From either point of view it is economically desirable that the land should not be overburdened with unnecessary expenditure in its improvement.
It has been observed that the increase of the value of the land, whatever be its rate or relation to original cost, is unproductive in itself, and unless the building provides a return upon it, it brings only upon its owner the attentions of the taxing authorities.
It may be suggested that the best policy to pursue is to provide in advance for such an enhanced value by erecting so large a building that its net returns will capitalize the increase as time proceeds. Such a suggestion looks like a short cut to an entire disposition of this question, but in reality it offers only a partial solution of the problem even when very conservatively practised.
The cost of construction of a tall building is relatively greater than a lower one, and there are relatively greater burdens immediately set up by its additional value, in taxation and assessments and its own depreciation. Not only so, but it will offer a greater obstruction to future improvement after its maximum effect has been reached. Its investment constitutes a pledge upon the ability of the land to maintain its desirability and of the locality to maintain a rate of rental, and any untoward future occurrences in either regard are magnified in their effects by its additional engagement of capital.
Fig. 7. Showing the effect of a gain in land value in excess of the depreciation on the building, when a greater return is secured by realizing profit before the end of the term of existence.
Modern methods of steel construction afford very wide opportunity for building ahead of the values of any site, and some of the unrelated and intrusive structures to be seen in the borough of Manhattan are the present result.
The ruling consideration in this connection should not be the maximum expenditure which can be placed upon a site and earn interest on its own cost of construction, but with how small an investment in cost of construction the capitalized value of the land can be maintained.
The relation which the earnings necessary to establish or maintain the value of a site bear to that value is shown in Fig. 8, covering annual rates of interest on the investment of 4, 5, and 6%, and including any relation of the cost of the building to that of the land, up to ten times the value of the latter.
The lower diagonal is that of taxation, based upon a rate of 1 % of the gross value of the whole property. The second line comprises the addition, to taxation, of a fund for amortization of the original cost of the building during a life of thirty years, a rate of compound interest being assumed for this fund of 4% per annum. The upper lines add to the two former the rate of annual interest upon the whole investment, at 4, 5, or 6%.
This diagram illustrates the extent to which the earning capacity of a site may be pledged or overburdened by excessive building. In the extreme case of a building costing ten times the value of the site, an amount practically equaling the entire value of the site must be earned every year in order to maintain its value as a 6% investment.
Land value $8 per square foot, or.....
per city lot of 2500 square feet.
Cost of a building assumed to be......
or three times that of land.
Then interest at 5%, added to depreciation and taxation, requires the improved property to return annually 29 1/3 % of the value of the land, or
This return of 5% upon the value of land and building requires a gross income of about . . .
In other words, the renting capacity of this piece of land, which in its unimproved condition requires only that provision be made for its or 6% of its value, would, by the improvement assumed, require the owner to concentrate on it interests or uses capable and willing of paying a gross income of ten times that amount, or about 60% of the actual value of the land every year for its use in connection with its improvement!
taxation of say............
and for interest, at 5% on its value, of ... .
The relation which the investment on the building should bear to the marketable value of the land is really determinable by the expenditure justified by the prevailing rate of rentals for any given form of occupancy.
When the value of the site combined with the building is to be established from known or assumed rates of rental, the following method will afford the means of determining the established value at any desired rate of interest:
T= [(S x n x r x f) / (100 x i)] x b
S = rate of rental per square foot occupied or rentable area.
n = per cent. of net rentable area to gross area of building.
r = ratio of net income to total income.
f = number of stories in the building.
i = rate of interest, per cent. per annum.
b = area of the building in square feet.
T = total invested value of site and building.
From the result of such a computation the actual cost of the building may be deducted, when the value established for the site remains. If this value be largely above the existing marketable value, then too great an investment in building has been assumed to be made, a result which may be exemplified by the following examples of the application of this method to a comparison of values.
It is proposed to erect either (1) an 8-story or (2) a 12-story housekeeping apartment-house upon a certain plot, the rentals in which will be $1500 per annum for a suite of 1120 square feet, or an average of $1.34 per square foot per annum. What will a net return of 5 % per annum justify for the value of the land plus the cost of the building?