Let's say we have 2 properties, A & B, that are identical in all respects (area, location, class etc) except that A is a vacant property while B has a house on it. How might we reconcile the price of the vacant land to one with a house? I propose an equation in this post.
Preface: This is for residential properties only. Commercial properties have better pricing mechanisms, cap rates.
Where vacant properties are rare or rarely sold (very urban spaces), the traditional model of using previous sales of similar properties may lead to sub-optimal pricing. A similar problem would arise in situations where built house sales are a rarity (agricultural spaces). In both these situations, I propose that the asking price of the property be equal to the amount of money needed to turn the property from vacant to built.
The general model would be:
Price(Vacant) = Recent Price(Built) - Construction Cost(Current) - Acc. Ammor(fixtures) - Chg. in Red Tape Costs
where;
- Price(Vacant) = optimal sale price of the vacant property
- Recent Price(Built) = most recent sale price of a property or properties in a similar location with the same zoning, power/water/heating supply
- Cost of Building(Current) = The cost of constructing a house identical to the one on the referential property or properties
- Acc. Ammor(fixtures) = This represents the amount of useful life of fixtures that a new buyer will not enjoy but would be included in the current cost of building an identical house. For example, if the water pipes cost $10,000 and last 10 years, then a new buyer in Year 5 will only enjoy $5,000 worth of benefits from the pipes before they need replacing.
- Chg. in Red Tape Costs = This represents the change in amount of money needed to satisfy costs imposed by the government(s) directly or indirectly. This would include, total cost of permits, property taxes, registration taxes, mandatory insurance costs, opportunity costs of higher deposits at the outset etc. Basically any cost that is a result of local, state/provincial or federal legislation or rules that is different from the time of the original construction of the Referential Property or Properties. This could be an increase (higher permit costs and registry charges) or lower (energy incentives, rural regeneration incentives, affordable housing scheme incentives etc)
I propose this to be a general model. It could be used by industry to price residential properties that lack truly comparable sales and it can be used by home buyers to check whether the asking price of a property reflects 'excess profits' which will theoretically be extinguished through higher supply**
That's all for now.
** I realize that in some cities - London, NYC, Toronto, Vancouver - this can be improbably or impossible since there is a lack of space and demand outstrips supply to such an extent that any change in supply is insignificant, however, in such cities, there ought not to arise a situation where optimal pricing is a problem because of transaction volumes.
