OVERCAPITALIZATION
david hornby

A "hypothetical development" valuation is carried out using the profit and risk factors to the example shown in highest & best use to obtain the appropriate land value. The land values thus determined are:

• OPTION 1: $80 000
• OPTION 2: $120 000
• OPTION 3: $90 000

Therefore, the highest and best use of the site is as a warehouse because that use shows the maximum land value of $120 000 when the appropriate profit and risk factor of 8%pa is applied.

If the owner of the land above went ahead and built the motel, its value on completion would be less than "replacement cost new". This is because the market value of the motel is determined by the present value of all future income and benefits. The net income generated will not be sufficient to cover the cost of building and at the same time provide sufficient reward to the developer for the high risk.

Such developments are overcapitalization of the land. Other examples are:

• a large and prestigious house built in a "rundown" neighbourhood

• a large planned regional shopping centre has just been completed. The highways department issues a statement that a major traffic bypass will be created diverting traffic away from the centre. Therefore, the shopping centre is now too large for the reduced trade area. That is, the site is overcapitalized.

Compare with undercapitalization