RESIDUAL METHOD

n  Used in valuing land or land and buildings

with development or redevelopment potential
n  This method is use to assess the residual
value of a property with development
potential.
n  The basic concept of residual method is the
amount of value that a developer is willing to
pay after considering its development
potential.
 RESIDUAL METHOD

The most commonly used valuation method to

determine the properties value with development
potential.

A property is identified as potential when the

current usage is no longer its highest and best uses.
 RESIDUAL METHOD
There are essentially 3 main purposes for which
the residual approach is appropriate:
1.  to estimate the most probable price of a
development site based on the highest and best
use of the site.
2.  to calculate the likely level of profit from a
development scheme given a known site
purchase price and a known cost of
development.
3.  to establish the construction cost ceiling given a
known land cost and the minimum acceptable
level of profit.
 RESIDUAL METHOD

Basic Method:

Value of Completed Development ( Gross

Development Value or GDV)
Less
Total Expenditure on improvement/
Development ( including developer’s profit)
Equals
Value of site or property in its Present
Condition (Residual Value)
The Residual Method
a. Value of completed development:
Residential : Direct capital value comparison- assessing the
future sale value on current residential sales of
similar property.
Commercial : Investment Method of valuation- capitalizing the
total achievable rent at an appropriate yield.
Leisure : Account Method – predicting future cash flow
based on comparable evidence of similar business
enterprises.
b. Total Expenditure on Improvement or Development;
Sub-divided into a number of constituent parts:
* Building Costs – gross area used with associated
items such as site clearance,
demolition etc.
 The Residual Method
b. Total Expenditure on Improvement or Development;
Sub-divided into a number of constituent parts:
* Building Costs – gross area used with associated items such
as site clearance , demolition etc.
* Professional Fee – 12 and 15% of construction cost.
* Finance – for total building cost, land cost and professional fee
* Advertising and Marketing- depends on the program, 0.5% to
1% of GDV
* Voids and Contingencies – empty after the development is
completed. 3 – 5% o n building cost
* Developer’s Profit and Risk – 15 – 20% on GDV or 20-25% on
total cost
The Residual Method

c. Value of Site or Property in its Present Condition:

The Value of completed development
Less The total estimated costs
Equals Value of site or property in its present condition
(residual Value)
 RESIDUAL METHOD

ü  Estimates are made of the cost of the project

and of the value created thereby.
ü  A reasonable allowance for profit and
contingency is made.
As with any other method of valuation, accuracy
relies on good application of techniques and the
knowledge and experience of the valuer. This
approach has the ability to reflect issues such as
planning and environmental concerns in the value
of the site.

The Residual Method is adopted in the valuation of

development property.

This may be of bare land which is to be developed

or redeveloped with entirely new buildings or of
land with existing buildings which are to be altered
and improved, an exercise commonly termed
refurbishment.
 Development Potential

The usage of every property is not permanently

static. Sometimes the usage can be upgraded
when the current usage of the property is not
considered to be the optimum usage.

Each of the developments involved cost and it

should be compensated by reasonable profit.

If the involved cost is too high or the profit is not

worthwhile, the development will not be
proposed even the development potential does
exist.
 Highest & Best Uses

The value of a parcel of raw land depends

on determining its highest and best use.
Unfortunately, when looking at a piece of
raw land, highest and best use often is a
matter of perspective.

(a) Highest Usages

(b) Best Usages
 Highest & Best Uses

The only allowable use for the subject site in

the that locality is residential, hence,
determining its highest and best use. In
addition, this use conforms to the
current zoning planning. The subject land has
been in vacant state for years and its size
is recognized to be appropriate and applicable
for residential development. The
site has a rectangular-based shape and flat
conforming topography, resulting in the
possibility
 Highest & Best Uses (example)

The only allowable use for the subject site in the that locality is
residential, hence, determining its highest and best use. In addition, this
use conforms to the current zoning planning. The subject land has been in
vacant state for years and its size is recognized to be appropriate and
applicable for residential development.

The site has a rectangular-based shape and flat conforming topography,

resulting in the possibility for the maximization of physical utility while
waiving additional construction cost.

Moreover, the site is surrounded by mostly residential and institutional

development. Therefore, the environment conditions and urban
infrastructure surrounding the subject site are suitable to support the use of
the site.
PROCEEDS OF SALES

  Arise from the disposal of the developed

property.

  Houses – the price anticipated for each unit

determined by the direct comparison method.

  Commercial – anticipated price obtained on a

sale.
COSTS OF SALE

The main costs incurred in a sale of the

interest will be the agents’ fees including
advertising costs and the legal fees. The
general level of fees on a sale are in aggregate
around 3% of sale price.
Investment properties- may be considered
desirable or even necessary in some cases to
let the property before selling. If so the agents’
and legal fees incurred in the letting should be
brought into account.
COST OF DEVELOPMENT

Actual cost of building the development and

funding costs.

(a) Cost of Building

(b) Miscellaneous

(c) Cost of Finance

SURPLUS FOR LAND

At this stage the valuer has determined the net

proceeds of sale and the total costs of
development and profits thereon.

The difference between these figures represents

the sum available to spend on land costs.

In some cases building will exceed net proceeds

of sale shows that there is negative value
for that development and thus the land is not
suitable for development.
SURPLUS FOR LAND (cont.)

The land costs comprise four items:-

(1)  Price to be paid for the land

(2)  Professional fees and stamp duty
(3)  Developer’s profit
(4)  Interest of the loan
DEVELOPMENT PROFITS

Target level of profit will depend on the nature of

the development and allied risks, the competition
for development schemes in the market, the
period of the development and the general
optimism in relation to that form of development.

The profit is usually related to the costs involved

but sometimes to the development value. The
profit is the gross profit to the developer before
meeting his general overheads and tax.
If profits are related to costs, at this stage in the
valuation the land costs are unknown so profits on
these will be calculated later as part of land costs.
The Basic Concept and Equation
CONCLUSION

It is clear that this valuation contains many figures

all of which are based on estimates of costs or
value or derived from such estimates.

As with any estimates, one person’s estimates may

differ from another so that in that way they are all
variables. Given a calculation based on a large
number of variables the actual range of answer
which may be produced is wide.

This uncertainty is the method’s weakness but it is

one which is acceptable so long as the estimates
are prepared with as much information as is
available to narrow the possible errors.
 The Residual Method
Example 1 :
Calculate the site value of 5 hectares of land, for which planning permission has been
granted for the building of bungalows at a density of 20 bungalows per hectare. The
development will be completed within 2 years of commencement of building and it is
anticipated that bungalows will sell at RM14,000each
Solution:
Sale price of 100 bungalows at RM14,000 each = RM1400,000
Less
Cost of Building : 80m² at RM100/m² =
RM8000 x 100 =RM800,000
Cost of roads and sewers: 800m at say RM70/m =RM 56,000
Other site works, say = RM2,000
Architect’s and quantity surveyor’s fee, say
10% of cost = RM85,800
Legal costs, advertisement and estate agency fees,
say 3% of value =RM42,000
Interest on capital borrowed for 1 year @18% of cost of building = RM154,440
Contingencies, say = RM 5,000
Developer’s profit, say 10% =RM 140,000
RM 1,259,764
RM 114,760
PV of RM1 in 1 year at 8% = 0.926
Site value =RM 106,268
say RM106,000
 SUMMARY

When it is used

–  DEVELOPMENT situation
–  REFURBISHMENT situation
–  Land either has or could have planning
permission
–  To determine how much should be bid for
the land
–  Land/buildings with alternative planning
permission