An overview of the enquiries on the issue of apportionment of value between land and improvements

Abstract

In the literature and in the practice of real estate evaluation, there are various opinions about whether or not the value of a property should (and can be) separated into two components: land and building. This paper supports separability and illustrates this with an empirical example using the hedonic approach and detailed data from the City of Montreal (Canada). Existing methods simply provide approximate results on separation and rely only on the use of vacant land transactions. The hedonic method presented here provides reliable and coherent results from the use of the total price of a property split into two independent systems of prices for the land and for the improvements by considering their specific attributes.

Keywords:

• land
• unimproved land
• building
• improvements
• improved land
• value apportionment
• separate evaluation

Notes

1. Some authors use the term ‘omelette’ to exemplify the inseparability argument. They are thus characterised as belonging to the ‘Omeletist School’ (Gaffney, 1965; Holland, 1970; Lindholm & Lynn, 1978). More recently, Hendricks (2005) used another example by considering a vase:‘When a vase breaks in two, the two parts are not likely to amount to the same value as the vase as a whole.’

2. Starting with Marshall (1922), the concept of ricardian rent becomes generalised when regarded as ‘composite’ in nature. This concept has influenced different authors, for example in the field of shopping centres. Fisher and Kinnard (1990) and Fisher and Lentz (1990) proposed that a part of the rent pertains to other types of production agents that they call Entrepreneurial profit or Business value.

3. It should be noted that various appraisal manuals use the terms ‘method’ and ‘technique’ interchangeably, whereas this paper considers techniques as being based on methods.

4. It was Marshall (1922) who anticipated the use of residual techniques in the income approach, and later Frederick Babcock’s Valuation of Real Estate (1932) explains how one can in practice split the income between the land and the improvements. Recently, Hendricks (2005) has brought into disrepute the use of the rent residual method by providing some empirical examples while, earlier, Robinson (1999) was professing its robustness with his two-step approach.

5. There are some factors that might have a common effect on the value of the land and of the improvements. This is usually the case with the time dimension and financial conditions. However, this can be addressed, for example, in the previous steps of price adjustments, before proceeding with separate estimations.

6. Researchers have adopted different functional forms for estimating property price and there are still debates about choosing the appropriate one. The different forms include linear, semi-log, log-log and a flexible Box–Cox transformation framework. Despite all these, the preference is usually accorded to the approach providing better estimations and statistical tests.

7. It was possible to use 27 boroughs in the same model as additional dummy variables, but for practical reasons, they are regrouped in three historical homogeneous sectors.

8. The CBD of Montreal is delimited according to the density of commercial and office building usages where the number of single-family properties is not significant. Thus, all the 13,384 properties are located outside of the CBD.