Is The Price Right?
Learning how appraisers value unique properties helps brokers better advise their clients.
A broker's client asks him to evaluate a
real estate asset. After looking up the property's assessment records,
the broker discovers that it's a one-of-a-kind, special-purpose
property. He suddenly wishes he had more time to prepare, as he
realizes he doesn't know how to value the property, much less what
value to recommend.
This broker is not alone in his
quandary. Unique properties such as airports, hospitals, and ski
resorts that have no direct comparables and often contain a business
element present interesting challenges to most commercial real estate
professionals. An appraiser's expertise is necessary to develop the
most-accurate market value, but brokers should understand how such
properties are valued to better serve their clients.
What Is a Special-Purpose Property?
The Appraisal Institute defines a special-purpose property as "a
limited-market property with a unique physical design, special
construction materials, or a layout that restricts its utility to the
use for which it was built."
all special-purpose property appraisals are challenging due to the
diversity of property types and the wide variations in market
characteristics. Before beginning an analysis, brokers and their
clients, with an appraiser's help, must make a series of important
decisions: They must agree on the function of the appraisal's intended
use, select the appropriate value definition, and identify the
special-purpose property type. These preliminary decisions provide a
framework for subsequent market research and analysis. Made correctly,
they lead to a supportable value estimate. Made incorrectly, no amount
of research or analysis likely will lead to an accurate value estimate.
Special-purpose properties such as large manufacturing
plants, railroad sidings, and research and development laboratories
have limited market appeal, typically attracting few potential buyers.
Such properties often are appraised based on their current use or the
likeliest alternate use. If a property's current use is so specialized
that no demonstrable market exists, but it remains a viable use, an
appraiser might recommend a use value if the assignment reasonably
permits a type of value other than market value.
practitioners value unique properties the market rarely provides enough
data to develop the usual value approaches of cost, income
capitalization, and sales comparison. Therefore, the scope-of-work
decision becomes more critical in these situations. The scope of work
is the amount and type of information researched and the analysis
applied in a valuation assignment. Scope of work includes, but is not
limited to, the following elements:
- the degree to which the property is inspected or identified;
- the extent of research into physical factors that could affect the property;
- the extent of data research; and
- the type and extent of analysis applied to arrive at opinions or conclusions.
Complying With Professional Standards
When confronted with a complex valuation assignment, brokers should
disclose their need for assistance to their client and enlist an
appraiser's help. Brokers also can gain the requisite competency
through personal study.
involved in unique property valuations should refer to the Uniform
Standards of Professional Appraisal Practice, which addresses some of
the most critical aspects of an appraisal problem, such as the defined
value the client seeks, the appraisal's intended use, and the scope of
work the project requires. Appraisal practitioners should stay abreast
of changes to USPAP's rules and standards, as the current edition
contains advisory opinions that illustrate appraisal standards'
applicability in specific situations.
have supplemental standards in addition to USPAP's minimum standards.
Government and financial institutions have requirements that can affect
a valuation's development and reporting. Brokers must be aware of such
applicable standards to ensure that the appraisers they enlist fully
comply with such requirements before commencing work.
Case Studies Involving Unique Properties
Unique property valuation assignments are complex and require both
diligent effort and creative thinking. The following three case studies
illustrate how appraisers tackle such assignments.
Private Toll Road. A
dispute over ad valorem taxes required the valuation of a
limited-access, private 14-mile toll road known as the Dulles Greenway,
which is situated between Washington, D.C.'s Dulles International
Airport and the area's outer suburbs. Compounding the appraisal
problem, the owner's certificate of authority expired in 35 years, and,
after having experienced an initial period of underutilization, the
road was undergoing enlargement and expansion on the appraisal's
effective date. Thus, the anticipated income stream was both finite in
duration and variable over the remaining term, which complicated the
The owner wanted to use the
income capitalization approach to obtain a limited appraisal; however,
a jurisdictional exception that is unique to Virginia law prohibits
using the yield capitalization technique, otherwise known as discounted
cash flow analysis.
The appraiser instead developed an
income model using direct capitalization based on an overall rate. He
compared the 35-year projection period's anticipated revenue stream to
a variable annuity due to the lack of a reversionary interest. To
determine the overall rate, the appraiser converted the variable income
stream into an equivalent annuity along with a tax load that reflected
the local millage tax rate. To obtain the fair market value of the
owner's conditional fee property rights, he then applied the overall
rate to the estimated net operating income and deducted the present
value of future capital expenditures for the road's enlargement and
expansion from the value indication.
Regional Airport Fixed Base Operations Agreement.
While intangible assets typically function as part of ongoing business
enterprises, many are bought, sold, and licensed as independent
properties because they generate income. Such was the case with the
following intangible property valuation.
confirmation of his reorganization plan, a debtor under Chapter 11
bankruptcy protection required the valuation of a sandwich leasehold
interest in a fixed base operation, or FBO, franchise agreement at a
regional airport. The FBO's privileges included exclusive use of a
10-acre tract improved with a 15,000-square-foot hangar to sell
aviation fuel, rent hangar space and tie-downs, and perform aircraft
maintenance. The assignment's potential gross income comprised contract
rental payments and a 20-year sublease deed. Expenses were limited to
the underlying real estate's taxes.
To solve this
valuation puzzle, the appraiser developed an income capitalization
approach using a yield capitalization technique (discounted cash flow
analysis). Perhaps the most critical element of the income model was
the selection of the yield (discount) rate. Taking into account the
investment risk in light of the property's characteristics and history,
alternative yields for investments with comparable characteristics, and
the use of a monthly convention, the appraiser selected an 18 percent
equity yield rate. When the concluded value was presented at trial, the
court confirmed the reorganization plan.
Fiber-Optic Cable License.
A regional park authority wanted to determine the value of a proposed
24-mile fiber-optic cable license agreement prior to offering it for
rent. A prospective tenant desired the cable license as part of a
national fiber-optic buildout.
The appraiser performed
a market study to determine market conditions and compensation levels
applicable to the identified telecommunications submarket. The study
found that the window of opportunity for private partners to gain
access to highway or other public property was limited; if the window
closed before a partnership was established, public agencies likely
would have to wait until market expansion or industry restructuring
generated new demand for linear rights of way.
appraiser developed a comparative approach, which is based on the
principle that when several similar or commensurate commodities, goods,
or services are available, the one with the lowest price attracts the
greatest demand and widest distribution.
data search revealed several fiber-optic license agreements in
existence, and the appraiser identified the rent per linear foot as the
most pertinent comparison unit. He then analyzed other comparison
elements in the agreements including real property rights conveyed,
financing terms, rent conditions, market conditions, location, and
physical and economic characteristics. He was particularly interested
in the various agreements' escalation terms and the fiber count
capacity that each allowed.
The appraiser conveyed his
concluded estimate of market rent and terms for a 20-year license
agreement to the client along with a sense of urgency that the window
of opportunity was closing. Unfortunately, protracted negotiations
ensued, and the anticipated transaction was never completed.
Valuing unique properties is challenging even for experienced
practitioners. Such assignments' complexities go far beyond the typical
skill set required to solve most traditional valuation problems.
Successfully developing such valuations requires a proper orientation
to all applicable professional standards, especially competency in
performing the scope of work that is necessary in light of the
appraisal's purpose and use.