How does holding cost enter the valuation of land bought for future development?
Correct Answer
C) It reduces what a buyer can pay for the land now
Why this is correct: Holding costs (property taxes, insurance, interest on capital) are ongoing expenses incurred while the land is held for future development. A rational investor will discount the price they are willing to pay today to account for these future cash outflows, reducing the present land value. Why the other choices are wrong: 'It is added to the land value as an improvement' is wrong; holding costs are expenses, not improvements. 'It is ignored, as it is a matter for the owner' is wrong; it's a fundamental investment consideration. 'It is recovered fully when the land is later sold' is wrong; recovery is not guaranteed and is factored into the initial price. Exam tip: In discounted cash flow or residual land analysis, holding costs are a deduction that reduces the present value of the land.
Why This Is the Correct Answer
Why this is correct: Holding costs (property taxes, insurance, interest on capital) are ongoing expenses incurred while the land is held for future development. A rational investor will discount the price they are willing to pay today to account for these future cash outflows, reducing the present land value. Why the other choices are wrong: 'It is added to the land value as an improvement' is wrong; holding costs are expenses, not improvements. 'It is ignored, as it is a matter for the owner' is wrong; it's a fundamental investment consideration. 'It is recovered fully when the land is later sold' is wrong; recovery is not guaranteed and is factored into the initial price. Exam tip: In discounted cash flow or residual land analysis, holding costs are a deduction that reduces the present value of the land.
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