What is the Building Residual Method?
The Building Residual Method is used in the real estate as an appraisal method in which there is a deduction in the net income of a property, the deduction serves as the estimated income from the raw land. In this appraisal technique, a reasonable amount representing the income to land is deducted from the net income of the property. The balance represents improvements to the land and the building erected on it if there is any.
How Does the Building Residual Method Work?
Using the building residual method as an appraisal technique entails that the land needs to be valued separately from the building erected on it (if there is any). The goal of estimating the value of the building and land separately is for tax purposes. For tax to be shared justly, the value of the property whether residential or commercial must be calculated differently from that of the land. When an appraisal or assessment is done, two vital things are measured, first is the value of the property and the second is the value of the land alone.
Once the income from the raw land is deducted from the property’s net income, the balance is the value of the existing building and improvements to the building such as construction materials, materials for maintenance and others. . In cases of residential properties, valuing the property and the land are quite straightforward. The estimation is based on the number of houses that change hands each year. In reality few properties change hands each year, which is why valuation might be based on the net income attributed to the property. Hence, property tax is turned to income tax. The building residual method is a desirable approach in which the land is valued first before the value of the property (building) is estimated.
The depreciated value of an existing building may be close to zero or negative. The owner of a property can decide to make a better use of the site if the ratio between what a property sells for is much higher than how much it rents for. Low property taxes cause the landlord or property owner to receive a low level of rent on the property however, when land values have higher taxes, the owner can replace an old property on the land with a new one that would bring in much more cash flow than the former. When the land is put to its best use, many people benefit from it and leads to an increase in market value. However, there are some appraisals or assessments that are based on the duration at which a property has been owned and not related to market value.
