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A Commercial Appraisal Report

Guy J. Bourgeois, AACI, P.App., C.R.P.Brandon N. Lo, B.Comm., B.A.(Econ), AACI, P.App.Chris N. Kroker, B.Comm.Simon J.H. Chin, B.Comm.Brett L. Coley, B.Comm.Devin R. Palmer, B.Comm.David M.T. Lemm, B.A.Mark W. Poechman, B.Mgmt.

Introduction

• How is a commercial real estate appraisal report written?

• What should it contain?

• How should you read and interpret a commercial real estate appraisal report?

Letter of Transmittal

Summary of:• Subject Property• Appraisal Techniques• Estimates of Market Value• Correlation of Market Value

Summary of Salient FactsSummarizes:• Location• Legal Description• Brief Description of

Improvements• Land Use Criteria• Highest and Best Use• Estimate of Market

Value by Each Approach

• Purpose of the Appraisal:– What is the purpose and function of the Appraisal

Report?

Assumptions and Limiting Conditions

• Ordinary Assumptions:– Data Sources– Government Regulations– Normal Financing– Title is Marketable– Defects to an Improvement– Capacity of Soil– Encroachments

• Limiting Conditions– Liability to Non-intended Users– Value Valid on Effective Date Only– Responsibility for Factors Relating to Legal Matters,

Health Inspections, Zoning, Fire Bylaws– Reliance on Portion of Appraisal Report– Responsibility for Unauthorized Alterations to Report– Original Signatures– Cost Estimates Not Reliable for Insurance Purposes

Extraordinary Assumptions and Limiting Conditions

• Market Value is Not Applicable Unless Assumption is Applied

• Stated in All Pertinent Areas, In Particular Wherever the Estimate of Value is Stated in the Report

• For Example:– Market Value for a Proposed New Development “As

Though Complete”– Invalid Lease Agreement in Place

Scope of the Appraisal

• Type and Extent of Research Completed Within a Report

• Instructions Provided by Whom?• When the Property was Inspected• Research• Approaches Applied to Estimate Market Value

Economic Analysis

• Local Economy• Market Trends

Regional Analysis

• Demographics• Statistics• Municipal Policies

Neighbourhood Analysis

• Immediate Area• Is Neighbourhood New, Mature, or in Transition?• Traffic Counts• Public Transit• Shopping Centres• Accessibility

Property Analysis

• Address and Legal Description• Shape, Size, and Configuration of the Parcel• Topography• Designated Land Use Criteria• Services• Registered Land Title

Description of Improvements

• Type of Construction• Building Area• Net Leaseable Area• Building Age• Interior and Exterior Finishing• Effective Age and Remaining Economic Life• Site Improvements• Photographs

Property Tax & Land Use

• Assessment Levy and Property Taxes• Land Use Designation

Highest and Best Use

• Will Determine How the Market Value of the Property will be Analyzed

• Based on the Preceding Discussions of:– Regional Analysis– Neighbourhood Analysis– Site Analysis– Description of Improvements

• Value “As Improved” > Value “As Vacant” = H/B Use “As Improved”

• Value of Vacant Land > Value of the Improved Property = Alternative H/B Use

The Cost Approach

~The Principle of Substitution~“A prudent Buyer would pay no more for a property than the cost

to acquire a similar site and construct improvements of equivalent desirability and utility without delay.”

Cost Approach In a Nutshell

Total Value = Building New - Depreciation + Improvements + Land Value

Step One: Estimate Land Value

• Estimating Land Value, “As Though Vacant”– Looking at locational and physical characteristics of

subject site – land size, exposure, access, zoning, developability and overall utility.

– Research: BRADS, MLS, Listings, Discussion with Realtors, Private Sellers, etc.

Step Two: Estimating the Cost of the Building

• Reproduction vs. Replacement Cost– Reproduction – Exact Replica– Replacement – Similar Utility (*Most Commonly Used)

• Determine Building Characteristics – i.e. Construction type, quality of construction, interior and exterior finishing, ceiling height and special features such as crane systems, heavy flooring, geothermal systems/design, etc.

• Get Current Cost of Building– Marshall Valuation Service (MVS)– Cuthbert and Smith Cost Guide– Local Contractors

Step Three: Estimating Depreciation

• 3 Basis Types of Depreciation: – Physical Deterioration– Functional Obsolescence– External Obsolescence

Step Three: Estimating Depreciation

• Physical Deterioration - ‘Wear and Tear’ from regular use and the impact of the elements.

• Curable Physical Depreciation (Cost to Cure)• i.e. replacement of flooring, paint, damages on exterior

walls.

• Incurable Physical Depreciation• Age of building

– Method(s): MVS Chart, Straight-line, Experience

Step Three: Estimating Depreciation

• Functional Obsolescence - A flaw in the structure, materials or design/layout that hinders or diminishes the function, utility, rent and hence, value of the improvement.

• Curable Functional Obsolescence• i.e. addition/removal of a washroom facility, HVAC units,

loading bays, etc.

• Incurable Functional Obsolescence• i.e. building height, overall building configuration.

Step Three: Estimating Depreciation

• External Obsolescence – Loss in utility and hence, value caused by external factors.

Location of Real Estate is Fixed

• Typically Incurable, although can be temporary• i.e. gravel-pit next to an apartment building, over supplied market,

proximity to negative environmental factors – house adjacent to nuclear waste facility, absence of zoning and land use controls.

Step Four: Estimating Cost of Improvements

• These improvements include anything that adds value to the real estate but not included in the main building. – i.e. ‘Built-in’ crane systems, site improvements such as

landscaping, paving, compacting and gravel, fencing, etc.

How to Read the Cost Approach“What the Cost Approach Should Look Like”

How to Read a Cost Approach“What the Cost Approach Should Look Like”

How to Read a Cost Approach“What the Cost Approach Should Look Like”

How to Read a Cost Approach“What the Cost Approach Should Look Like”

• Recap:– Total Value = Building New –

Depreciation + Site Improvement + Land Value

– Value tend to support the higher end of the range.

– Most applicable:• New/proposed properties• ‘Special-use’ type properties• Limited comparable market

information

The Income Approach

“The theory of the Income Approach is that the value of the property is the present worth of all the net income

that it would produce during its remaining useful life. Net income serves as a measurement, which in turn, is

capitalized into a value estimate by the use of a proper rate taken from the experience of similar properties,

which have already sold, or from the state of the financial market at the time of the appraisal.”

Analysis of Existing Sources of Income

• This is the first step in establishing the ability of the property to generate income.

• If the property is an income producing entity and there are leases in place, an examination of the rent roll provides important information that is pertinent for analysis.

• Important characteristics of a rent roll include the date the lease was negotiated, term length and expiry.

• Triple net leases are the norm in today’s marketplace.

Sample Rent Roll

Market Rental Survey

• Encompasses the most current and comparable lease rate information available from competing developments.

• Establishes if there are identifiable shortages/overages in the rental income generated by the existing leases.

• Allows for a comparison to be made for the current experience for operating expenses.

Pro Forma Operating Statement

Direct Capitalization Technique

• The Direct Capitalization Technique is the mostly widely utilized method of capitalizing net income for appraisal purposes.

• The analysis is based on specific sales of similar property types where income information is available or alternatively via a general cap rate study that allows us to examine the relationship between the income being produced and the sale price achieved after marketing.

• Cap Rate = Net Operating IncomeSale Price

• Does not reflect a rate of return.

General Cap Rate StudyIndividual Sale

Cap Rate Analysis

Reconciling “Market Value” Utilizing the Direct Capitalization Method

• Cap rates vary by property within the same market sector and canvary within the same property.

• Increasing cap rates suggest declining property values and vise versa.

• “Market Value” = Net Operating IncomeCap Rate

Discounted Cash Flow Analysis (DCF)

• Incorporates a number of the elements utilized in completing the Income Approach through the Overall Capitalization Technique.

• Is best applied in valuing an income producing investment property where we can accurately forecast the revenue generated into the future.

• To forecast future revenues we apply a number of specific assumptions.

• Assumes that the property is sold at the end of the investment horizon, which is typically over a 10 year period.

Future Cash Flows

Prospective Present Value & Reversion

The Direct Comparison Approach

Steps in the Direct Comparison Approach

• Market Research• Comparative Analysis• Reconcile an Estimate of Value

This Approach Estimates Value Using Direct Market Evidence

Market Research

• Understand the Subject Property • Consider the General Market Data• Gather Sales Information Regarding Similar

Properties

Comparative Analysis

Establish method of Comparison• Price per Sq. Ft./Acre of Land (Gross or Net

Developable)• Price per Sq. Ft. of Building Area (Gross or Net

Leaseable)• Price per Suite• Price per Guest Room• Gross Income Multiplier (GIM)

Comparable Data Chart (Walk Up Apartments)

Comparable Data Chart (Industrial Property)

Elements of Comparison

• Property Rights, Financing, Conditions of Sale, Expenditures

• Time• Location• Physical Characteristics (Age, Condition, Size,

Construction, Site)• Economic Characteristics (Expense Ratios,

Leases, Management)• Use (Zoning)• Non Realty Components (Fixtures, Goodwill)

Quantitative vs. Qualitative Analysis

• Limited Comparability of Commercial Properties

Reconciliation by the Direct Comparison Approach

• Consider all Information Gathered• Correlate an Appropriate Value Range for the

Subject

Limitations

• Dependant on Market Activity• Special Use Properties

Reconciliation of Final Value

Reconciliation of Final Value

• Estimated Market Value by:– Cost Approach– Income Approach– Direct Comparison Approach

• Is the Subject Better Suited as a:– Special Use Property?– Investment Property?– Owner User Property?

• “Value in Use” vs. “Market Value”• Correlate Market Value in Accordance to Best

Approach Applicable

Research Department

BRADS

• Bourgeois Research And Data Systems– What Is It?– What Information Is Available?– Why Is It Important?– How Can It Help You?

What Is It?

• Database of ALL non-residential real estate sales within the capital region– Edmonton– Leduc– St. Albert– Sherwood Park– Fort Saskatchewan– Spruce Grove– Stony Plain

What Information Is Available?

• Address/Legal Description• Land and Building Descriptions• Income/Lease Information• Title Registrations• Pending Changes

Why Is It Important?

• Comparable Properties– Identifying The Factors That Affect Value

• Current Positive/Negative Property Characteristics• Future Possibilities Or Development

• Market Absorption Rates• Current/Future Income Expectations

How Can It Help You?

• Access To Information– Effective Decision Making– Help Your Clients More Effectively – Double Check Or Verify Information– You Now Have A Guy

Thank You

Questions?