The decision-making process in real estate depends mainly on determining the value of land or property. Before you invest in a property, you must consider the project’s feasibility in the current market scenario, which the residual valuation method offers. It ensures you are making the right choice and have better revenue potential in the future.
With our 12+ years of experience helping property investors find the best property, we can assist you in the property valuation process. This guide will give you a brief overview of the residual property valuation method so you can understand how it works.
What’s covered in this guide:
What is a residual method of valuation?
The residual valuation method assesses the value of land or property with potential for development or redevelopment. It subtracts the developed value of the land from the price of developing it.
Residual value is the amount remaining after deducting relevant development costs and profits made from the property.
If the residual land value is lower than the price you are paying to purchase it, your development profit will also fall. It will increase only when the land purchase price is lower than the residual land value.
Why is residual valuation crucial for property development?
1. Project viability
The residual method gives a clear financial picture of the development project. By estimating its potential revenue generation against the development costs, you can understand if the project is viable. If the residual land value is negative or too low, the project indicates that it is not feasible under current conditions.
2. Attract investments
Residual property value acts as an essential determinant of the long-term profitability of an investment. As an investor, this value helps you understand risks and return potential. By assessing the future potential worth of a land or property, investors make better decisions about the feasibility of a venture. When residual values are high, they will attract more investments than properties with lower residual values.
3. Raise finances
To calculate the residual value of a property, you need to consider all development costs, including construction costs, tax, and other fees for regulations. This gives you complete information on the capital investment required for the project to maximize the property’s revenue potential. You can understand how much finance you need to raise to complete the project successfully and what returns you can expect.
4. Identify project risks
This calculation evaluates all the potential risks and uncertainties associated with the project, such as changes in market conditions, regulatory changes, inflation, etc. It will also help you understand the requirement for contingency funds to meet unexpected expenses in property development.
How to calculate the residual value of a property?
To calculate the residual value of a property, you need to go through a few steps. This ensures you get the proper estimate of the property’s valuation based on its future earning potential and associated costs. Here’s how we breakdown the whole process:
- Establish the GDV (Gross Development Value)
This is the estimated market value of the completed development project, which is ready for sale, lease, or occupancy. It represents your property’s projected market value, considering factors like rental income, sale prices, and any other revenue generation stream. With these details, developers can understand if the expected revenue from the property can cover all associated development costs and provide the desired ROI return on investment.
The components involved in calculating GDV are:
- Property valuation: Determine the market value for each unit within the development by assessing comparable sales in that area for residential properties. Consider size, location, and amenities for calculation. For commercial properties, you must consider the rental rates and demands of similar properties in the area.
- Unit count: Calculate the total number of units in the development project and determine whether they are apartments, shops, offices, etc. Then, multiply this count by the estimated market value of each unit.
- Additional revenue: GDV calculations will also include other income sources like parking fees, service charges, and other income generated by the development.
- Contingencies and costs: Consider development costs like construction costs, financing, legal charges, and other associated costs in calculating GDV. Additionally, you must prepare contingency funds to meet unexpected expenses and include those funds in your GDV calculation.
Development Profit = GDV – Development Costs & Contingencies
Where GDV = Sum of Unit Values + Income from Additional Sources
- Identify the cost of construction
Research the local market where your land is located and obtain multiple quotations from contractors to calculate its development or construction cost.
Additionally, you will need to allocate funds or obtain actual figures for professional fees, including planners, architects, quantity surveyors, and project managers.
- Determine the additional expenses for the development project
You must identify all the costs associated with the development project. This includes the lending costs that you must pay monthly or quarterly to finance the building. Other fees include acquiring and disposing of the property, including legal fees, agency fees, different property and income taxes, and furnishing rooms.
- Establish the desired outcome
You won’t take this work and all the risks without a goal. Developers usually aim for a 25% profit margin from such projects. You also require a contingency fund for budget overruns, which is generally 10% of the GDV. However, these targets can vary based on the developer’s preferences and the project goals.
- Calculate the residual value
To calculate the residual value, subtract construction costs, additional expenses, and the estimated GDV
The formula for the residual method of valuation calculation
You can find the residual land value by subtracting all the associated expenses for development along with the developer’s profit from the overall development cost.
The formula you can use here is,
Residual land value = (Gross Development Value) – (Construction costs + additional expenses + desired results)
Example for residual value calculation
The table below shows an example of how the residual value for properties is calculated:
GDV Calculations | Number of Residential units | 60 |
| Average Unit Size (Sq.ft) | 1,000 | |
| Total size of residential units | 60 × 1000 = 60,000 | |
| Estimated market value (Per Sq ft) | £300 | |
| Total market value | 60,000 × £300 = £18,000,000 | |
| Parking fees | £1,000,000 | |
| Service charge | £1,000,000 | |
| Gross Development Value | £18,000,000 + £1,000,000 + £1,000,000 = £20,000,000 | |
Cost calculation(Cost of construction and Additional expenses) | Site cost | £5,000,000 |
| Construction cost | £5,000,000 | |
| Professional fees | £1,000,000 | |
| Marketing and selling costs | £500,000 | |
| Financing cost | £1,000,000 | |
| Total Development Cost | £12,500,000 | |
Desired Returns | Profit 25% | 25% of £20,000,000 = £5,000,000 |
| Contingency 10% | 10% of £20,000,000 = £2,000,000 | |
Residual land value | Total costs for the project | £19,500,000 |
| Current land/property value | £20,000,000 – £19,500,000 = £500,000 |
What are the key factors that affect residual valuation?
The key factors that affect the residual valuation of land or property are:
- Land location
The primary factor affecting residual value is the land or property location. Properties in prime locations or developing areas tend to have higher market prices, increasing the GDV and directly impacting residual valuation.
- Property type
There are two main types of properties: Residential and commercial. However, you can also find properties that are used for both purposes. You need to understand these property types as they have different market values and impact the GDV calculations, affecting residual valuation.
- Market conditions
The Gross Development Value of a property depends on market conditions, mainly the demand and supply of properties in the current market scenario. When the demand for a particular property type increases, the overall prices and GDV rise.
- Development quality
The market value of property units depends on the development quality, which includes the cost of construction, designs, and amenities. If your construction materials are of high quality, your development cost will rise, and this will affect the GDV.
- Economic factors
Multiple economic factors, such as changes in interest rates and market inflation, can affect the residual valuation. For example, when interest rates are high, financing costs increase, reducing the GDV, which impacts the property’s residual valuation.
When to use residual valuation?
The residual valuation method is used for assessing undeveloped land or properties that have good redevelopment potential or properties with room having higher income generation potential. However, this method is suitable for properties having planning consent or are under local planning policy.
If your property or land doesn’t have that planning guarantee, you can calculate the value of the asset using other methods, depending on the property type. These include the market comparison method, the investment method, the replacement cost valuation approach, and the profits method.
We have listed a few use cases of the residual valuation method:
1. Land
The residual valuation is applicable for determining land value that makes sense for development. It gets the maximum value of an undeveloped plot that has been theoretically developed. The best-case scenario for this method is directly related to the land’s location and its existing planning legislation. The method’s logic depends on the maximum price that any investor would be willing to pay for the property.
2. Land with unfinished buildings
The residual method for valuing unfinished buildings is preferred when the existing building has nearly or fully used up its allowable development capacity or the building factor and for buildings that are almost ready or whose structures are in good condition.
If these conditions aren’t met, the residual method assumes the existing building will be demolished, and the demolition costs are included in the development costs.
3. Land with buildings that need reconstruction or redevelopment
Another use case of the residual valuation method is for buildings that aren’t in their best use and require reconstruction or redevelopment to maximize future revenue. For example, converting an old office building into an apartment in a residential location can increase its value.
In this case, you must check the possibility of demolishing the building before identifying the best redevelopment scenario and then calculate the capital required for its implementation.
4. Preserved building requiring renovation
When using the residual method for preserved buildings requiring renovation, you must know that they cannot be demolished. Here, you don’t consider the construction cost unless there is a construction permit. The valuer, using the residual method, will determine the best way to utilize the existing building, considering its preservation status and renovation needs.
Choose Pluxa Property for best property deals in the UK
Residual valuing of properties or real estate is a multidimensional process and requires a comprehensive analysis of multiple factors and considerations. We have the experience and expertise to help you with property valuation and allow you to invest in properties that have higher development and revenue potential.
Our expert investors at Pluxa Property provide valuable property insights, help validate assumptions, and guide you through the difficulties of the property valuation process.
Pluxa Property has been dealing with residential and commercial properties for over 12 years, and we can assist you with UK and overseas property investments.
We insist you select the best investment strategy within your budget and achieve desired outcomes within a fixed timeframe.
WHAT TO DO NEXT:
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FAQ
Is it possible to have a negative residual land valuation?
Yes, it is possible to have a negative residual land valuation when the total development costs and desired results exceed the estimated GDV (Gross Development Value) of the completed project. When the land value is in negative, it indicates the project isn’t financially viable under the current conditions, and developers need to reassess its scope, costs, and expected revenues to determine project feasibility.
How often should a residual valuation be updated?
A residual valuation should be updated at least once a year, at the end of each financial year, as uncertainties are associated with the estimates. For example, market conditions, project costs, and development progress can constantly change, affecting the GDV, and your residual valuation also changes. For long-term projects, you can update residual valuation quarterly to ensure it remains accurate and responsive to any changes.
Can residual valuation predict future property market trends?
Yes, residual valuation can predict future property market trends by analyzing the potential development profits based on current market conditions.
It can evaluate the potential income of the property and understand whether a project is viable. If multiple projects are seen as feasible based on market conditions, it may indicate the rising demand for properties in the area.
What types of properties can be calculated under residual valuation?
Residual valuation can be used to calculate the potential and required renovation of properties with development and redevelopment potential. This includes residential properties like single-family homes and apartments, commercial properties like office buildings, and mixed-use developments. Residual valuation can also be used for industrial properties like warehouses and manufacturing units.
Peter Juhasz is the founder of Pluxa Property, the biggest property investment company in UK and Group CEO of AIP Capital Group and a property investment expert with over a decade of experience in the UK market.
He built a successful property company using innovative cashflow strategies like Serviced Accommodation and HMOs, scaling to 200 units in four years.
Peter leads a team specializing in property and business acquisitions across various sectors. A former co-host of “Cashflow With Property,” he shares his expertise in real estate investing and business scaling.
He is committed to continuous learning and helping SME owners and investors maximize their returns, driven by his passion for empowering others to achieve their financial goals.
To learn how Pluxa Property can help you in UK property investment, contact our experts.
