The valuation of land used for residential housing is mysterious and often misunderstood. The valuation of lots and raw land requires a detailed knowledge of construction and marketing costs as well as a good estimate of the sales price of the final product: a residential housing unit. In short, the value of a lot is the total revenue (sales price of the home) minus the costs of production and the necessary profit. Land value is a residual calculation.

Irvine, California has been almost entirely developed by a single land owner, The Irvine Company, as a large, master-planned community. The development has been wildly successful. The median income of buyers on The Ranch is 30% above the Orange County median. This translates into higher home prices and higher land values. The Irvine Company makes a profit by selling its land to builders who build and sell houses in the community. Once the forces governing land value are understood, it becomes obvious why the Irvine Company is protective of house prices in Irvine, and why The Irvine Company wants to maximize salable density on its land holdings like any other developer would.

The value of a piece of land is whatever is "left over" after all the other costs of production and profits are subtracted from revenue. This is a key point. Land for residential home use has no intrinsic value. It is a commodity useful for the production of houses just like lumber or concrete. A finished lot is a manufactured product, and it is subject to many of the same market forces as commodity markets.

If land or lots become scarce, the price increases; if this commodity is plentiful, the price decreases. If the sales price of the final product increases revenue, like in a bubble, the value of land increases; however, if revenue decreases, like after a bubble, the value of land decreases. For a given price level, if the cost of house construction increases, the value of land decreases; if the cost of house construction decreases, the value of land increases. This last point is often confusing as the inverse relationship between building cost and land value does not seem intuitive, but since land value is a residual calculation, this relationship is the reality of the marketplace. The value of a piece of land used for residential housing is directly tied to the revenues and costs of house construction.

Lawrence Roberts is the author of The Great Housing Bubble: Why Did House Prices Fall?
Learn more and get FREE eBooks at: http://www.thegreathousingbubble.com/
Read the author's daily dispatches at The Irvine Housing Blog: http://www.irvinehousingblog.com/ Visit Valuation of Lots and Raw Land.