The MacRo Report Blog is pleased to welcome in its premiere guest post, MAI appraiser Steven P. O’Farrell.
Appraising vacant land at any point in a real estate market cycle is challenging. Each site has to be extensively studied to determine highest and best use, which then directs the appraiser toward the selection of comparable sales. In expanding markets, land sales are generally plentiful while a declining market yields few sales and an elevated number of liquidations. Regardless of the point in the cycle, the appropriate selection and analyses of comparables is paramount.
In my experience, owners tend to focus on the physical and legal characteristics of their land for sale when contemplating value. These include: zoning, utilities available, entitlements, site size, topography, frontages, etc. While these certainly play a large role, at some point a realistic assessment of the demand for the site is needed. Demand drives markets, which plots the course of the real estate cycle. To adequately gauge demand, study is needed to categorize the sub-market in which the property resides. Sub-markets tend to be formed by like locations that are being shopped by the same buyers and geographic distance can have little relevance if similar market factors are present.
Once the sub-market is defined and its actions considered, judgments can then be made about its future. Some light can be shed on the type of buyer present. Land markets that are in an accelerated state of transition (improvement and development) are more commonly purchased by owner-users, while markets that are years from being developed are eyed by investors and speculators: two separate motivations with price adjusting accordingly.
Not surprisingly, expanding markets see a higher percentage of owner-user transactions as investors are priced out of the real estate market, while a declining market yields a higher percentage of investor-purchased property. Currently, there are few owner-users as a result of the recession and tightened credit, while investors are actively seeking land for three- to five-year holds. All are indicative of a down real estate market, although we are starting to witness signs of improvement.
Ideally, current land sales from within the sub-market of like motivated buyers are present — and these transactions make the best comparables. In reality, our markets are imperfect and the appraiser is often forced to consider land sales that might be dated and/or sales with discernable physical differences. This does not discredit the analysis, although it is imperative that the appraiser recognize the underlying motivations of the comparables that he/she analyzed and how these correlate to the subject site.
When a land owner is trying to get a sense of the value of the property, he/she should look to see what development plans are in the works for recently transferred comparable sites. When most remain vacant, we are likely experiencing a down market with pricing flattening or moving downward.
As a general rule of thumb, investors who purchase and do not develop are not reducing supply, because such properties are being held for an end user. Conversely, if the real estate is being developed, ask yourself if your property could have been used for the same purpose and also whether or not there is additional need by similar users. When an owner-user purchases land, supply is reduced and this generally improves market conditions.
Actions do speak louder than words when establishing values within the vacant land market. Properly identifying the motivations of these actions provides the needed insight into where the real estate market cycle is and where it is going.
Steven P. O’Farrell, MAI, Vice President of William G. Bowen, Inc., has 18 years of regional experience and holds General Certified Licenses in Maryland, Pennsylvania and West Virginia. He provides real estate appraisal and consulting services for national, regional and community banks as well as Fortune 500 companies, investment groups, attorneys, individuals and government agencies. He is a designated member of the Appraisal Institute and holds a bachelor’s degree in Economics from the University of Maryland Baltimore County.