Pricing land for development can be a daunting task for the untrained investor. As a niche subset of both residential and commercial real estate, using comparables for land can be as dangerous to a developer as it is mysterious, sometimes causing the failure of what was certain to be a fantastic development. However, for the savvy investor, there is one universally accepted land valuation method used by development professionals, corporations, and appraisers alike; the Land Residual Method. By using this method you will be able to determine the current and future value of any piece of land, whether its use be residential or commercial. You will also be able to price land, such that any development you propose will have built in profit. With some practice, you will be able to employ the land residual method in just a few moments, summing up the value of almost any property just on sight. The land residual method has a fancy sounding name, but to use it all you need is an understanding of some simple math. The land residual method is a calculation that takes the highest and best use of a particular piece of property and subtracts out the total cost of development to arrive at the residual value: the land value. Once you have the numbers it’s that easy. “How do you get the numbers?” You ask. It takes some research, but even a novice investor can figure it out relatively quickly. For the sake of this article I’ll be speaking to residential single family development or single family lot land. Rest assured, commercial development uses the same principles, though the calculations are a little more in depth. Use and Utility You’ve heard the term “Location, Location, Location” thrown around in many real estate circles.  It is never more true than when developing land.  While I don’t recommend using any type of comparables for valuing land, it’s generally accepted that land near the ocean, or any other high priced corridor, has a higher intrinsic value that land based further away from a hub or commercial center.  It boils down to use and utility.  For instance, a 100 unit office building in downtown Seattle will probably be worth more than the same building in rural Arkansas.  Generally speaking, the land those properties sit on will be valued accordingly.  It’s one thing to accept that, but another to understand why. Property value is determined by its highest and best use. A piece of property that can be developed into a regional shopping mall will be more valuable than a property that can only be developed into a single family home. This is because the end use of the former has a much higher finished value than the latter. The value of the materials are more and the expected income from renting or owning the first is significantly more valuable than the second. It all comes down to profit and a return on investment. Generally speaking there is more profit to be made in larger commercial buildings than a single family home. However, the commercial property takes significantly more risk and money to develop. Hence, the larger land value. The first part of the land residual method is to estimate the final or future value of the proposed property.  This can be done by several approaches.  In the case of a single family home development it can be quickly estimated by using recent sales comps from a local real estate broker or agent.  Make sure you’re dealing with true comps; similar in style, size, amenities, and age.  You shouldn’t be using a 10 year old sale as a comp for an about to be built home. For our example, let’s assume you’re building a 3 bedroom, 2 bath home, 1,500 sf in size, with a lot size of 1/2 acre.  Let’s also assume your comparable report shows the median home sales price in the last 6 months for this type of home to be $500,000. Once you’ve arrived at an estimate for the final or completed value of your property you move on to figure out what it will cost to build your proposed property. Development Costs Development costs can vary wildly from state to state and city to city, dependent on things like the amount of work in the area and the cost to deliver materials to your site.  When estimating development costs I counsel investors to research their market by calling local developers.  Find out what they paid.  Talk to contractors and find out what the going rate for material and labor is.  Talk to local builders’ associations.  They often keep data on home building costs in the area. There are two ways to estimate costs.  You can use a $/sf method, or actually go line item by line item.  The second method can only be done if you have a list of all the line items required to build your home.  The $/sf method is easier to obtain, but not as accurate as the line item method. Your goal is to determine the total soft and hard development costs.  Soft and hard costs break down as follows: A hard cost is anything that contributes to the direct construction of the structure itself.  These are usually limited to the costs to go vertical. Soft costs are anything that do not fit into that category.  Some soft costs are brokers fees, financing fees, horizontal development like running of utilities, demolition of existing structures, clearing and grading of the land, curbs, roads, and driveways, among others. If your local contractor tells you the average hard and soft cost to build your home would be $100/sf, then you know your total development cost would be $150,000 ($100/sf  X 1,500 sf  = $150,000). Do the Math Now it’s time to resolve your numbers.  The value of the completed home is estimated at $500,000, which is hopefully the amount it will fetch when you’re ready to sell.  Your development costs are  $150,000.  The residual land value is the difference between finished value and development costs.  In our example, the residual land value of the proposed property is $350,000 ($500,000 – $150,000 = $350,000). What this means, is that for you to build a home that would cost $150,000 and have a value of $500,000 in the open market, you could pay up to $350,000 for that piece of land.  This is the break even point.  If you pay more for the land there is a great potential for you to lose money.  If you pay less for the land you’re potentially building in profit.  And that’s exactly how a professional developer would do it.  They don’t stop at the residual land value.  They go one step further by working in their profit. Work in your profit As a developer/investor you’re here to make a profit.  You want to work that into the equation before you price your land and make your offer.  Most developers of residential property like to make between 20-30%.  Anything below that will be hard to finance through a conventional lender, and would also be a risk on your part. Markets move up and down, sometimes as much as 10% in a few months.  If your profit margin was only 15% and the market drops 10% you’re left with a 5% profit.  For that kind of money you don’t need the risk of development you can just go out, buy a T-Bill, and sip iced tea on your front porch until retirement. If you’re cost to develop was estimated at $150,000 and you’d like to make a 30% profit on costs, your profit margin would be $45,000 ($150,000 X 30% = $45,000).  This number is then subtracted from the residual land value of $350,000 for a maximum offer price of $305,000  ($350,000 – $45,000 = $305,000).  That means, to make a 30% profit on your development costs, you wouldn’t pay more than $305,000 for the land. Well that’s fine and good, but most developers want to make profit on their entire project, not just the costs.  Thus we do this calculation one more time; this time on the land purchase portion as well.  Assuming you’d want to make 30% on the land portion to, how much would you have to back out?  You’d back out approximately $90,000 ($305,000 X 30% = $91,500). Max Offer Price Take your residual land value minus your profit on cost and your estimated profit on the land cost and you can determine your maximum land offer price.  For our example, the final land value and max offer price would be $215,000 ($305,000 – 90,000 = $215,000). For the property cited in the example I would offer the seller no more than $215,000  to purchase their piece of land.  This ensures I can get the development done and make a nice profit for myself.  Just to check my numbers, I run the math one more time. Check the math To check your final expected profit, simply run the numbers forward from the start.   Here’s how it would look: $215,000 Land Purchase + $150,000 Development and Construction Costs $365,000 Total Project Cost $500,000 Projected Revenue from Sale –  $365,000 Total Project Cost $135,000 Profit $135,000 profit / $365,000 total project cost = 37% total profit Margin Keep in mind we have not accounted for taxes of any kind.  That will of course reduce your profit margin, but still, this is not bad for a development that probably took less than a year from start to finish. For even higher returns, your land offer would be made at an even lower number than your max offer price, in case you end up negotiating the price higher with your seller. You can see that the residual land value method of obtaining land value is an easy and efficient way to make sure you’re paying the true market value of the land, while working in profit for your potential development. 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This is the third blog post of three meant to share answers about commercial investing from the BiggerPockets community. Be sure to also check out the first, “Should You Invest in Commercial Properties? 10 Investors Weigh In,” and the second, “Why Is the First Commercial Deal the Hardest? Advice From Investors.”  While working on new lender partnerships for BiggerPockets members, I realized there was a gap in my knowledge of how commercial investors decide which property to buy and who to work with. Since only 15 percent of investors on BiggerPockets invest in commercial, I thought that perhaps there are questions many investors want to ask—specifically about getting that first deal. So, we posted a survey about commercial investing in the BiggerPockets Announcement Forum. Below you’ll find the answers from top commercial investors in our community. The questions are: What made you decide to invest in commercial properties? What was the hardest part about the first commercial deal you completed? What should every first-time commercial investor know to be prepared to speak with a lender? Today we tackle question No. 3. What Should Every First-Time Commercial Investor Know to be Prepared to Speak With a Lender? Here’s what investors have to say! Starting With My Favorite… “They should know what a lien waiver is. I cannot believe they loaned my dumb ass the amount of money they did.” — Anonymous “Know a successful commercial investor.” “Every first-time commercial investor should know someone who is successful in your field and doing business in the area you’re doing business. If you have the opportunity to partner up with those who already have a track record, then that’s gold. You can learn and earn all at the same time.” — Jeffrey Rollon, San Diego, CA, Developer “Share your past successes.” “Best to have some experience doing what you propose to do. A success story or two or three that you can show a lender goes a long way.” — Jim Schneck “Know your numbers. For real.” “Be ready with a personal financial statement.” — Aravind M. “Know the project inside and out. Understand the challenges, and be prepared to have an answer to it, and mitigate the risk to investors. Every project has challenges. Be realistic.“ — Karen Margrave, Redding, CA, Realtor with 35 years of experience “Know the numbers inside and out. You should be able to speak about income, leases, and who your tenants are. You should also know every expense and who pays for them. Hopefully, your property has triple net leases.” — Danny Randazzo, Charleston, SC, Apartment Syndicator & Commercial Investor with 6 years of experience “You have to know how all the numbers associated with the property are related. On the income side, know what current market rents are, what increases are currently in the area, and what your competition is. Be on top of why someone would want to rent from you vs. the other available spaces near you. This will help maintain your income stream and lessen chances of vacancy. On the expense side, you must know all your expenses. What are your utilities, taxes, impact tenant change-over will have, upcoming repairs on the HVAC system, etc. As you scale up with multiple commercial tenants, so too will the expenses. Keeping expenses in line and making small increases in rental income can provide for quick increases in property value. On the flip side, escalating expenses and stagnant rents can just as quickly eat away at your value.” — Will Kenner, Seattle, WA, Rental Property Investor with 10 years of experience “The current lease terms and length, any existing tax debt or other debts, actual income generated by the property.” — Efrain Hernandez, Queens, NY, Rental Property Investor with 2 years of experience “The lender wants to know the income and expenses for the building (Pro tip: you should want those numbers, too!) The lender will then calculate the debt service coverage ratio and will want to see at least 1.25. Loan terms are typically no longer than 20 years and there is often a balloon well before that.” — Bob Langworthy, Brunswick, ME, Accountant & Real Estate Investor with 10 years of experience “KNOW YOUR NUMBERS. Go in there with the numbers the lender is going to care about: rent rolls, cap rate, cash flow/mortgage ratio, and your personal or business balance sheet plus income statement. You should know your net worth and show them that it really doesn’t matter because the deal can stand on its own. If you show them you’re in the business of doing business, they’re very receptive.” — Jonathan Bombaci, Lowell, MA, Real Estate Agent with 1 year of experience Takeaways & Resources Takeaway 1: Learn from someone who has done a commercial deal. Recommended Resource: Find networking events near you to attend to meet local investors, and learn from the best in the BiggerPockets Commercial Real Estate Investing Forum. Takeaway 2: Complete a deal or two before scaling into commercial investing. Recommended Resource: Share your residential investments with the BiggerPockets community by adding it to your profile under “Investments.” It’s a great place to highlight your work, so when you need to brag to a lender, you can point them to your BiggerPockets profile. You’ve already done the work! Takeaway 3: Know your numbers. Recommended Resource: This is an oldie but a goodie: Commercial Real Estate Vocabulary 101 – Commercial Deal Analysis. I hope reading the above answers helps you understand what you need to prepare before scaling into commercial properties. Be sure to read the answers to the other questions here and here. If you feel the need to ask more questions about commercial investing—I know I have many more—start talking with our community in the Commercial Real Estate Investing Forums. The reason BiggerPockets exists today is that people in real estate like to talk about real estate. When I say like, I mean LOVE. So go ahead and start learning how to scale. If you are interested in commercial investing, what is your next step to get started? Share in a comment below!   Free eBook from BiggerPockets! Join BiggerPockets and get The Ultimate Beginner's Guide to Real Estate Investing for FREE - read by more than 100,000 people - AND get exclusive real estate investing tips, tricks, and techniques delivered straight to your inbox twice weekly! Actionable Advice for Getting Started, Discover the 10 Most Lucrative Real Estate Niches, Learn how to get started with or without money, Explore Real-Life Strategies for Building Wealth, And a LOT more Sign up below to download the eBook for FREE today! Click Here to Download the eBook Now! We hate spam just as much as you

This is the second blog post of three meant to share answers about commercial investing from the BiggerPockets community. Click here to read the first, “Should You Invest in Commercial Properties? 10 Investors Weigh In.”  In an attempt to spotlight the opportunities associated with commercial investing, I asked commercial investors on BiggerPockets three commonly asked questions about this type of investing. The questions are: What made you decide to invest in commercial properties? What was the hardest part about the first commercial deal you completed? What should every first-time commercial investor know to be prepared to speak with a lender? In this post, we tackle question No. 2. What Was the Hardest Part About the First Commercial Deal You Completed? Here’s what investors have to say! “Getting others to see the vision.” “Getting others to see the vision for the project and putting their hard-earned money behind it.” — Karen Margrave, Redding, CA, Realtor with 35 years of experience “Overcoming the belief that everyone should get started with a single-family house. My first investment purchase was a $1 million office building, and I knew I had to get it done in order to prove my business model.” — Danny Randazzo, Charleston, SC, Apartment Syndicator & Commercial Investor with 6 years of experience “Getting commercial property financing.” “Getting financing on a vacant, foreclosed, mixed-use building in what was then a bad neighborhood.” — Jim Schneck “Spent a long time looking for and finding the right lender.” — Aravind M. “Overcoming a learning curve.” “The hardest part for me was learning how to be a landlord as I went. I had no experience with commercial real estate and was simultaneously trying to develop my dental practice. It took a lot of dedication and time to learn, network, and really put myself out there to find tenants, negotiate leases, and be ready to manage projects when something broke, build-outs needed to be done, or building improvements were needed.” — Will Kenner, Seattle, WA, Rental Property Investor with 10 years of experience “Finding a good deal on a property close to downtown was difficult. A vacant 4-office building came on the market and I decided to make it work.” — Bob Langworthy, Brunswick, ME, Accountant & Real Estate Investor with 10 years of experience “Learning all of the lingo. When you first start in commercial real estate, it can be like learning a new language. I started at a large REIT and had to write down every word and acronym I did not understand during a meeting to Google later.” — Anonymous “Learning the zoning and ordinances and rules. I bought the land while zoned ag, even though it had a large structure on it. I got the necessary permits to demolish and burn the existing buildings on site. There were also 3 buildings that I dismantled and sold. When I was burning the debris, the neighbor got pissed. The state was worried I was burning asbestos but I had a professional remove it. I am sure glad he documented everything well. Building the new building was uneventful, except for pouring a nice truck dock and a bunch of concrete inside that had to get torn out. The truck dock is beautiful but has never been used. I guess to sum it up, being new was the hardest part about the first deal.” — Anonymous “Planning upgrades.” “Just getting into all the units and building out that day 1 punch list. Prior to jumping into a 7-family house, I only house hacked. Trying to get my arms around deferred maintenance on 7 units was tough. I trimmed it down to only focus on the things where I had immediate returns from (heating system, insulation) and health/safety (fire alarm system), then set it up so the tenants can request maintenance from the property manager on the things they wanted fixed. This seems to be working out well and prevented me from spending money fixing something that the tenants find no value in.” — Jonathan Bombaci, Lowell, MA, Real Estate Agent with 1 year of experience Takeaways & Resources Takeaway 1: Managing a commercial property can be difficult. Recommended Resource: 4 Key Considerations to Successfully Manage Commercial Property Takeaway 2: Finding financing can take longer than you think. Recommended Resource: Talk and start to understand what you need to get a commercial loan. You can start by connecting with top commercial lenders on BiggerPockets. Takeaway 3: There are so many things you need to learn when you decide to scale into commercial investing. Recommended Resource: Network, ask questions, and read posts about commercial investing in the BiggerPockets Forums and on the BiggerPockets Blog. They are free! If you are currently investing in commercial, what was the hardest part in closing on your first deal? Share in a comment below!   Free eBook from BiggerPockets! Join BiggerPockets and get The Ultimate Beginner's Guide to Real Estate Investing for FREE - read by more than 100,000 people - AND get exclusive real estate investing tips, tricks, and techniques delivered straight to your inbox twice weekly! Actionable Advice for Getting Started, Discover the 10 Most Lucrative Real Estate Niches, Learn how to get started with or without money, Explore Real-Life Strategies for Building Wealth, And a LOT more Sign up below to download the eBook for FREE today! Click Here to Download the eBook Now! We hate spam just as much as you

This is the first blog post of three meant to share answers about commercial investing from the BiggerPockets community. Let me start by saying I am not a commercial investor. However, I have had the pleasure of speaking with both commercial investors AND commercial lenders over the past couple of months. My main takeaway: commercial investing isn’t that different than residential, but not all investors are ready to scale into commercial. Since we don’t have a commercial investing webinar (yet!) I asked commercial investors the following three questions: What made you decide to invest in commercial properties? What was the hardest part about the first commercial deal you completed? What should every first-time commercial investor know to be prepared to speak with a lender? Today we tackle question No. 1. What Made You Decide to Invest in Commercial Properties? Here’s what investors have to say! “I was tired of paying rent.” “My start into commercial properties was purely by accident. I was a recent dental school graduate and had my office in the building that I eventually purchased. The owner at the time got the property in a divorce settlement and did not like being a landlord. Consequently, the building was not well maintained nor operated efficiently. As I was trying to grow my dental practice, I was faced with either moving my office to a new location (which isn’t easy or cheap) or taking over the building that I was in and fixing it up. Either way, I wasn’t flush with cash, as the economic downturn was in full effect. After almost signing a 10-year lease with another property that would have required an expensive build-out with little TIs, I made the decision to approach the owner of my current building about selling. Looking at the total rent that I would be paying for my new space, I figured why don’t I put that toward owning?! Fortunately, I was able to negotiate with the owner a seller-financed deal that worked for both of us. We ended up closing on the deal at the same time our first child was born—just in case things weren’t already interesting enough! Since then, I’ve been able to increase the monthly rental income by nearly 50% through value-add sweat equity and creating more rentable space within the building. And it was during this process that I truly began to appreciate the power of commercial property investments. Those regular 3-4% annual rent increases, creation of an additional rentable SF, and creating a desirable building that people compete to be in all equate to significant increases in cap rate valuation of the property and cash flow.” — Will Kenner, Seattle, WA, Rental Property Investor with 10 years of experience “I own a small accounting practice and was tired of paying rent. I knew the math behind owning real estate and decided it was time to take the plunge. Looking forward to closing the next deal this summer.” — Bob Langworthy, Brunswick, ME, Accountant & Real Estate Investor with 10 years of experience “I have several businesses and I needed a commercial space because the city enforces zoning laws in the area that I was located.” — Anonymous “My small business had the equipment and expertise to construct commercial buildings more cost-effectively than most. Keeping the construction costs low keeps the returns high.” — Anonymous “I was looking for another property.” “I was looking for another property in a certain small town I invest in, and Fannie Mae had a foreclosure listed for a 4-unit apartment building. As I learned more about the property, I found that it also included a building of storage units, as well. Since the price was right, I bought it. We are in the middle of rehabbing the apartment and still working on possession of the storage units.” — Lynnette E., Tennessee, Rental Property Investor with 2 years of experience “I saw an opportunity.” “Saw a niche in the market that wasn’t being met and designed projects to fill them. We’ve designed and built spec office buildings, small office parks, office/retail condos, residential subdivisions, medical/dental clinics, and more.” — Karen Margrave, Redding, CA, Realtor with 35 years of experience “I just wanted more units under 1 roof. Anything over 4 units had to go commercial. I found a 5-unit that I liked and went down the commercial lending path and found it super easy and fun. Now I only want to deal with commercial lending. The credit union that I’ve been partnering with lets me do way more creative financing stuff and rolls with whatever I want to do. Of course, the deals I’ve brought to them make sense on the key metrics they use in underwriting.” — Jonathan Bombaci, Lowell, MA, Real Estate Agent with 1 year of experience “Commercial property is valued based on the income it generates, and investors have the ability to control how much income is generated. Thus, investors can control the value of the asset.” — Danny Randazzo, Charleston, SC, Apartment Syndicator & Commercial Investor with 6 years of experience “I found a mentor in commercial investing.” “Six years before I got into commercial, I met a successful developer already doing commercial deals, and he was younger than me. Over the next 6 years, I’ve followed his success and we stayed in touch. When he invited me to help with his downtown projects, I jumped on the opportunity to learn from and work with him.  That—and I see the growth in downtown San Diego—and it was a no-brainer.” — Jeffrey Rollon, San Diego, CA, Developer “Mentorship through employment at large commercial real estate investment firms.” — Anonymous Takeaways & Resources Takeaway 1: If you are interested in scaling into commercial investing, finding a mentor or someone you can shadow is helpful in learning the ropes. Recommended Resource: BiggerPockets Commercial Real Estate Investing Forum is a great place to start meeting seasoned investors. Takeaway 2: Own a business? If you have the cash flow, it might be worth buying a property instead of renting. Recommended Resource: Talk with a realtor in your neighborhood to see what’s available. It’s free to talk & view properties. Takeaway 3: There is always an opportunity to scale from residential to commercial, you just have to be open to scaling. Recommended Resource: This helpful video explains how one investor began scaling: “How I Went From My First Rental Property & Scaled to Commercial Real Estate.” When you are ready to get a commercial loan, we can help, too. If you are interested in commercial investing, what is your next step to get started? Share in a comment below!   Free eBook from BiggerPockets! Join BiggerPockets and get The Ultimate Beginner's Guide to Real Estate Investing for FREE - read by more than 100,000 people - AND get exclusive real estate investing tips, tricks, and techniques delivered straight to your inbox twice weekly! Actionable Advice for Getting Started, Discover the 10 Most Lucrative Real Estate Niches, Learn how to get started with or without money, Explore Real-Life Strategies for Building Wealth, And a LOT more Sign up below to download the eBook for FREE today! Click Here to Download the eBook Now! We hate spam just as much as you