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Estimating Land Values

by Ted Gwartney, MAI
Assessor, Greenwich, Connecticut

Contents The Nature of Land and Natural Resources

  • Characteristics of Land
  • Land Rent Compared with Market Value
Principles of Land Assessment
  • Utility, Scarcity and Desirability
  • Limitations on Land Ownership and Use
  • Factors that Contribute to Land Value
  • Highest and Best Use of Land
  • Procedures for Land Assessment
    • Defining the Assignment
    • Determining the Data Required and Its Source
    • Collecting and Recording the Data
    • Verifying the Data
    • Analyzing and Interpreting the Data
    • Estimating the Market Values
    • Public Examination and Analysis of the Land Market Values
    • Periodic Updating of Assessments
Methods Used to Assess Land Value
  • Three Approaches to Valuing Real Estate
  • Specific Methods Used in Appraising Land Value
  • Sales Comparison
    • Per Dwelling Unit Site
    • Per Square-Foot
    • Per Acre
    • Per Front-Foot

  • Proportional Relationship
  • Developmental Analysis
  • Allocation
  • Extraction
  • Ground Rent Capitalization
  • Subdivision Development
  • Land Value Maps
  • Computer Estimated Land Values
The Source of Public Revenue
  • Environmental Preservation
  • Efficiency of Public Revenue
  • How Much Land Rent Should the Community Collect?

THE NATURE OF LAND AND NATURAL RESOURCES

Characteristics of Land

Land, in an economic sense, is defined as the entire material universe outside of people themselves and the products of people. It includes all natural resources, materials, airwaves, as well as the ground. All air, soil, minerals and water is included in the definition of land. Everything that is freely supplied by nature, and not made by man, is categorized as land.

Land holds a unique and pivotal position in social, political, environmental and economic theory. Land supports all life and stands at the center of human culture and institutions. All people, at all times, must make use of land. Land has no cost of production. It is nature's gift to mankind, which enables life to continue and prosper.

Land's uniqueness stems from its fixed supply and immobility. Land cannot be manufactured or reproduced. Land is required directly or indirectly in the production of all goods and services. Land is our most basic resource and the source of all wealth.

Land rent is the price paid annually for the exclusive right (a monopoly) to use a certain location, piece of land or other natural resource. People receive wages for work, capital receives interest for investment, and land receives rent for the exclusive use of a location. Equity and efficiency require that the local general public, who created land value, should be paid for the exclusive use of a land site. That Payment is in the form of a land tax.

When considering world-wide economics, most people think that land rent contributes only a small insignificant portion of value. But as societies progress, land has become the predominant force in determining the progress or poverty of all people within a community. Land in major or cities is so costly that people are forced to move further away and travel great distances in order to get to work and social attractions. In the more developed countries of the world, land rent represents more than 40% of gross annual production.

Since land is fixed in supply, as more land is demanded by people the rent will increase proportionally. Demand is the sole determinant of land rent. Changes in land rent and land taxes have no impact on the supply of land, because the land supply is fixed and cannot be significantly expanded. Labor and capital are variable in supply. A higher price for commodities causes more labor and capital to make itself available. Labor and capital are rewarded for their work. A high price is an incentive to work harder and longer, while a low price is not an incentive to work harder and longer.

The rent of land, however, serves no such incentive function, because the supply of land is fixed. The same amount is available no matter how high or low the price. Buildings are not a part of land rent. Land rent results from the desire made by everyone who lives within a community to use land. Economic rent is the only source of revenue that could be taken for community purposes without having any negative effect on the productive potential of the economy. Economists consider rent to be a surplus payment which is unnecessary to ensure that land is available. When a community captures land rent for public purposes, both efficiency and equity are realized.

The economic market rental value of land should be sufficient to finance public services and to obviate the need for raising revenue from taxes, such as income or wage taxes; sales, commodity or value-added taxes; and taxes on buildings, machinery and industry. Public revenue should not be supplied by taxes on people and enterprise until after all of the available revenue has been first collected from the natural and community created value of land. Only if land rent were insufficient would it be necessary to collect any taxes.

The collection of land rent, by the public for supplying public needs, returns the advantage an individual receives from the exclusive use of a land site to the balance of the community, who along with nature, contributed to its value and allow its exclusive use.

LAND RENT COMPARED WITH MARKET VALUE

Land Market Value is the land rental value, minus land taxes, divided by a capitalization rate. (1) Each of these terms is defined as follows:

  1. Land Rental Value is the annual fee individuals are willing to pay for the exclusive right to use a land site for a period of time. This may include a speculative opportunity cost.
  2. Land Taxes is the portion of the land rental value that is claimed for the community.
  3. Capitalization Rate is a market determined rate of return that would attract individuals to invest in the use of land, considering all of the risks and benefits which could be realized.
  4. Land Market Value is the land rental value, minus land taxes, divided by a capitalization rate.

The mathematical relationship is then:

Land Market Value  =  Land Rental Value - Land Taxes
Capitalization Rate

Land Rental Value = Market Value  x  Capitalization Rate  +  Land Taxes

For example, assume that the land rent for a site is $1,800, the land taxes are $300 and the capitalization rate is 6%, what would the land market value be?

Land Market Value  =  Land Rental Value - Land Taxes
Capitalization Rate

Land Market Value  =  $1,800 - $300
6%
 =  $1,500
6%
 =  $25,000

What would result if a larger portion of the land rent were collected? Let's consider $1,650 rather than $300.

Land Market Value  =  $1,800 - $1,650
6%
 =  $150
6%
 =  $2500

If any three factors are known, the fourth can be calculated. The term land rental value can be used instead of market value, or vice versa, in the discussion of land assessment systems.

If only a small amount of land rent remained to be capitalized after land taxes were collected, land could have a lower market value. It would, however, continue to have the same rental or productive value to the community

Not only is land rent a potentially important source of public revenue, the tax on land is a means of limiting excessive speculation in land prices. This would ensure that the equal opportunity to be productive would be available to all citizens. With limited money to invest, people could invest in productive equipment and wages, rather than in high land prices which produce no additional tangible wealth.

The formula indicates how simple it would be to translate market value to rental value or vice versa, depending upon the policy of any nation. In the United States and most other countries, land values are estimated and assessed. Land taxes, however, are a portion of land rent. The balance of this paper will explain how land values are estimated.

PRINCIPLES OF LAND ASSESSMENT

An appraisal is essentially an expert opinion of the market value of a site; the assessor must present one that is supportable and comprehensible. The assessor must develop and use specific terminology suitable and pertinent to land appraisal.

Land is the entire non-reproducible, physical universe, including all natural resources. A land site includes everything within the earth, under its boundaries and over it, extending infinitely into space. In addition to a location for a house or building, a land site would include the minerals, water, trees, view, sunshine and air space. The shape of the site can be described as an inverted cone with its apex at the center of the earth and extending upward through the surface into space.

In appraisal, a land site is a parcel of land that is finished and ready for use under the standards prevailing in its area. It might have the necessary public utilities in place, like gas, electricity, water, telephone and sewer, with streets, sidewalks drainage and grading completed.

The assessment process is essentially the valuation of rights to use or possess land sites. Other kinds of rights include subsurface mineral rights, riparian (water) rights, grazing rights, timber rights, fishing rights, hunting rights, access rights and air rights.

The assessor bases his estimate of land market value upon basic economic principles which serve as the foundation of the valuation process. There are many economic principles which people and assessors must understand and use when implementing judgment to estimate land market values. It is necessary to discuss a few of the more important principles.

The principle of substitution maintains that the value of a property tends to be set by the price that a person would have to pay to acquire an equally desirable substitute property, assuming that no expensive delay is encountered in making the substitution. A person would pay no more for a site than would have to be paid for an equally desirable site.

The principle of supply and demand holds that the value of a site will increase if the demand increases and the supply remains the same. The value of the site would decrease if the demand decreased. Land is unique, since the supply is fixed; its value varies directly with demand.

The principle of anticipation contends that land value can go up or down in anticipation of a future event occurring, or a future benefit or detriment.

The principle of conformity contends that land will achieve its maximum value when it is used in a way that conforms to the existing economic and social standards within a neighborhood.

UTILITY, SCARCITY AND DESIRABILITY

Land value can be thought of as the relationship between a desired location and a potential user. The ingredients that constitute land value are utility, scarcity and desirability. These factors must all be present for land to have value.

Land that lacks utility and scarcity also lacks value, since utility arouses desire for use and has the power to give satisfaction. The air we breathe has utility and is generally considered important, since it sustains and nourishes life. However, in the economic sense, air is not valuable because it hasn't been appropriated and there is enough for everyone. Thus there is no scarcity -- at least at the moment. This may not be true in the future, however, as knowledge of air pollution and its effect on human health make people aware that clean and breathable air may become scarce and subsequently valuable.

By themselves, utility and scarcity confer no value on land. User desire backed up by the ability to pay value must also exist in order to constitute effective demand. The potential user must be able to participate in the market to satisfy their desire.

LIMITATIONS ON LAND OWNERSHIP AND USE

While land is the gift of nature, certain legal, political and social constraints have been imposed in most societies throughout the years. Every nation imposes certain public limitations on land ownership and use for the common good of all citizens. Four forms of governmental control include:

  1. Taxation -- Power to tax the land to provide public revenue and to return to the community the costs incurred to pay for the various public benefits, services and environmental protection, which are provided by the government;
  2. Eminent Domain -- Right to use, hold or take land for common public uses and benefits;
  3. Police Power -- Right to regulate land use for the welfare of the public, in the areas of safety, health, morals, general welfare, zoning, building codes, traffic regulations and sanitary regulations;
  4. Escheat -- Right to have land revert to the public's agent, the government, when taxes are not paid or when there are no legal heirs.

FACTORS THAT CONTRIBUTE TO LAND VALUE

The physical attributes of land include quality of location, fertility and climate; convenience to shopping, schools and parks; availability of water, sewers, utilities and public transportation; absence of bad smells, smoke and noise; and patterns of land use, frontage, depth, topography, streets and lot sizes.

The legal or governmental forces include the type and amount of taxation, zoning and building laws, planning and restrictions.

The social factors include population growth or decline, changes in family sizes, typical ages, attitudes toward law and order, prestige and education levels.

The economic forces include value and income levels, growth and new construction, vacancy and availability of land. It is the influences of these forces, expressed independently and in relationship to one another, that help the people and the assessor measure value.

HIGHEST AND BEST USE OF LAND

A land site should be made available to the users who can make the highest and best effective use of the site and maximize the site benefits for all people. The proper system of assessment and taxation of land can provide for the proper economic use of the land. A high land tax on an improperly improved site tends to cause the site holder to either better improve his site to obtain greater return with which to pay the land tax, or to look for someone else with the means to properly improve the site. A land tax can also provide the source of public revenue which the local governing body could use for the benefit of all people. Before an assessment can proceed, the highest and best use must be determined for each site.

The economics of production should provide the atmosphere for the most efficient use to be made of all land. The assessment process is based on the highest, best and most profitable use of land. The highest and best use considers only the uses that are legally permissible (meeting zoning, health, and public restrictions), physically possible (has adequate size, soil conditions, and accessibility), and is economically feasible (income is anticipated). The use that meets these criteria and produces the greatest net earnings (best returns) is the highest and best use.

PROCEDURES FOR LAND ASSESSMENT

An assessment (or an appraisal) is essentially an opinion of value made by an experienced knowledgeable person. Specialists are known as assessors who base their estimate of land market value, upon basic economic principles which serve as the foundation of the valuation process. Anyone can learn how to do this and learn to do it better.

The assessment or appraisal process is an organized procedural analysis of data. This procedure involves six specific phases, each of which contains numerous procedures.

1. Defining the Assignment

The goal is to estimate the market value of all land sites within a given district. This will include manufacturing enterprises, apartments, commercial enterprises, single family home sites, government land, farms and all other land and natural resources of various descriptions.

The assessor should be able to support his estimate of land market, both in discussion and in writing. The assessor must define and use specific terminology suitable and pertinent to land appraisal. Economic Land Rent was defined as the value paid or imputed for the exclusive right to use a land site location or natural resources for a period of time, generally one year.

2. Determining the Data Required and Its Source

A land market assessment system is based upon data related to land attributes. These data generally include maps; aerial photographs; descriptions of physical characteristics like size, shape, view and topography; permitted uses; economic usefulness; present uses; available utilities; proximity to town centers or employment; and site improvements like streets, curbs, gutters, sidewalks and street lights. Governments have much of this data available in the different agencies.

How are values or acquisition fees currently being determined and paid by land occupiers? Are records being maintained for the values or fees that are currently being paid by land occupiers? If land market values have been estimated in the past, attempts should be made to build upon the existing systems while making constant improvements to data collection.

3. Collecting and Recording the Data

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