When a spec home builder is evaluating the purchase of a lot, they make a series of project estimates and use these estimates along with a required profit margin to back-into an estimated lot value.
Lot value is calculated by taking an expected home sale price and subtracting away the soft costs, hard costs, financing costs, sellling costs and the builders required profit.
|$3,000,000 (Estimated Home Sale Price)
|- $1,800,000 (Total Costs Excluding Land)
|- $450,000 (Required 15% Profit)
|= $750,000 (Land Value)
A speculative home builder, or "spec" builder takes ownership of a lot on which to build a new home without knowing:
1) Who the eventual buyer will be 2) What the eventual sales price will be, and 3) What their exact costs will be. They make assumptions for each of these inputs based on their experience.
The builder bears the risk of home prices going down in the 18-30 months it takes to permit, build and sell a home.
They also bear the risk of cost overruns, permitting issues and time delays.
Spec builders also have selling costs in the form of commissions, excise tax, title and escrow when the finished new home is sold.
Spec builders typically target a gross project profit margin of around 15–20% to make taking these risks worth while.
After overhead and management costs, a builder's typical net profit margin target is around 10–18%.
We maintain a list of the most active spec home builders in Washington State.
This calculator solves for finished lot value—not raw (undeveloped) land value. If the land being considered doesn't have utilities, roads or sidewalks, the "Site-Prep" cost will need to be increased by a minimum of $60K.
Builders review comparable home sales in the area and estimate a future home sale price based on those sales.
Builders generally build homes that are slightly larger than other in the area but they try not to overbuild for an area. For example, if a certain neighborhood has many 4000 sqif homes that sell for aroudn $2M, a builder may target a homes that is 4,400 sqft with a sales price of $2.5M.
Builders don't (or shouldn't) build a 4,400 sqft $2.5M home in an area surrounded by $1M homes because buyers generally want homes where the location, neighborhood, lot and home value are all in sync.
When estimating a new home's sales price, home builders must consider current prices and how prices might change during the build process. If the real estate market weakens during the build process, the home builder can end up with little to no profit. If prices increase, the profit margin widens.
In competitive land markets, spec builders may factor in 4–10% market appreciation over the period of time they're building the home. This can often lead to over-valuation of land.
Home builders that use overly optimistic future home price predictions are the most likely to run into financial trouble if a market is flat or down. This is especially true if they've used a significant amount of debt to finance their land purchases and operations.
In upward trending housing markets, spec builders do very well because average land purchases end up being more profitable than expected and poor land purchases still end up working out.
In recent years, market prices have both increased by 15% and decreased by 15% in as little as 12 months. Such changes are enough to double a builders profit on the upside or eliminate it completely on the down-side.
Valid cost inputs vary widely based on the specific circumstances of each new home construction project:
The default values used here generally reflect current costs and prices for new construction in Seattle and surrounding areas and assume building on a relatively flat 4,000-8,000 sqft lot.
Later in this guide, we will review typical value ranges for each input. These ranges are not intended to encompass the whole range of possible values. The auto-populated input values used in the calculator should be treated as estimates.
Some inputs can be changed to accomodate those trying to determine the value of a lot being considered for a custom home (as opposed to a home to be sold).
|Estimated size of the home to be constructed in SQFT
|Cost Per SQFT
A spec home builder's direct home building costs are usually around $150-350/SQFT.
|Estimate of final home value
|Plans, Permits & Fees
Spec home builders typically have lower design costs, usually between $5,000 and $10,000.
If they are building a home they've already designed, the design fees will be even lower.
The remaining part of this line item is reserved for fees due to the permitting jurisdiction and to utility companies. These costs change based on location and typically range from $10,000 to $40,000.
Spec builders generally finance about 75% of the project cost.
They hold the land for 18–24 months and their loan balance grows while building
If mortgage rates are around 4%, a spec builder can likely borrow at around 6%. A good estimate for total financing costs is to multiply the borrowing rate times the home value.
Example: A $2,000,000 home will cost around $120,000 in interest ($2,000,000 x .06 = $120,000) if approximately 75% of the project is financed and the project takes about 24 months from land purchase to home sale closing.
|Misc Soft Costs
|Other special or extra costs like getting extra studies or legal fees.
|Total Soft Costs
|Auto-calculated sum of all soft costs.
Spec home builders typically know what a home is going to cost on a per-foot basis once they get the lot to a baseline state.
This line item is used to make adjustments for extra costs such as demolition of an existing structure ($8,000–$15,000), building retaining walls or extending utilities to the lot.
This value can be huge if the lot hasn't been prepped for a home or if the lot has steep slopes or sensitive areas.
|Direct Home Construction
|Auto-calculated using: Home Size SQFT X Building Costs / SQFT
|Landscaping and Other
Spec home builders usually limit landscaping budgets to about 1% of the value of the home.
Custom home often allocate closer to 2% of the home's value for a landscaping budget, which often excludes a budget for the construction of decks and patios.
|Total Construction Costs
|Auto-calculated sum of all construction costs
|Total Costs Before Closing
Auto-calculated sum of the costs that come due before the selling of the home.
Spec home builders need to see how much total capital the project is going to require.
|A negotiable percentage split between the listing agents representing the seller and the buyer.
|Excise Tax, Title Escrow, Misc.
|Taxes due on the sale of the property plus fees for title insurance and escrow services.
|Total Closing Costs
|Auto-calculated sum of the costs due at closing.
|Grand Total Costs
|Sum of all costs
|Gross Profit / Profit Margin
This is the home builder's target gross profit margin, which usually ranges from 15 to 20%.
In a subdivision with large economies of scale, the required gross profit margin could be as low as 10%.
For a semi-custom, one-off home on a difficult to build lot, the required margin could be 25% or more.
Gross margins are not net margins—the home builder still has staffing and overhead costs and each builder allocates costs differently, often on a per project basis.
If direct construction cost inputs don't assume any overhead for management or jobsite supervision, the target margin will likely need be higher.
|This is the value that remains for the lot once all of the costs have been deducted from the home sale price
This calculator solves for estimated lot value using assumptions typical for new homes in Seattle and the surrounding areas being built by spec home builders. It can be adjusted to help value land being considered for a custom home. Our guide to building a new home in Seattle may also be helpful.
Please Note: This calculator is subject to miscalculations and poor outputs based on poor inputs. Valuations are rough estimates, and this tool is provided without warranty or representations of any kind. Please contact us if you see room for improvement.