Generally, how much does development increase value of property?

[Mighty-Dollar]

When I hear ads from real estate developers fishing for investors I wonder, generally speaking, how much does building an apartment complex, business building (or whatever the case may be) increase the value of a vacant lot? Or rather how much do developers realistically expect? After they buy the land if they spend $100,000 to build, what would be a typical value for how much the completed place then becomes worth?

[Michael in ABQ]

Land costs what it costs, regardless of what's sitting on it. When the value of the land as vacant exceeds the value of the land and the structure on it, you will generally get a tear-down situation. An improved site, i.e. utilities at the property line, level and rough graded, zoning in place, etc. will be more valuable than raw land, but what you put on the site doesn't change the value of the land.

It's all about highest and best use. If you have a 900 square foot, 2-bedroom house built in the 1950s on a one acre lot in San Francisco, the land is not at it's highest and best use. If it were vacant somebody would probably try to build an apartment complex or office building or something that would make better use of that land. That land might be worth $1,000,000 either way. If it's got the old house on it, it will probably sell for right at a million because the cost to demolish a small old house is a rounding error at that point, maybe $5k. If it had an old concrete warehouse sitting on it, the value might actually be lower because the buyer would discount for the higher cost of demolishing that, maybe $50-100k. If it has a 6-story apartment building on it, the whole thing might sell for $10 million, of which $1 million would be allocated to the land, and $9 million to the improvements.


Developer's expected profits can be calculated several ways. I knew one developer who built Walgreen's drug stores. He expected to make $250k in profit on each one. Generally the land for a prime corner lot would cost about a million, construction of the building would be around $3 million, and then it would sell for somewhere over $4 million.

If you're building a subdivision from raw land you have a much greater risk so you will expect a higher profit, at least 20-30% annualized. If you're building a cookie cutter fast food restaurant or retail that will quickly sell on the secondary market (drug store, auto parts store, etc.) you can't expect as high of a profit, maybe 10%.

It's the same as any other market, risk vs. reward. The greater the risk, the higher the reward someone needs to make that investment.

[Mighty-Dollar]

I knew one developer who built Walgreen's drug stores. He expected to make $250k in profit on each one. Generally the land for a prime corner lot would cost about a million, construction of the building would be around $3 million, and then it would sell for somewhere over $4 million.

Spend 4 million then sell for 4.25 million? That's just a 6.25% return, assuming it's completed in one year.

If you're building a subdivision from raw land you have a much greater risk so you will expect a higher profit, at least 20-30% annualized.

What are the greater risks? Seems like the same risk, just that you don't have to do demolition.

[Michael in ABQ]

I knew one developer who built Walgreen's drug stores. He expected to make $250k in profit on each one. Generally the land for a prime corner lot would cost about a million, construction of the building would be around $3 million, and then it would sell for somewhere over $4 million.

Spend 4 million then sell for 4.25 million? That's just a 6.25% return, assuming it's completed in one year.

If you're building a subdivision from raw land you have a much greater risk so you will expect a higher profit, at least 20-30% annualized.

What are the greater risks? Seems like the same risk, just that you don't have to do demolition.

In the case of that Walgreens, they probably borrowed a lot of that $4 million, so they might have only put down $1 million in cash. In that case their cash-on-cash return would be 25% - pretty good for one year.

If you buy a 40-acre parcel of land there are a lot more steps to go from that to a bunch of completed houses that you can sell. Depending on the market some of those steps have more risk and will mean more profit. In some areas going from raw land to an approved subdivision plat is a mere formality, in others it might take multiple years to get approvals. In that case you might buy the 40-acre parcel for $10,000 an acre, but could resell it with no physical change, just an approved subdivision plat and zoning approvals, for $50,000 an acre. If getting a plat map approved and zoning approvals is easy, you might increase the value of the land from $10,000 to $15,000 an acre. Then you're usually looking at $30,000 to $40,000 per lot to build the infrastructure - more if it's steep or has very large lots that are spread out.

Even in the best case scenario from raw land to selling the last completed house in a subdivision is going to take a couple of years. My in-laws live in a subdivision that started building houses in 2006 or so. About 70% of the neighborhood was built by 2008 when they bought their house. The next house wasn't built until about 2013, and there are still a couple of lots left as it's taken 7+ years to sell the lots and build houses on the 30-40 lots that were left over from 2008.

In my market a finished lot in a typical subdivision might sell for around $60,000. Typical density is about 4-5 lots per acre, so around $270,000 per acre as finished lots. The original price of that acre of land, as part of a larger parcel, might have only been $30,000. But in between the developer had the opportunity costs and/or financing costs of the capital for purchasing the land, the cost of designing a subdivision and getting it approved, and the cost of actually building all the infrastructure and getting it ready to build houses on. Plus their profit at each step along the way. Finally, the homebuilder (usually separate from the land developer) has their own profit on building the house. They might have bought the lot and built a home speculatively, or waited for a buyer to come along and built a home based on a standard plan for them (or semi-custom or custom).

[Mighty-Dollar]

In the case of that Walgreens, they probably borrowed a lot of that $4 million, so they might have only put down $1 million in cash. In that case their cash-on-cash return would be 25% - pretty good for one year.

But they're still paying interest to the bank on all that money that they borrowed. So I'm guessing more like a 20% ROI. Still good though.

In some areas going from raw land to an approved subdivision plat is a mere formality, in others it might take multiple years to get approvals.

I would imagine that the risk of not getting approved is not that high if the developers know the laws and tendencies of the local government. Seems like most of the higher expected return (20% - 30% or whatever) is just plain due to the long wait time. The longer the wait, the lower the annualized ROI. 

[Telecaster]

In the case of that Walgreens, they probably borrowed a lot of that $4 million, so they might have only put down $1 million in cash. In that case their cash-on-cash return would be 25% - pretty good for one year.

Walgreens probably paid cash for the whole thing, and then sold it and leased it back.