Hypothetical Development Method

36150 — Hypothetical Development Method

Valuation Fundamentals (36100)

Overview

Node 36150 addresses the hypothetical development method, also known as the residual method, a valuation methodology applied to land or improved property with development or redevelopment potential, which derives an opinion of value by deducting the estimated total cost of a hypothetical development, together with an allowance for developer’s profit and risk, from the estimated gross realisation of that development on completion.

The method is applied where a property’s highest and best use lies in a development or redevelopment scheme rather than in its existing use, and where direct comparable sales evidence for land with an equivalent development potential is limited. The residual figure produced by the calculation represents the amount a purchaser could pay for the property, in its existing condition, while still achieving the assumed developer’s profit on completion of the hypothetical scheme.

This node serves valuers, developers, and financiers seeking to understand how the hypothetical development method operates as a valuation methodology. It is a distinct exercise from the development feasibility modelling addressed in node 32210 and the residual land value analysis addressed in node 32220, which apply a comparable calculation for feasibility and acquisition decision-making rather than for the purpose of forming a valuation opinion.

Scope & Boundaries

This node addresses the hypothetical development method as a valuation methodology, including the derivation of gross realisation, development cost, and developer’s profit and risk allowance. It does not address development feasibility modelling conducted by a developer for project appraisal purposes, addressed in node 32210, nor residual land value analysis conducted for acquisition or feasibility purposes, addressed in node 32220.

It does not address the statutory planning process that determines the development potential assumed in the hypothetical scheme, addressed in node 35410, nor the fundamental principles common to all valuation methods, addressed in node 36100.

Scope Note

This node describes generally applicable principles of the hypothetical development method as at the time of writing. The assumptions as to development potential, cost, and developer’s profit appropriate to a given site depend on the property, locality, and prevailing market conditions, and require the judgement of a suitably qualified valuer.

Key Concepts

Gross Realisation

The estimated aggregate sale or letting value of a hypothetical development on completion, before deduction of development costs and profit.

Developer’s Profit and Risk Allowance

An amount deducted from gross realisation, expressed as a percentage of cost or realisation, representing the return required by a developer to undertake the risk of the hypothetical scheme.

Residual Value

The value produced by deducting development costs and the developer’s profit and risk allowance from gross realisation, representing the amount attributable to the land or property in its existing condition.

Highest and Best Use

The use of a property, among all reasonably probable and legally permissible alternative uses, that is physically possible, appropriately justified, and financially feasible, and which results in the highest value.

Regulatory & Legal Framework

API/IVSC Professional Practice Standards

Australian Property Institute & International Valuation Standards Council

Set the methodological standards governing the application of the hypothetical development method, including sensitivity disclosure requirements.
Environmental Planning & Assessment Act 1979 (NSW)

State & territory planning authorities

And equivalent state and territory planning legislation governs the statutory planning framework that determines the development potential assumed in the hypothetical scheme.
Valuation of Land Act

State Valuers-General

(state-based, for example the Valuation of Land Act 1916 (NSW) and equivalent legislation in other states) establishes the statutory basis on which value derived by the hypothetical development method may be applied for rating and land tax purposes.

Practical Application

The hypothetical development method is applied wherever a property’s highest and best use lies in a development or redevelopment scheme rather than its existing use.

Scenario	Application	Outcome
A low-density site suitable for townhouse redevelopment is valued for a family estate settlement	The valuer models a hypothetical townhouse scheme, deducting construction cost and developer’s profit from projected sale proceeds	The residual value informs the distribution of the estate
A vacant commercial site with an approved development application is valued for a mortgage security assessment	The valuer applies the hypothetical development method using the approved scheme as the basis for gross realisation	The resulting valuation supports the lender’s assessment of security for a development loan
A strata-titled retail building suited to a mixed-use redevelopment is valued for a potential sale	The valuer models a hypothetical mixed-use scheme against comparable evidence of achievable sale rates	The residual value supports the vendor’s assessment of an appropriate reserve price