The residual is not the land price: the land has to carry its own purchase costs and its own interest, and the appraisal is far more sensitive than it looks.
Start from the gross development value, deduct sale costs, construction, fees, contingency, statutory costs, finance and the developer's required profit, and what remains is the residual: the sum the scheme can spend on land. Then divide out the land's own acquisition costs and finance to get the price you can bid. On an illustrative 60-unit scheme the residual is 2,991,000 and the land value is 2,446,119, 18.2 per cent less than the residual, and a 5 per cent fall in sales values takes 31 per cent off it.
Worked in full in The Real Estate Development Manager by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
The residual method is how development land is priced: the land is worth what is left once the completed scheme has paid for everything else, including a return to the developer for the risk. The arithmetic fits on one page, which is part of the danger. Two things go wrong in practice. The residual is treated as the price, forgetting that the land itself carries costs and interest. And nobody shows how far the number moves when the inputs do.
| Input | Value |
|---|---|
| Units × average sales price | 60 × 400,000 |
| Sale costs (agency, legal, marketing) | 2% |
| Construction cost | 12,000,000 |
| Professional fees, on construction | 10% |
| Contingency, on construction | 5% |
| Statutory and planning contributions | 900,000 |
| Finance rate, a year | 7.0% |
| Developer's profit, on GDV | 20% |
| Land acquisition costs (transfer tax, legal, agents) | 6.8% |
Residual = GDV − sale costs − build costs − build finance − profit
Land value = residual ÷ [(1 + land costs) × (1 + rate)years]
In Excel, with the residual in Res: =Res/((1+LandCosts)*(1+Rate)^(Months/12)). Build finance in a summary appraisal is usually approximated as =BuildCosts*Rate*Months/12*0.5, on the logic that the cost is drawn evenly and is outstanding for half the programme on average. Land is paid on day one, so it carries interest for the whole programme.
| Line | Amount |
|---|---|
| Gross development value, 60 × 400,000 | 24,000,000 |
| Less sale costs at 2% | −480,000 |
| Construction | −12,000,000 |
| Professional fees at 10% | −1,200,000 |
| Contingency at 5% | −600,000 |
| Statutory and planning contributions | −900,000 |
| Build finance: 14,700,000 × 7.0% × 2 years × 0.5 | −1,029,000 |
| Developer's profit, 20% of GDV | −4,800,000 |
| Residual available for land | 2,991,000 |
| Land acquisition costs at 6.8% | −166,336 |
| Land finance, 24 months at 7.0% | −378,545 |
| Land value: the bid | 2,446,119 |
The divisor is 1.068 × 1.072 = 1.2228, and 2,991,000 ÷ 1.2228 = 2,446,119. That is 40,769 a unit and 10.2 per cent of GDV. The check is that the land, its costs and its interest add back to the residual: 2,446,119 + 166,336 + 378,545 = 2,991,000.
The 20 per cent profit on GDV is 4,800,000. Total cost including the land and its carrying costs comes to 19,200,000, so the same profit is 25.0 per cent on cost. If the developer's hurdle is 20 per cent on cost instead, the profit falls to 4,000,000, the residual rises to 3,791,000 and the land value to 3,100,380. Because profit on cost depends on the land price, which depends on the profit, that version is circular: solve it with Goal Seek or a short iteration rather than a single formula. Two bidders quoting "20 per cent" can be 654,261 apart on the same site.
| Case | Land value | Change | Change, % |
|---|---|---|---|
| Base | 2,446,119 | 0 | 0% |
| GDV −5% | 1,680,634 | −765,486 | −31% |
| Construction +5% | 1,842,318 | −603,801 | −25% |
| Programme 30 months | 2,161,365 | −284,754 | −12% |
| GDV −5% and construction +5% | 1,076,832 | −1,369,287 | −56% |
A 5 per cent movement in sales values moves the land value by 31 per cent; every 1 per cent of GDV is worth 153,097 of land. Two ordinary 5 per cent movements in the wrong direction take more than half of it. That gearing is why competitive land bidding tends to be won by whoever is most optimistic about the inputs, and why the sensitivity belongs on the same page as the bid.
The sensitivity also tells a seller something. A vendor marketing a site is effectively selling the bidders' optimism: the developer who assumes 5 per cent more on sales values can pay 31 per cent more for the land and still show the same profit on paper. That is why the reverse question belongs beside the bid, namely what fall in value or rise in cost would eliminate the profit entirely at the price being offered.
The common mistake is to bid the residual. Paying 2,991,000 for this site means paying 544,881 more than the scheme supports, 22.3 per cent over, because the acquisition costs and the interest on the land still have to be paid and now come out of the profit. The second mistake is quieter: running build finance on the half-cost approximation without checking it against a cash flow. The approximation can be well short when costs are back-loaded or the programme slips, and the land absorbs the difference.
The residual is what the scheme can spend on land; the land value is that sum net of the land's own costs and interest, here 2,446,119 from a residual of 2,991,000. State the profit basis, and put the sensitivity beside the bid. The residual appraisal workbook in the free companion files for the book runs the same tests with a quarterly cash flow under the summary, and the yield on cost article covers the measure investors use for schemes held after completion.
Gross development value, less sale costs, construction, fees, contingency, statutory costs, finance and the developer's required profit, gives the sum available for land; dividing it by one plus land acquisition costs and land finance gives the price. Illustratively, a 2,991,000 residual divided by 1.2228 gives a land value of 2,446,119.
Either, but say which, because they are not the same rate. On the illustrative scheme a 20 per cent profit on GDV of 24,000,000 is 4,800,000, equal to 25.0 per cent on cost. Twenty per cent on cost instead allows 4,000,000 of profit and lifts the land value from 2,446,119 to 3,100,380, a quarter more for the same scheme.
Because land is the small number left after subtracting large ones, so a percentage move in value or cost becomes a much larger percentage move in land. On the illustrative scheme a 5 per cent fall in GDV takes the land value down 31 per cent, a 5 per cent rise in build cost 25 per cent, and both together 56 per cent.
This article is one calculation from The Real Estate Development Manager. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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