What it means
A property usually has two parts: the land and the improvements on it, such as buildings, roads and utilities. The land value is what the plot would be worth if it were empty.
Improvements usually lose value over time as they age, while land often keeps or increases its value. Several factors drive land value.
Location is the biggest, followed by access to roads and services, the size and shape of the plot, the soil and slope, and what the law allows you to build. A small plot in a busy city centre can be worth far more than a large plot in a remote area.
Valuers use a few common methods. The sales comparison method looks at recent sales of similar plots, while the residual method starts with the value of the finished property and subtracts the costs of construction and profit.
A third approach, the extraction method, takes the total property price and subtracts the value of the buildings. Land value matters in many areas of finance.
Lenders consider it when deciding how much to lend, and local authorities may base property taxes on it. Developers use it to decide whether a project is viable, since the land cost must leave room for building costs and profit.
Because land is limited and cannot be moved, it is often seen as a long-term store of value. However, values can fall when demand drops, rules change or an area loses its appeal, so it is not risk-free.
Land value can be changed by decisions made far from the plot. A new railway station, a school, a rezoning decision or a change in property tax can add or remove value almost overnight.
Investors therefore follow local planning documents as closely as they follow prices.
In practice
Real-world examples.
Example
A homeowner receives a property tax bill based partly on land value. She checks the valuation, notices that it is higher than similar plots nearby and appeals to the local authority. Her appeal is supported by recent sales of similar plots.
Example
A developer evaluates a site at an asking price of $1.2 million. After estimating construction costs and expected sales, the residual method suggests the land is worth only $950,000, so he negotiates a lower price. This keeps him from overpaying and protects his profit margin.
Example
A bank considers a loan against a factory. The credit officer separates the land value from the building value, because the building will lose value with age and the land may keep its worth. If the borrower defaults, the lender can rely on the land to recover its money.
Formula
Calculation
Land value = total property value - value of improvements
Land share of value (%) = land value / total property value x 100
Worked example: a commercial property sells for $900,000. A valuer estimates the buildings and improvements, after allowing for age, to be worth $540,000.
Step 1: Land value = 900,000 - 540,000 = $360,000.
Step 2: Land share = 360,000 / 900,000 = 0.4.
Step 3: Convert to a percentage = 0.4 x 100 = 40%.
Land accounts for 40% of the price. If the plot measures 2 acres, the land value is 360,000 / 2 = $180,000 per acre.Case study
Seen in the real world.
Riverside Homes is a fictional builder that found a plot on the edge of a growing town, offered at $800,000. The sales manager believed that new houses would sell for $4 million in total.
The finance team calculated construction costs of $2.4 million, other costs and finance of $400,000 and a required profit of $600,000. Using the residual method, the land was worth 4,000,000 - 2,400,000 - 400,000 - 600,000 = $600,000.
In this illustrative story, the builder offered $600,000 and the seller eventually agreed to $650,000. The builder walked away from the original asking price, showing how a clear view of land value protects project returns. The seller later admitted that two other buyers had also stepped back from the asking price.
Watch out
Common mistakes.
- Assuming land value equals the price paid for a property, when buildings make up part of that price.
- Ignoring planning rules, which can change land value dramatically.
- Believing land never falls in value, when local demand and rules can reduce it.
Questions
People also ask.
How is land value different from property value?
Property value includes buildings and improvements, while land value covers only the plot itself. For example, a house on a large plot may be worth less than its land, if the building is old and the plot could hold more homes.
What affects land value most?
Location, permitted use, access, size and demand in the local market. Nearby infrastructure projects and planned zoning changes can also move values quickly.
Why do lenders care about land value?
Because land tends to hold its worth better than buildings, so it provides stronger security for a loan. They often require a recent valuation that separates land from buildings before they approve a mortgage or development loan.
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