply. The cost to extend the water supply to the land is $10,000.
The broker also orders an environmental site assessment. The assessment finds the presence of soil contamination, making any installation of a well unusable.
Since the comparable properties listed in the agent’s CMA were already connected to the public water supply — making the presence of water a non-issue for the comps — the agent deducts $10,000 from their initial valuation to account for the need to connect the subject property to the water supply to make it usable.
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Rights in another’s property are appurtenant or in gross.
An easement burdening an owner’s property as an encumbrance on their title is classified as either:
- an appurtenant easement, meaning the allowed use belongs to and benefits an adjacent property and is said to run with the land as an interest the adjacent property holds in the burdened real estate; or
- an easement in gross, meaning it belongs to an individual, not land, as their personal right to a specified use of the burdened real estate.
An appurtenant easement is incidental to the title of a property, the ownership of which benefits from its use. An easement is not reflected as a recorded interest on title to the parcel of land it benefits. Nor is it a personal right held by a particular individual who may now or have previously owned the parcel benefiting from the easement.
Accordingly, an appurtenant easement is recorded as an encumbrance on title to the burdened property. The easement remains on title to the burdened property after conveyance of either property to new owners. An enforceable easement need not be referenced in the grant deed conveying either property as easements run with the land. [Moylan v. Dykes (1986) 181 CA3d 561]
Conversely, an easement in gross benefits a particular person — not the real estate owned by that person. An easement in gross is personally held only by the individual who may use the easement. No parcel of real estate benefits from an easement in gross as only the individual holding the easement benefits.
An easement in gross is a personal right that is not transferred with the sale of any real estate which may be owned by the holder of the easement. However, the right can be transferred by the easement holder to another person by a writing – unless the transfer of the easement in gross is prohibited by a provision in the document creating the easement. [LeDeit v. Ehlert (1962) 205 CA2d 154]
Appurtenant rights in another’s land
Included in landownership rights are incidental rights of ingress and egress, also called appurtenances, as they are located on parcels owned by others.
An appurtenant easement gives the owner of a parcel of real estate the right to use adjoining real estate. The right to use another property is part of the ownership of real estate, although it is not reflected on the title to the real estate but is an encumbrance on the title to other property.
This right to use adjoining property runs with the land. Thus, the right is automatically conveyed with the real estate when the owner conveys it, as in a sale or leasehold. Appurtenant rights remain with the ownership of the real estate they benefit and are not transferable separate from the property.
Other appurtenant rights to real estate include the right to the lateral and subjacent support provided by the existence of adjoining real estate. For example, the owner of real estate cannot remove soil from their land when doing so causes the adjoining real estate to subside or collapse.
Appurtenant rights held by an owner of one property are an encumbrance on title to another property burdened by the appurtenance, typically recorded, as are most easements. Also included in ownership of a parcel within a homeowners’ association (HOA) as an appurtenant right is the exclusive right to use portions of other real estate for storage and parking, as well as an undivided fractional interest in the common areas. [CC §4125]
Also, the installation of active solar collectors has led to the right of access to sunlight and air which passes through airspace above property owned by others. This right of access to the sun for a solar collector is considered an easement — an appurtenant right. [Calif. Public Resources Code §§25980 et seq.; CC §801.5(a)(1)]
The rights of others in the subject property
An easement is the right of one property owner to use another’s property for a specific purpose. It is an interest one property owner holds in someone else’s real estate. It grants its holder the right to limit the activities of others on the property burdened by the easement, including the owner of the burdened property. [CC §§801 et seq.]
For example, a landowner holds an easement allowing them to construct and have access to a pipeline across their neighbor’s property, such as for water, sewer or electricity. The neighbor’s right to develop their own property is now limited as they may do nothing to interfere with the easement owner’s access to the pipeline.
An owner’s rights in other property
The most common easement is used for ingress and egress. An easement for ingress and egress creates a right of way allowing one property owner to traverse a portion of another’s land to access their property.
An easement creates a tenement relationship between two parcels of real estate, as it:
- benefits one property, referred to as the dominant tenement, whose owner is entitled to use the easement; and
- burdens another property, referred to as the servient tenement, limiting its owner’s use of the portion of their property subject to the easement.
When an owner whose property is burdened by an easement interferes with the use of the easement by the owner of the property benefiting from the easement, the easement holder is entitled to have the use of the easement reinstated. The easement is reinstated by either removal, relocation or modification of the interference.
Further, the neighbor who holds the easement is entitled to compensation for their money losses caused by the servient tenement owner’s obstruction of the neighbor’s use of the easement. [Moylan, supra]
License for use
A license grants its holder a personal privilege to use property, but no possessory right to occupy it by excluding others. Unlike easements, licenses are not exclusive rights — an owner may give many licenses to perform the same or different activity in the same area.
Unlike an easement, a license may be revoked at the will of the person who grants it, unless agreed to the contrary or it has become irrevocable.
Highest and best use for the parcel
Consider an agent tasked with creating a BPO for a vacant parcel of real estate. They first check the zoning regulations for the subject property and find the parcel is zoned for rural use.
The rural zoning designation allows for residential use, as well as agricultural uses like farming or keeping livestock. Depending on the size of the parcel, it may be subdivided into lots.
How does the agent develop a BPO for the parcel, when it has so many different possible uses — and thus, different types of comparable properties to consider?
To determine use for evaluation of a vacant parcel, the agent considers what is the property’s highest and best use under current market conditions.
The principle of highest and best use holds that the greatest market price of the property is realized when its use is maximized. The test for highest and best use requires that the use:
- be physically possible;
- be legally permissible;
- be economically feasible; and
- achieve maximum productivity.
Once the agent determines which use is the property’s highest and best, the agent seeks out comparable properties improved and put to the same use.
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Land value by allocation or extraction
The agent developing a BPO on a vacant parcel locates very few vacant parcels sold in the area within the past year. None are similar enough in size or quality to use as comparable properties to work up a CMA.
As an alternative to the CMA approach, the agent chooses the allocation method to evaluate the land. This method separates the land’s value in the property from the value of its improvements by establishing a land-to-improvement ratio.
The agent initially looks at the value of land sales in past years compared to a recent sales price of the same parcel with improvements. The principle behind this estimation is: while property values change over time, the ratio of land-to-improvement value changes little.
For example, the agent finds several newly built homes which sold five years ago. The developer purchased the vacant lots for $90,000 each. After developing each site, each property sold for $650,000. Therefore, the land-to-improvement ratio is 90,000:650,000 or 14%.
The agent confirms this ratio for land value with other similar properties sold in the area in recent years.
With this data, the agent can now reference the recent sale of similar parcels of land with improvements at the highest and best use — homes — as comparable to the subject property without any improvements, which sold. The agent then applies the 14% ratio to sales price of the comps to arrive at the valuation for the subject vacant parcel.
In contrast, the extraction method pulls out the value of the land from the value of the improved property by first calculating the value of the property’s improvements.
For example, to proceed with the extraction method, the agent evaluates the improvements separate from the parcel to analyze recent sales using the cost approach. Using the extraction method, the agent calculates the cost to replace the improvements for each property and subtracts accrued depreciation from the value of those improvements.
The resulting aged value of the improvements is subtracted from the sales price of the improved parcel. The result is the value of land.
Performing this calculation for each comparable property, the agent arrives at an average land value per square foot (or acreage) and applies that average to the subject property.
For example:
| Sales price | $1,000,000 |
| Value of improvements | $710,000 |
| Extracted land value | $290,000 |
Land Residual Method for feasibility
Consider an agent hired by a buyer to prepare a BPO for a vacant parcel the buyer plans to use as the site for constructing an industrial building. The buyer needs an evaluation of the parcel to decide whether the agreed price to acquire this parcel is a proper price for a completed project in this location.
To make a decision, the potential buyer-developer needs to know what value is attributable to the land as though the industrial improvements exist on the parcel.
To determine its value as a vacant parcel for the intended use of adding improvements, the agent uses the land residual method for valuation. This method considers the intended improvements as existing, already in place. This method is also used for valuing land for development into a residential neighborhood (subdivision). Thus, this method has become known as the subdivision development method.
Initially, the agent evaluates comparable improved industrial property sales in the area using the income approach. With a comparative marketing analysis (CMA), the agent determines both the rental income the client can anticipate from the completed project on the subject parcel and the projects likely fair market value, known as the gross development value.
Next, the agent calculates the estimated development costs, including the costs of:
- construction;
- permitting;
- financing;
- agent fees; and
- architectural fees.
Subtracting the total development cost from the CMA determined value for the subject property as a completed development gives the agent the residual land value for the parcel as vacant.
The formula is:
gross developed value – development costs = residual land value
The residual land value is the maximum the potential buyer ought to pay for the property to meet their development goal for an investment. Any purchase amount over the residual land value calculated is not “worth it” for the buyer.
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Ground Rent Capitalization Method
Another way to estimate value for a developable income-producing site is the ground rent capitalization method.
This method is especially useful for calculating the anticipated income a ground lease generates for the owner of the property to convey a leasehold estate to a tenant rather than conveying the fee estate. This rent capitalization method considers a tenant as owner of a ground lease with the right to possession and use of the parcel for the life of the leasehold.
Thus, the tenant owning a leasehold uses the parcel to build improvements they will own for the duration of the ground lease (typically spanning decades).
With this method, the agent developing a BPO evaluation for the vacant parcel first establishes a proper capitalization (cap) rate for the parcel.
To set the cap rate for the property based on recent sales prices (which is one of two ways to set the cap rate), the agent preparing the BPO uses the seller broker’s approach to determining a property’s cap rate. The agent analyzes the sale of other similar properties, including their sale price and net operating income (NOI) (annual operating income minus expenses). The agent inputs this information into the seller broker’s cap rate formula:
sales price / NOI = cap rate
Performing this equation on at least three similar properties provides the agent with the average cap rate the property can expect to generate under current sales conditions when improved as intended.
Then, the agent performs a market analysis to determine the anticipated annual ground rent likely to be collected were the parcel to be leased, not sold.
Here, annual property taxes when paid by the owner are deducted from gross leasing income to determine the net operating income from the vacant land for calculating the land value. The result is input into the formula. Since this is for a ground lease, no other operating expenses are deducted as all operating costs are paid by the tenant.
To arrive at the value of the vacant parcel, the agent inputs the net ground rent information into the formula:
annual NOI ground rent / cap rate = land value
The agent can also use this formula to arrive at a range for the owner, providing a bottom and top amount the investor can aim for.
For example, consider a vacant parcel well-suited for a ground lease. The agent researches nearby ground leases and finds the annual rent can range based on how the tenant uses the property.
When the ground lease is for a residential development, the annual rent generated for a parcel of this size is around $50,000. Or, when the ground lease is used for a commercial development, the annual rent generated is closer to $60,000.
Likewise, the cap rate for these separate uses is also different, say, 9% and 10% respectively.
Therefore, the agent inputs the numbers into the formula twice:
Residential use: 50,000 / 0.09 = $555,555
Commercial use: 60,000 / 0.1 = $600,000
The agent can present both results in their BPO, to inform the owner about how best to market the property (in this case, for commercial use).
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