Wealth Opportunities in Commercial Real Estate: Management, Financing, and Marketing of Investment Properties

Residual Land Value

The preceding fact pattern makes several assumptions: the project cost, the absorption time period, the interest rate that will be charged against the outstanding construction loan balance, and the purchase price of the land.

What if the feasibility study shows that the $26.79 net, net, net annual base rent cannot be achieved? It is possible that you can reduce the project cost, or that the project will lease up in eight months rather than 12 months, or that the interest rate will fall below 7.5 percent. However, it is also possible that the construction costs will exceed the budgeted amount, or that the project will take more than 12 months to achieve stabilized occupancy, or that the prime rate will balloon to 18 percent. In order to construct a rational analysis it is necessary to make realistic assumptions. Nonetheless, if the target yield cannot be achieved based upon the assumed numbers, which variable most likely must give in order to hit the target yield? The answer is the purchase price of the land, since this variable can be controlled.

What value should be ascribed to the land in order to achieve the given yield goal? If we assume our target yield is 12 percent and we can achieve rents of $21 net, net, net, then up to what figure can we afford to pay for the land? A simple formula for determining the applicable project cost would be as follows:

Total Project Cost × 12% = NOI

We know that at $21 base rents, the NOI would be $1,176,000 ($21 × 56,000). ...