Emerging construction technology, such as the preconstruction intelligence tools we’re developing at Join, can radically change the value of land, enabling denser development that benefits both owners and cities. In this post, we’ll walk through the process that developers use to value land parcels, then show how technology-driven reductions in hard construction costs can impact that analysis. The result? A win for owners and municipalities: increased value, taller buildings, and more sustainable development.
Mixed-use and multifamily infill development is a critical source of new urban housing in major US metropolitan areas. For our scenario, we’ll take a simplified view of one mixed-use development to see how developers value land. However, the value improvements we discuss also apply to a wide range of project types.
Procuring the land parcel is the most important step in a construction project. If land cannot be bought, or cannot be bought at a price that pencils out given expected project value and costs, the project cannot proceed. When evaluating a plot of land, real estate developers create a proforma, usually in the form of a spreadsheet, to outline potential projects. The proforma is an analytical tool that weighs value against cost, helping developers determine the maximum to pay for a parcel of land.
Working from the site location and city building code, developers outline separate scenarios for potential projects. First, by approximating apartment rents or unit sales prices, they arrive at the expected value: the best estimate of what they can sell the completed project for. To attract equity and debt, the project must also demonstrate a certain level of profitability, as a function of both cost and project duration. This puts a ceiling on the project budget—capital sources need to see an appropriate annualized return before making investments in or loans to the project.
Finally, the proforma tallies the itemized costs of the project, including finance costs, developer fees, design fees, and hard construction costs. Summed, they constitute the budget. Hard construction costs dominate, accounting for about 60% of the total. Except for the cost of the land, all of these can be estimated based on a parcel and the prevailing market. Developers subtract construction and permitting costs from the budget ceiling to arrive at the land value for a given scenario.
This means that developers solve these spreadsheets for the price of the land as they negotiate with owners. For the project to proceed, developers must configure it to value the land at more than the seller wants. The sale price of a plot of land is therefore largely determined by the cost of construction.
Surprising consequences can result. For example, an Oakland area developer was considering a plot of land under two scenarios: one with a mixed-use high-rise of almost 400 units, and one with a mixed-use mid-rise of around 150 units. Given the steep rental prices in the Bay Area, you might expect the land to be more valuable with the larger 400-unit development. However, this is not the case.
High-rise construction is almost always Type I construction (concrete and steel), whereas the mid-rise would be primarily Type V construction (wood framing, on a concrete podium). Type I construction is more expensive and slower. This meant that the proforma for this high-rise development valued the land at below $0. The mid-rise project, by contrast, valued the land at several million dollars. If the project proceeded with traditional methods, the owner would choose the smaller development—an unexpected result given the Bay Area’s insatiable demand for housing.
But what if we apply new technologies to reduce construction costs and timelines? Proponents of technology in construction, such as the authors of this University of Berkeley paper on offsite construction, claim that adoption can lower project budgets by over 20%. These savings are in line with the productivity gains that industry analysts believe are possible through the development and adoption of a wide range of processes and technology.
Reducing hard costs for Type I construction by even 10% flips the proforma analysis on its head. The land in the high-rise scenario is now worth almost double its value in the mid-rise scenario. Advances in construction technology have a key impact during this early decision-making process, when they can add millions of dollars of value to existing parcels of land.
Construction cost reductions are more leveraged with larger buildings, as hard costs are a larger overall fraction of the budget. In our example, reducing the Type V construction cost for the mid-rise development does raise the value of the land. However, the increase in land value is less than the Type I scenario. With cost reductions uniform across the two construction types, not only is the land worth something rather than nothing under Type I construction, it leapfrogs Type V construction entirely.
This means that reductions in construction costs will encourage taller buildings. Taller buildings bring denser, more sustainable development while increasing the tax base of the municipality. Cities and landowners share the benefits of increases in land value, and both parties should do what they can to support new digital construction technologies and emerging construction techniques.
It’s an exciting time for construction technology—witness the rise in investment, the emergence of dedicated R&D roles inside leading construction companies, and a multitude of success stories from the field. Technologies that improve construction and project delivery can improve not just the lives of people involved in project delivery, but the built environment as a whole.
At Join, we’re developing tools to improve Preconstruction, a critical project phase where the owner, contractor, and design teams work to balance owner priorities with budgets, schedules, and aesthetics. We see this as the right place to surface information about emerging construction methods and augment teams in their decision making as they optimize the projects and cities that we will live and work in.