Valuation

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."

Nearly 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.

When 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.

Brokers 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.

Clients often 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 capitalization process.

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.

For 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.

The 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.

A regional 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.

Lessons Learned

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.

William C. Harvey II, CCIM, MAI

William C. Harvey II, CCIM, MAI, is principal of Harvey Realty Group, a full-service brokerage, and William C. Harvey & Associates, a commercial and residential appraisal and consulting company, both in Great Falls, Va. Contact him at 703.759.6644 or wharvey@ccim.net. Property Profiles Aid Unique Property Valuations A structured property profile often helps brokers get a handle on valuing unique properties. These profiles include property history, building and lot descriptions, location, area factors, and nearby businesses. Brokers can find such information through assessors, multiple listing service and off-market sales data, title company data, and regional appraisers, among other sources. The following charts illustrate how a property profile guided one broker through a historic tavern valuation. Property history: Built in 1900 as a railroad way station, this building was converted to a hospital in 1920. In 1940 it was turned into a tavern with a café on the expanded lower level. In 1960 the upper level was closed off and the stairs removed. Building description: The two-story building is red brick. The lower level is 5,000 square feet and the upper level is 2,500 sf. Lot description: The property comprises two 2,500-sf city lots. Location: The property is located on a main north/south arterial in the central railroad district. The east and west boundaries are two-lane, one-way streets. Area factors: The south corner border is a 50-space public parking lot, and the north corner border is an antique mall. The city's downtown redevelopment association is very active, and the economic development agency is well established. The area has a good local and tourist customer base. Nearby businesses: A grocery-anchored strip center that includes service retailers, six antique malls, and three upscale ethnic restaurants are nearby. Lot 1 $28,040 Lot 2 $28,040 Lot 1 $22,850 Lot 2 $22,850 Lot 1 $30,819 Lot 2 $30,819 Median lot value $27,236 Building $240,870 Building $296,899 Median building value $268,885 Total property value $296,121 Business value $60,000 Inventory $16,000 Audit Equipment and fixtures $24,525 Total business value $100,525 Subtotal value $396,676 Valuation adjustments: Deferred maintenance and rehab ($92,300) Loss of cash flow during rehab ($15,000) Improved cost of funds through economic development agency for buyer $21,484 New revenue from upper level $30,000 Final valuation $340,860 Property listing and sale price $350,000 by Randall Simonson, CCIM, owner of the Commercial Real Estate Co. in Medford, Ore. Contact him at 541.779.5021 or rsimonson@ccim.net

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