Residual land value: how to work out what a site is worth to a developer

The asking price tells you what a vendor wants for a site. It does not tell you what the site is worth to you. That number depends on what you can build, what it will sell for, what it will cost to deliver and how much profit you need for the risk. Work those through and what is left is the residual land value: the most you can pay for the land and still have a project worth doing.

Developers use it to set a ceiling before they negotiate. Valuers use the same method, the residual approach, when there are few comparable land sales. Lenders look at it to judge whether a purchase price is supported by the scheme or has simply been bid up. This guide explains how it is worked out, why it moves so sharply, and where it usually goes wrong.

What residual land value means

A development site has no income of its own. Its value comes from what can be built on it. The residual method starts from the far end of the project, the completed value, and works backwards: take away every cost of getting there and the profit a developer needs, and the remainder is what the land can carry.

Put simply:

Residual land value = net realisation − development costs (excluding land) − required profit

The result is the total the land can absorb, including the costs of buying it, such as transfer duty and legal fees. To get the price you can offer, those acquisition costs come off as well.

Because the answer depends on the scheme, the same site can have several residual values: one for a duplex, another for four townhouses, another for apartments if planning allows. The scheme that produces the highest supportable residual is, broadly, the site's highest and best use. That concept matters to lenders too, as explained in how a highest-and-best-use finding changes what you can borrow.

The inputs, in order

1. Gross realisation. What the completed product will sell for, based on comparable sales of similar new stock nearby.
2. GST and selling costs. Deduct GST on the chosen basis and the costs of selling, to reach net realisation.
3. Development costs other than land. Construction, contingency, professional fees, statutory charges and contributions, holding costs and finance costs.
4. Required profit. Usually set as a target margin on total development cost, which includes the land itself.
5. Acquisition costs. Transfer duty, legal and due diligence costs, which scale with the price you pay.

The fourth point is where people most often get the arithmetic wrong. If your target is a margin on cost, and cost includes the land, then the profit you need rises as the land price rises. You cannot simply subtract a fixed dollar profit. The land price and the profit have to be solved together.

A worked example

The figures below are illustrative only and describe no real site. Four townhouses are expected to sell for $2,500,000 each including GST, a gross realisation of $10,000,000. Selling costs are 2.5% ($250,000). Development costs other than land and its acquisition costs total $4,880,000, made up of construction of $3,600,000, contingency of $180,000, professional fees of $300,000, statutory charges of $150,000, holding costs of $100,000 and finance costs of $550,000. For simplicity those are held fixed, although in practice holding and finance costs rise a little with the land price. Duty and acquisition costs are assumed at 6% of the land price, which is not the rate for any particular state. The target is an 18% margin on cost.

With full GST

• GST: $10,000,000 ÷ 11 = $909,091.
• Net realisation: $10,000,000 − $909,091 − $250,000 = $8,840,909.
• Most the total cost can be for an 18% margin: $8,840,909 ÷ 1.18 = $7,492,296.
• Available for land and its acquisition costs: $7,492,296 − $4,880,000 = $2,612,296.
• Land price: $2,612,296 ÷ 1.06 = $2,464,430, with $147,866 of duty and acquisition costs on top.

So the most this developer can pay, on these assumptions, is about $2.46 million.

Under the margin scheme

If the margin scheme applies, GST is one eleventh of the sale price less the land cost, so a higher land price means less GST. The calculation becomes circular, because the land price you are solving for is also an input to the GST. Solved together, the land price comes out at about $2,657,585. At that price GST is ($10,000,000 − $2,657,585) ÷ 11 = $667,492, net realisation is $9,082,508, and total cost is $7,697,040, which leaves exactly an 18% margin on cost.

The margin scheme lifts what the site can carry by almost $200,000 in this example. That is why the GST basis must be confirmed before the residual is relied on. Whether the scheme is available depends on how and when the property was acquired, and it needs a written agreement with the buyer on or before settlement. Eligibility is a question for your accountant, not for the model. There is more on this in the GST margin scheme in a development feasibility and on the ATO's margin scheme page.

Why the residual moves so much

Residual land value is what is left after everything else, so any change elsewhere lands on it in full. And because the land is only one part of the total, a small percentage change in end value becomes a large percentage change in what you can pay.

Using the margin-scheme example:

• End value 5% lower, at $9,500,000: the residual falls to about $2,276,476, around 14% less.
• End value 10% lower, at $9,000,000: the residual falls to about $1,895,366, around 29% less.
• Target margin of 20% instead of 18%: the residual falls to about $2,527,248.
• Target margin of 15%: the residual rises to about $2,862,277.

A 5% change in end value moves the land price by roughly three times as much. The same gearing works on costs. That is why two developers can look at the same site and arrive at land values hundreds of thousands of dollars apart, and why a residual built on the top of the sales evidence is a fragile basis for an offer.

Residual land value and market value

A valuer assessing a development site will usually look at comparable sales of similar sites first, and use a residual calculation as a check or where there is little land evidence. The two can disagree. Where a market is competitive, sites can trade above the residual a cautious developer would calculate, because buyers bid with thinner margins or more optimistic end values.

That gap matters when you finance the purchase. If you pay more than the site is valued at, the lender's loan is sized on the valuation, not on your contract price, and the difference comes from your equity. The development site LVR decision tree sets out how a lender approaches that question.

How a lender reads it

A construction lender does not lend against your residual calculation. It rebuilds the feasibility with its own valuer's end value, usually net of GST, and its quantity surveyor's cost to complete, then checks whether the margin that remains clears its hurdle. If your land price only worked because the end value was at the top of the range, the lender's version of the feasibility will show a thinner margin than yours.

Paying close to the residual leaves no room for that rebuild. Paying comfortably below it is what gives a project the buffer a lender wants to see. The full sequence of a feasibility, of which the residual is one output, is set out in how to do a development feasibility, step by step.

Costs that move with the land price

The worked example holds every cost other than duty fixed. In a real feasibility, several more lines rise with the price you pay. Interest on the land component of the loan grows with the land value. Land tax is assessed on the land's value, so a dearer site usually carries more of it. Some lenders size the land loan on the purchase price or valuation, which changes how much equity goes in at settlement and how much interest runs from day one.

The practical fix is to iterate. Solve the residual once, put that land price back into the full model, recalculate holding and finance costs, and solve again. Two or three passes are usually enough for the answer to settle. A calculator that runs the cashflow month by month does this for you.

Residual land value for a project you keep

The same method works for a build-to-rent or hold project, with two changes. End value becomes the value on completion, usually the net rent divided by a capitalisation rate supported by local sales evidence. The target becomes a yield on cost, the net rent as a percentage of total development cost, rather than a margin on a sale. Work backwards from the yield you need to the total cost the rent can support, take away every cost except the land, and what is left is the residual. A hold residual is especially sensitive to the capitalisation rate, because a small change in the rate moves the value on completion a long way.

Common mistakes

1. Starting from the asking price. The residual should set your ceiling before you know what the vendor wants, not justify a number already agreed.
2. Forgetting acquisition costs. Duty alone can be a meaningful share of a site price. The residual is what the land can absorb in total, not the contract price.
3. Subtracting a fixed profit. If the target is a margin on cost, the profit needed rises with the land price.
4. Inconsistent GST. Revenue on the margin scheme and costs on another basis, or the margin scheme assumed without confirmation.
5. Ignoring time. A longer approval or sell-down period adds holding and finance cost, which comes straight off the residual.
6. Using the best comparable. The residual is most sensitive to end value, so an optimistic sale price overstates the land value by several times the error.

How the calculator shows it

Siare's development feasibility calculator reports this figure as Pay no more than: the highest land price that still reaches your target margin on cost, which is 18% by default. It sits alongside the rest of the result, so you can see the ceiling before you negotiate and test how quickly it moves when the end value or the build cost changes.

What counts as a reasonable target margin in the first place is covered in development margin explained.

This article is general information about business and investment-purpose finance only. It is not financial, credit, legal, accounting, valuation or tax advice, and you should obtain your own professional advice before acting.

Before you make an offer on a site, run it through the free residual land value and feasibility calculator and see what the scheme can actually carry.