What Has Happened to Land Values in New York Metropolitan Area?

What Has Happened to Land Values in New York Metropolitan Area?

 

By James R. MacCrate, MAI, CRE, ASAMacCrate Associates LLC

 

 

The Financial Accounting Standards Board has found it very difficult and a time consuming task to define fair value, establish a framework for measuring fair value in generally accepted accounting principles (GAAP), and expand disclosures about fair value measurements (FAS 157). Last week, FAS 157-e, put forward by the Financial Accounting Standards Board, gave financial institutions more discretion over mark-to-market accounting. 

 

We in the real estate appraisal profession must estimate market value to assist tax assessors and protesters, judges, estates, lawyers, the IRS, accountants, etc. all the time, whether a market exists or not. In times like these, the demand for vacant land has disappeared at prices that were obtained in 2005 and 2006. In addition, it is more difficult to find recent comparable land sales, but real estate appraisers who have been properly trained continue to do their job to the best of their ability in these difficult times. 

 

Real estate appraisers have been taught that there are six appropriate techniques to estimate land value. These include: 

  1. Sales comparison approach
  2. Allocation
  3. Extraction
  4. Land residual approach
  5. Capitalization of recent ground rents
  6. Subdivision or land development method. 

The land value can be zero or even negative when environmental or market conditions warrant. This occurred in New York City and in certain locations on Long Island during the 1960’s and 1970’s. Properties were taken over by the City for non-payment of real estate taxes and other reasons. Sites were placed on the Environmental Protection Agency’s Super Fund List in New York City and in certain locations on Long Island. Real estate appraisers are continuously marking assets to market as it should be. 

 

In this post, the allocation method for estimating the market value of vacant sites will be explored. The extraction method is a variation of the allocation method for estimating site value. The following definition from the Appraisal Institute is used for this purpose. 

  1.  The general process of separating value between the component parts of a property.
  2.  A method of estimating land value in which sales of improved properties are analyzed to establish a typical ratio of land value to total property value and this ratio is applied to the property being appraised or the comparable sale being analyzed.
  3.  A method of separating a whole property value into land and improvement components. The appraiser estimates replacement cost, subtracts an appropriate amount for depreciation, and subtracts the remainder from the whole property value to estimate the land value. (IAAO) 

MacCrate Associates LLC recently completed a short land investment survey of brokers, developers, lenders and appraisers serving the greater New York Metropolitan area, including the Manhattan, Queens, Brooklyn, Bronx, and Nassau and Suffolk Counties. The purpose of the survey was to determine the estimated land value as a percentage of the total price paid for new construction in each county in 2005, near the peak of the market. At that point, many buyers were speculating in the acquisition of vacant sites, and the financial industry financed the speculative transactions. (Remember, we are bailing them out now). In each county, building sites are scarce because the New York Metropolitan area is almost fully developed. Land to total selling price ratios also vary with the highest ratio on Nassau County’s North Shore.

 

In one of the survey questions, we asked, “If the finished residential unit sold for $500,000, what percentage did land represent as a percentage of the total?” The percentage of responses to each price range is summarized below:

 

Land to Total Sale Price Ratio

20%-30%

30%-40%

40%-50%

50%-60%

Greater than 65%

Nassau County

25.00%

37.50%

25.00%

12.50%

0.0%

Suffolk County

33.30%

33.30%

22.20%

11.10%

0.0%

Queens

42.90%

28.60%

28.60%

0.00%

0.0%

Brooklyn

42.90%

28.60%

28.60%

0.00%

0.0%

Staten Island

50.00%

50.00%

0.00%

0.00%

0.0%

Manhattan

22.20%

22.20%

22.20%

33.30%

0.0%

 

 It is not surprising to see more responses in the lower percentage range of land to total sale price ratio falling, because Fannie Mae and Freddie Mac underwriters and sellers have frowned upon appraisers indicating a land value in excess of 30% without taking the time to explain, justify and support the estimated percentage. It is healthy to see that certain real estate appraisers buck the pressure placed on them by government agencies. The reported land values as a percentage of the total price was the highest in Nassau County with the median land value falling between 30% and 50% of the total price for a new residential dwelling. The tightest range was indicated in Staten Island with land value representing 20% to 40% of the total price. If the price of a new home exceeded $1,500,000, the ratio of the land value as percentage of the total value increased in every county, with Nassau County indicating an average site value of approximately 40% to 60% of the total value.

 

Based on this information, it is clear that current land values have fallen in every market area. If one applies the midpoint of the range indicated the cost of the improvements, including profit, can be abstracted to provide an indication of the site value in 2005. The following chart provides a summary of the residual value of the improvements, including profit:

 

Sales Price

 

$500,000

$1,500,000

Estimated Site Value

$200,000

$750,000

Residual to Improvements

$300,000

$750,000

Including Profit

 

 

 

 

Fast forward to 2009 and the prices for homes have dropped substantially. If we assume that the average price dropped approximately 17.00% from 2005 at the peak through the end of 2008, land values had to drop, assuming that construction costs remained level and the ratio of land to total remains unchanged. The following chart summarizes the minimum loss in value that must have occurred during this time period:

 

Sale Price End of 2008

 

 

Sale Price

 

$415,000

$1,245,000

Cost of Improvements

$300,000

$750,000

Residual to the Site

$115,000

$495,000

 

 

 

 

Minimum Estimated Loss in Land Value

42.50%

34.00%

 

This does not take into account that it takes longer to sell a residential property, because of increased carrying costs, such as interest, real estate taxes paid during the holding period, insurance, security, etc.

 

The brief analysis above confirms Dan Houlihan, MAI‘s (President of Houlihan & O’Malley Appl. Co., Inc.) suspicions that land values have dropped by about 33% to 40% in the New York Metropolitan Area, far more than the indicated loss in residential property values. Based on this, lending institutions should reevaluate their construction loans and the underlying land values and make adjustments to their loan portfolios to account for the indicated losses that have occurred.  (I wonder if this was taken into account in the projections made by the Federal Reserve Bank of New York’s forecast on land value in New York City or New York City’s valuation of the site under Yankee Stadium. The Fed probably didn’t since their rather rosy outlook was based on 2006 data. The Yankees are another story.)

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About Jim MacCrate

Real estate appraiser and valuation consultant for more than 30 years specializing in reviewing real estate appraisals, risk management and quality control.
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6 Responses to What Has Happened to Land Values in New York Metropolitan Area?

  1. Francis S. says:

    Excellent piece…and with out a doubt land prices have fallen with home prices…and clearly more than actual home prices – how much more is the truly intellectually interesting question?

    With out a large number of recent land sales…the Appraisal industry has become versed to lean more heavily on the Residual Land Methodology for valuation analsyis – similar in concept to what you have displayed in your blog above.

    Let me play devils advocate – and please take it in the context of an intellectual discussion, not a professional or personal criticism…

    With that disclaimer – I pose the question to you of – why do real estate appraisers think that homebuilders would operate under different economic rules in the intermediate and long term, with respect to what the Returns on Capital they deserve to earn in a capitalistic system; where excess returns should and are competed away in commodity businesses? Put another way, why does the Appraisal industry turn the equation around and think that land values are the residual – when its the home building sector that operates in the highly competitive business, which should result in the long term Returns on Capital (which you could use operating margin as a proxy – assuming a constant capital structure) being at or slightly above their true cost of capital. And we could use the public homebuilders to derive that cost of capital…but I think we would agree its probably a high single digit number (WACC).

    In looking back at the froth of 2005 was the returns on the bricks and sticks part of the business truly excessive relative to their cost of capital or did all of the home price appreciation accrue to owners of land during this time period?…and thus they are the ones who will bear the brunt of the economic loss or new world reality. If you stripped away the land margin profit expansion in 2002-2005, were the public home builders still only making 7-9% returns on their bricks and sticks businesses?

    I would say that the answer is – both were excessive…but that in tight supply / demand markets like the NY metro or Boston or San Fran etc… where land is structurally pressured over time…I would argue that the bricks and sticks are the greater commodity and its Returns on Capital will contract until they get close to their cost of capital and that land will not fall as much as a typical Land Residual Model would dictate vs 2005-2006 implied or surveyed home prices.

    Which one is the commodity?

    I don’t think the Land Residual Model represents reality in strong land markets. But is probably much more reflective of reality in markets where land is also a true commodity – Florida, Georgia, Arizona, Inland California.

    The Land Residual Model assumes a condition in tight land markets that is probably not true – that market disagregates the Land margin/return versus the returns of the bricks and sticks. The marginal buyers of land set the price in the NY metro area; and they are integrated builders players – niche players; because there just aren’t large numbers of undeveloped pieces of land in the area for the large public homebuilders to exploit. Smaller, private, integrated home builders drive the price of land (and thus returns on capital)…and they don’t care if they make their Returns on Capital in the land business or the bricks and sticks. They know it will shift through the cycle. Land purchased today will have higher returns in the future, but bricks and sticks will have lower returns in the short run due to the short term lack of pricing power. As the demand improves, pricing will improve and then the margins will expand.

    The Land Residual Model assumes that the market is driven by the homebuilder or investor who doesn’t own land. That they like the bricks and sticks business better than the land business. But that’s not how the market pricing dynamic is set up. Today, integrated builders are now looking for land so that they can accelerate their home sales as the market recovers. If they don’t have land, they can’t build homes. So, the game of chicken will begin. But remember where the laws of effecient markets plays here. Which function or asset is the commodity and which one is not?

    I would argue in strong land markets – homebuilding, the bricks and sticks business, has the signficantly weaker hand in this negotiation. No different from the existing home seller vs the new home seller/builder. Which one cut prices drastically to move inventory?

    What’s your thoughts?

  2. Pingback: Follow Up -What Has Happened to Land Values in New York Metropolitan Area? « Appraisal & Valuation Issues

  3. Gerald Carey says:

    What if new construction sales prices (2008)reflect a lower profit margin? Hence- you would be understating Land Values???

    • jmaccrate says:

      That has happened in the past. There are several developers that lowered their profit expectations to keep folks employed. That is a great concept when you think how much money they made. and, then, they were kind and generous to those who helped them make the money.

      But, the fact of the matter is land values have declined. How much we can debate for another time. If there are no comparable sales or they are limited, then land values must have declined.

      Keep in the back of your mind that expected returns (profits) increase when markets are speculative.

  4. Bill B. says:

    I understand the concept of the allocation method but would the ratio be obtained from taking a survey? How do those being surveyed derive their ratio?

    • jmaccrate says:

      I am not sure sure but I have to assume that they have done it correctly. But I have have now analyzed approximately 60 land sales between 2002 and 2008 and will be posting a new blog in thirty days with my findings.

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