Following is a laundry list of valuation complications presented to Dixie Phair by some Any Municipality County officials. They compiled the list after hearing about appeals in other districts, and wanted to know Dixie’s plans for tackling:
- functional obsolescence
- underlying land lease
- architecture just declared historically significant
- encumbered by a lease that is below market or above market
- your brother-in-law owns it
As the County’s Commercial Real Property Analyst, Dixie first stated that she is very familiar with those complications and agreed that they all serve to slow down the valuation process. Dixie explained that while everyone is on their own with the brother-in-law, the other complications listed above are each too variable to accurately handle in a valuation model; they require additional time and appraisal expertise.
Dixie articulated the dilemma by repeating that four of the five laundry list items are too variable to model. But, she then also confirmed that modeling can definitely help! She realized those two seemingly contradictory statements caused confusion among the County officials, so she asked them to hang in there, and continued… Continue reading
The term plottage refers to the incremental value above the sum of individual values of parcels brought about by their combination. Can combining parcels ever reduce value? As always, the answer is found in the principles of Highest and Best Use
The concept of Highest and Best Use requires testing for: 1) physical possibility, 2) legal permissibility, 3) financial feasibility, and 4) maximal productivity. The first three are readily determined; for #4 a proxy for highest value is often most accurately measured by the income approach.
As an example. let’s compare two commercial developments that are identical in terms of utility, appeal, and market value. Next imagine there is an empty tract adjacent to one of the developments. Would adding the site area from that vacant adjacent parcel to the development automatically increase the market value? Not necessarily. In fact, the value of that development might actually be reduced if the extra land increases ownership expenses, for example higher taxes & maintenance costs.
For the assessment professional, this means awareness of how additional land contributes to value… if it does.
Salable excess land would contribute, but surplus area not contributive to highest and best use can be a detriment. It is possible for 1 + 1 to equal less than 2.
A couple of comps and you’re golden. Seems simple enough, doesn’t it? I mean, how difficult can the commercial real estate assessment process be if all that’s required is to track down a few comps that are similar to the subject property.
Then after you find those comps, one or two may require some basic adjustments… easy right? Since the comparables are nearly identical to the subject, shouldn’t adjusting be straightforward?
Well, before you make a broad judgment regarding the process based on “all it takes is a couple of comps” consider the following case study:
16,000 SF general office building with five tenant suites, located at the outer edge of the local commercial area. Leasing has been tough, with three tenant spaces still available two years after development. Following are the “comps” from the local market.
- 25 year old former drugstore of 9,500 SF, in good condition with drive-up.
- Dental office of 850 SF in former dwelling, detached garage included.
- 80,000 SF discount shadow anchor, 40 years old with nine acres of weedy parking lot.
- New 14,500 SF drugstore subject to a 25-year triple net lease to credit national drug chain.
- Two sales of historic multiple story town square buildings, both 30 ft wide, one @ 9,000 SF and the other @ 11,000 SF.
- Modular used car sales building of 1,100 SF on a very small parcel (majority of car sales lot was sold separately).
- 12,000 SF, one story funeral home building, 25 years old, with vehicle barn at rear.
- 40 year old former fast food, 4,500 SF with three drive cuts, signage still present.
- Food anchored, 15 year old 82,000 SF shopping center with undeveloped outlot.
- 100 year old church building, street parking only, last repurpose was a restaurant.
This post illustrates the reality and complexity of the commercial assessment process. Finding properties that are truly comparable can be extremely challenging. Comps are not everywhere, even in dynamic markets. Without solid support, adjustments to comparables are not reliable. In addition to physical characteristics (building size & condition, acreage) many other factors need to be considered, including but not limited to conditions of the sale, timing, location (specific/general), and more.
That’s how difficult it really is.
As a commercial real estate broker in the year 2000, I was involved in the sale of a 400,000+ SF midwestern warehouse. At that time, and in that local market, good quality warehouses of over 20’ clear height were selling above $20 per SF, but this one sold for less than half that.
About 40% of the building was 2 story, so there was considerable functional obsolescence. Even though both stories were in excess of 18’ clear and the property was in good condition, the idea of multiple floors in a warehouse harkened back to decades-old building practices in urban environments.
But the advent of online retailing is a great example of how things can change. In April 2017 a well known international industrial developer/owner broke ground on a 3 story 500,000+ SF warehouse. It is located in a rapidly growing western U.S. area, where there’s a lot less flat land compared to the midwest; nonetheless multiple storied industrial buildings are still news!
While it is certainly a warehouse, the new property is called a fulfillment center and had two requirements for development: a) proximity to a large population center for the “last mile” delivery of online sales, and b) material handling systems through use of robotics. Given the huge & rapid technological improvements in robotics, this is sure to be a trend.
To determine total valuation for these properties, the challenge for assessors will be to separate the real property from the personal property. A future appeal tactic will undoubtedly be to attribute much of the total value to personal property for faster depreciation.
The guy across the hearing table appears increasingly agitated about his assessed value. Or maybe this occurrence is simply what is expected, thus perceived? Perhaps that is for the best because it cues your instincts, as an Assessment Professional, to diligently provide a format for productive communication.
Simply acknowledging that the lines of communication are open may in itself diffuse some of the property owner’s angst. It’s hard to stay mad at someone who obviously is trying to be reasonable.
On the other hand, we all know that a negative reaction to agitation often makes a situation worse, fanning the flames.
Here’s a neutral statement you may find helpful: “We do our best to get these values right, but your viewpoint is important to us. If you disagree with our results, we need to explore it together.”
Fair or not, public service provides Assessment Professionals with only limited opportunities for expression.
The (daylight active) eagle famously has extraordinary eyesight, with four times the sharpness of humans and ability to dual focus frontally and to the sides, as well as excellent hearing. The (nighttime active) owl has such great hearing it locates prey largely by sound, and also possesses exceptional far vision, particularly in low light.
Being disappointingly human, in our work with real estate we miss stuff all the time, which is easy to do when the properties are both numerous and complex. Perfection is not a realistic goal, and usually what we miss doesn’t impact value greatly except when it involves either a limitation in (or a step forward in) property rights, utility, or design.
Failing to notice that air rights have been sold off in a densely developed urban environment is certain to launch an appeal, as is not realizing the necessity for leased, proximate parking for tenant use.
If we are somehow unaware that a manufacturing facility is so specific in design as to preclude alternative use to all but a tiny and diminishing number of occupants, we have ignored significant functional obsolescence. Continue reading
Much is now hyped in the real estate press about the renewed life of retail bricks and mortar.
In-store sales are enhanced by such ethereal concepts as “experiential retailing” offering a sense of community and collaboration, all branded (and personally curated no less). Buzz words are everywhere, but any actual contribution to real property value is even thinner ether. These are business marketing concepts which are unrelated to real property value.
The addition of personalization and specialized branding to the retail business models in industries such as fashion may be spectacular, and those catchy buzzwords get the message out. But the site improvements and physical components of a retail building serve both the existing tenant and next tenant, with impartiality.
What is the significance of this, particularly to less experienced commercial assessment professionals? The existence of your newly favorite retailer in the shopping center does not add to the real estate bottom line; that bump in select retail stocks does not increase market value. Nothing personal… it’s just about the rent.
Today’s assignment for Commercial Real Property Analyst Dixie Phair is an apartment property. Dixie always uses an income model (and you surely should too!) to aid in apartment valuation. In this case, her model is especially helpful because it allows her to test under three valuation scenarios.
The particular model used by Any Municipality County stratifies multifamily property by Gross Rent Multiplier (GRM) and Overall Capitalization Rate (OAR) as follows:
GRM for 2 to 4 unit properties
GRM for 5 to 19 unit properties
OAR for 20 to 59 unit properties
OAR for 60+ unit properties
Never at a loss for relating almost anything to income-based analysis for real property, I find a ready analogy in the renovation of an older car.
Just consider the rebuilding of an auto transmission as an example of how important it is that all components work together:
| Tranny Components
|| Income Value Components
| Clutch facing
|| Rent rate
| Gear roller bearings
|| Expense ratio
|| Overall cap rate
Your success in the auto renovation will be limited at best if you do only a partial rebuild of transmission components, like switching out only a clutch facing when the flywheel and bearings are also worn. You may get instant gear engagement, but the ride will suffer greatly from related noise and vibration.
If you try to skimp on updating an older income model for property valuation, much the same will be true. Update only the rental rate, and the outcome won’t be an accurate value because the outdated components of vacancy, expenses, and cap rate remain.
The examples are similar, but there’s one main difference between them… with a partial renovation, the car might still get you from point A to B, albeit with some annoyance. But that partially updated property model simply won’t get you to market value.
Recent history tells us that real property values almost never stand still. In many markets, values broadly tanked beginning in 2008 until a slow climb back up began in about 2011.
But what if values did stand still, even as population, employment and credit availability fluctuated? That would only happen if there somehow was a fortuitous synergy of precisely offsetting economic and social events. Humans creating policy will never effect that scenario.
Real property values don’t stand still for long, and the fluctuations are not consistent or linear. Market changes impact different market segments in different ways: values for office and industrial product can increase while multifamily and retail decline… quickly, slowly, or erratically.
Keeping up with fluctuating property economics is a real challenge for assessors of commercial property. Don’t short change your market model. Maintenance of accurate values means watching local trends in:
- Tenant Improvements
- Overall Cap Rates
All of these elements (not just rents) must be sensitized to type, subtype, tenant design, size, quality, and location.
Since available sales are rarely sufficient for commercial stratification, income modeling is critical. If you craft your own models, they must reflect local reality from the start and be updated annually. This is the only way to stay current with changes in your market.