comment 0

Acquisition price vs. current market value — which should be your land input?

If you’ve bought land with the intention of developing it and you now think the value of that land has either gone up or down, there comes the question of what number you should plug into your development pro forma. Do you input what you paid for the land or do you input the current market value of the land? The former is probably more common than the latter, but in my view it’s important to consider both scenarios.

If the value of the land has gone up, it means that you think you could turn around and sell it for that price today. And that would mean you would be making a profit without doing anymore work and without taking on any additional risk. That’s an option that exists right here and right now (t = 0). What you want to get at in your pro forma, or at least understand, is the incremental profit margin from taking on the risk and brain damage of actually doing and completing the development project.

To do that, you need to consider the current market value of the land. That way you isolate your land margin from your build-out margin. The one problem with this approach is that the numbers may then tell you not to develop. In a hot market (which is not right now), it is not uncommon for land to get bid up beyond current fundamentals. There’s always someone else who is willing to be more aggressive.

In this case, you may find that most of the development margin is in the land. And you will start thinking to yourself, “How can anyone afford to pay this much? It doesn’t make sense.” This doesn’t necessarily mean that you shouldn’t develop. But at least it gives you a better understanding of the risk and reward trade-off that you’re about to take on. It might also tell you some things about the market.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s