A tract will yield 40 lots selling at $80,000 each. Development costs are $1,200,000, sales and marketing run 8 percent of gross, and the developer requires a 20 percent profit on gross. These deductions include all nonland costs and incentive. Ignoring timing and discounting, what land value is indicated?
Correct Answer
A) $1,104,000
Gross = 40 × $80,000 = $3,200,000; selling = $256,000; incentive = $640,000; residual = $3,200,000 − $1,200,000 − $256,000 − $640,000 = $1,104,000. The indicated value is $1,104,000. This is the result under the stated inputs, not a universal market ratio or an approval of a proposed development. Common errors: leaving out the marketing costs and profit gives $2,000,000; leaving out the developer profit gives $1,744,000; leaving out the marketing costs gives $1,360,000.
Why This Is the Correct Answer
Option A is correct because gross sales are 40 × $80,000 = $3,200,000, selling costs are 8% of gross or $256,000, and developer incentive is 20% of gross or $640,000. Subtracting all three deductions gives $3,200,000 − $1,200,000 − $256,000 − $640,000 = $1,104,000. Because timing and discounting are ignored, this residual is the indicated land value.
Why the Other Options Are Wrong
Option B: $1,360,000
Option B, $1,360,000, results from deducting development costs and profit but leaving out the marketing costs: $3,200,000 − $1,200,000 − $640,000 = $1,360,000. The correct residual also subtracts the $256,000 in selling costs, giving $1,104,000.
Option C: $1,744,000
Option C, $1,744,000, results from leaving out the developer profit: $3,200,000 − $1,200,000 − $256,000 = $1,744,000. The required 20% incentive of $640,000 must also be deducted, giving $1,104,000.
Option D: $2,000,000
Option D, $2,000,000, deducts only development costs and omits both marketing and profit: $3,200,000 − $1,200,000 = $2,000,000. Subtracting the $256,000 selling cost and the $640,000 incentive as well gives the correct $1,104,000.
Gross minus build, sell, profit
Think of the land as what is left on the table after the builder, the broker and the developer each take their share of the gross sales.
How to use: Use this when a subdivision problem lists several deductions, to check that you subtracted all of them from gross.
Exam Tip
When costs are stated as a percentage of gross, compute each one from the gross sales figure before subtracting. Distractors are often built by leaving out one deduction.
Common Mistakes to Avoid
- -Forgetting to deduct developer profit as a cost of producing the lots
- -Leaving out selling and marketing costs stated as a percentage of gross
- -Reporting gross lot sales minus development cost as land value
Concept Deep Dive
Analysis
This question tests the subdivision development method in its simplest undiscounted form. You first compute gross lot sales, then subtract all of the nonland deductions: development costs, selling costs as a percentage of gross, and developer profit as a percentage of gross. What remains is the residual attributable to the raw land.
Background Knowledge
The subdivision development method estimates raw land value by projecting the gross sales of finished lots and deducting all costs to create and sell them, plus the developer's required profit. A fuller application discounts the net proceeds over the development and absorption period to reflect the time value of money.
Real-World Application
An appraiser values a 40-acre tract zoned for single-family lots where no comparable raw-land sales exist. Using builder cost estimates, marketing rates and developer profit expectations from the market, the appraiser projects lot sales and deducts all nonland costs and incentive to estimate what a developer could pay for the land.
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