Residual land values and sales negotiations

Q. My parents own a vacant eight-acre parcel of land that they want to sell to an abutting institution that has continually expressed interest over the years. How can they best identify and maximize the potential value in order to negotiate from a position of strength with the institution?

A. The standard answer would be to have the property appraised and utilize that opinion of the property’s value to establish a strategy for negotiations. The appraisal process is the least cumbersome and most timely to complete, but one must rely upon the appraiser to determine the highest and best use for the vacant land parcel.

An alternative that I have been successful with is to establish a residual land value for a conceptual property development as the highest and best use and basis for negotiations. Highest and best use is defined as legally permissible, physically possible, financially feasible, with maximum profitability. The highest and best use of the property as envisioned by the property owner may not be how the institution wants to utilize the property, but will usually yield the highest value.

I define residual land value as the land value determined for a specific (highest and best) use, after deducting the associated costs of securing development approvals, the required on and off site cost of improvements, the soft costs and a developer profit. Land has three specific different levels of value depending on its potential utilization.

Unimproved land without development approvals or site improvements provides the lowest value to the property owner as all of the costs and risk of approval, development and sale or leasing are borne by the purchaser.

Land that is unimproved but approved for a specific use is the next level of value because the approval process has been completed, with the associated costs paid for and the permits received. A portion of the risk and cost associated with the property’s development has therefore been quantified.

The highest level of value and risk to the property owner is associated with improving the land and placing it in use. This step involves securing all development permits and approvals, plus physically improving the property, funding the improvements and locating the eventual user (tenant or purchaser) of the improvements.

The initial step in order to determine highest and best use is to establish what is legally permissible and physically possible for the property. At a minimum, a civil engineering firm should be engaged to investigate the zoning, utility availability and physical characteristics of the property. An attorney also may be required to opine on zoning issues at this step. Basic boundary and topographical survey information will be necessary to develop conceptual site and/or subdivision plans, incorporating the legally allowable and physically possible uses.

After determining the types of development that are legally permissible and physically possible, the next step would be an analysis to determine which financially feasible concept will yield the highest potential profit. This step will require the assistance of a commercial real estate professional experienced with land development to investigate the market demand, to assist in estimating specific project approval and development costs and to establish the project’s potential improved value. The real estate professional can apply the researched information to each of the development concepts and establish a potential residual land value for each one. One or more of the development concepts may not be financially feasible.

The financially feasible development concept yielding the greatest potential profit is the highest and best use and the scenario from which your parents would establish the guidelines for the negotiations with the institution. Being knowledgeable about the potential of the property will greatly enhance the chances of achieving the best sales price to a specific purchaser.

David B. Eaton, president of Eaton Partners, Manchester, manages the firm’s commercial mortgage group. Questions can be submitted to him at commercialnotes@eatonpartners.com.