Why must the proceeds in the subdivision development method be discounted to present value?
Correct Answer
A) Lots sell over time, not all on the same date
Subdivision receipts and development expenditures usually occur at different times during absorption. Discounting brings the modeled net cash flows to a common valuation date using a supported return appropriate to their risk. Costs, entrepreneurial incentive and the discount rate must be treated consistently so a return component is not counted twice. A longer schedule can affect value, but timing and risk must be modeled rather than assumed from gross sellout alone.
Why This Is the Correct Answer
Option A is correct because lots sell over time during an absorption period rather than all on the valuation date. Discounting brings the future net proceeds back to present value using a rate appropriate to their risk.
Why the Other Options Are Wrong
Option B: Land is worth less than the improvements to be built
Option B, that land is worth less than the improvements to be built, is not the reason for discounting. Discounting reflects the timing of cash flows, not a comparison of land and building values.
Option C: The method is prohibited without a discount rate
Option C, that the method is prohibited without a discount rate, gives a rule rather than the reason. Discounting is used because sales and costs occur over time, not because of a prohibition.
Option D: Discounting removes the need for a profit figure
Option D, that discounting removes the need for a profit figure, is wrong. Entrepreneurial incentive and the discount rate must be treated consistently so a return is not counted twice or left out, but discounting does not by itself eliminate profit.
Sold over time, discount
Money received later is worth less today. Because lots sell over time, their proceeds must be discounted.
How to use: Use this idea to explain discounting in any method with cash flows spread over time.
Exam Tip
Discounting in the subdivision development method reflects the timing of lot sales and costs over the absorption period; reject answers that tie it to a rule, to a land-versus-building comparison or to eliminating the profit allowance.
Common Mistakes to Avoid
- -Using gross sellout without discounting
- -Double-counting profit in both expenses and the discount rate
- -Assuming all lots sell immediately
Concept Deep Dive
Analysis
This question tests why the subdivision development method uses discounting. Lots are sold over an absorption period, and costs occur at different times. Discounting converts those future net cash flows to a present value as of the valuation date.
Background Knowledge
The subdivision development method projects lot sales revenue, subtracts development costs and appropriate profit, and discounts the net cash flows over the absorption period. It is used to value land suitable for subdivision. Absorption rates should reflect projected market demand.
Real-World Application
An appraiser values raw land approved for 60 lots expected to sell over three years. She projects sales and costs by period and discounts the net cash flows to the valuation date.
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An appraiser is valuing a vacant site of 18,400 square feet. Three recent sales of vacant parcels with a similar highest and best use are: Comp A, $800,000 for 16,000 square feet; Comp B, $945,000 for 18,000 square feet; Comp C, $1,100,000 for 20,000 square feet. No other adjustments are needed. Based on the mean of the three sales' prices per square foot, what is the indicated land value?
Next Question
Three parcels assembled under single ownership (standard appraisal guidance assemblage / plottage) support separate as-is values of $240,000, $195,000, and $170,000. After assemblage for a higher-utility use, the combined site is valued at $720,000. Assemblage costs (legal, demolition, holding) total $45,000. What net plottage (assembled value − sum of separate values − assemblage costs) results?