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B

ack in 1992 in the very first issue of the Ballyhoo, we discussed the concept of estimating the value of a property based on a ratio between the raw land value and the finished (unfurnished) house. At the time, we suggested a ratio of 1:4. The idea behind this rule of thumb is that it gives a quick way to figure if a particular piece of land is worth building on from an investment point of view, or conversely, it gives a quick way of checking the logic of the asking price of a house based on the underlying value of the land. If we see that the land is much less than one quarter of the total value, it could mean that the investment in the house is too high for the location or for the size of lot. When I find that I have to examine a description of a house for sale, the first thing I check is the municipal evaluation. If I see that the land value is a tiny fraction of the total, then I know that there is something wrong. Most of the time, it is a result of over-investment.

One example of how this could happen is as follows: In the old days, summer houses were often built on lots as small as 5000 square feet. In the early 1980's, the Ministry of the Environment obliged municipalities to establish minimum lot sizes for the proper accommodation of private septic systems. In consequence, while the five thousand square foot lot with an existing house benefits from an acquired right, new homes could no longer be built on lots that small. That didn't stop people from continuing to invest in the summer cottages, but once renovated and winterized, the cottage often cost as much as building a new house on a larger lot would have. Comparing the two on the market, the land value on the smaller lot would be lower, even though the house costs may be equivalent. As a ratio, the land value for the smaller, renovated property would reflect a higher ratio than the ratio of land and total value for the new property.

When the market improves, while the value of the property increases, it does so as a function of the value of the underlying land. While the change in value for a lot may be less significant, it is magnified where there exists an appropriate house. On today's market, a building lot may have risen in value from, say, $70,000 to $110,000. The increased value is $40,000. However, in a situation where the lot has been properly developed with the appropriate house, the value could have changed by the same proportion. A house that sold for as high as $280,000 when the lot is worth $70,000, could sell for as high as $440,000, if the lot value increased to $110,000.

This is, of course, a rule of thumb, and often what actually happens is that the house, built respecting different parameters, is no longer suitable to the newly re-valued lot and the total price may not be a simple function of the ratio. While land appreciates, houses depreciate. The exercise is useful in many cases, though, and may encourage you to think about how much to invest in renovating an existing house. It does not mean that you will not sell your house for more than four times the value of the underlying land. It simply suggests an optimum target for investment for any particular property. There is another, extremely important influence on the market value of a particular house, and that is the appropriateness of the house. Was it built to standards? Were the materials and finishing used of suitable quality? Are the stairs, counters and windows of standard height? Are the 'extras' something that would appeal to the market? If so, and the house still costs much more than the ratio would suggest you should invest, it does not mean you won't get your money out, either. It just means you might have to discount it.

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