defending a commercial assessment using the three...

WAAO Quarterly Meeting December 1, 2014

Defending a Commercial Assessment Using the Three Approaches to Value

Jim Siebers Steve Miner

Let’s Meet the Audience!

Show of hands:

• How many of you are employed by an Assessors Office?

• How long have you been in the appraisal industry? – 0-5 Years? 5-10 Years?

– 10-20 Years? 20+ Years?

• How comfortable are you with the Cost Approach? Income Approach? Market Approach?

– Very, Somewhat, Not at All

Key Takeaways from This Presentation

• This presentation is meant to be a high–level look at how to prepare a defense of a commercial property

• How to properly collect the data required for each approach to value and where to find it

• How to properly apply the three approaches to value

• How the information from the three approaches to value can be used to defend an assessment

Aerial photo of the progress through late September 2014 of the Watertown Plank Road Interchange.

Credit DOT

The Property: 10001 Innovation Drive Milwaukee County, WI

Geographic Information Systems (GIS)

Use to Verify Parking Lot Size

Aerial Sketch

Sketch Created Using APEX

Sales Comparison Approach

In the sales comparison approach, an opinion of value of market value is developed by comparing properties similar to the subject property that have recently sold, are listed for sale, or are under contract (i.e. for which purchase offers and a deposit have been recently submitted)1.

Source: The Appraisal of Real Estate, 13th edition, page 297

Sales Comparison Approach

Definition: The process of deriving a value indication for a subject property by comparing similar properties that have recently sold with the property being appraised, identifying appropriate units of comparison, and making adjustments to the sales prices (or unit prices, as appropriate) of the comparable properties based on relevant, market-derived elements of comparison.


Information Sources

• Property Appraisal and Assessment Administration, IAAO

• The Appraisal of Real Estate, 13th Edition, The Appraisal Institute

• Wisconsin Property Assessment Manual, DOR

• Loopnet

• Xceligent

• Other Assessor’s offices

Sales Comparison Approach – Key Points

• State constitutions, statutes, and case law define market value standards for assessments

• In the absence of a sale of the subject, sales prices of comparable properties are usually considered the best evidence of market value

• Comparable properties are selected for similarity to the subject

• Sales prices are adjusted and the market value is estimated

Source: Property Assessment & Administration, IAAO, Page 153

Relation to Appraisal Principles

1) Supply and Demand

2) Substitution

3) Balance

4) Externalities

5) Market Analysis and Highest and Best Use

Required Steps – per PAAA

• Definition of the appraisal problem

• Data collection

• Analysis of the market to develop units of comparison and select attributes for adjustment (model specification)

• Development of reasonable adjustments (model calibration)

• Application of the model to adjust the sales prices of comparables to the subject property

• Analysis of the adjusted sales prices to estimate the value of the subject property

Source: Property Assessment & Administration, IAAO, Page 153

Required Steps – Per The Appr of RE 13th Ed.

• Research the competitive market

• Verify the information

• Select the most relevant units of comparison

• Look for differences between comparable sale properties and the subject property

• Reconcile the various value indicators

Sales Comparison Approach – How Used

The sales comparison approach may be used to value:

1) improved properties

2) vacant land or

3) land being considered as though vacant when an adequate supply of comparable sales is available


Data Sources for Sales Data

• Public Records

• Commercially available data from electronic reporting, multiple listing and subscription services

• Published news articles in local newspapers or real estate periodicals

• Interviews with market participants


Recommended Adjustments

• Qualitative vs. Quantitative Adjustments

• Transactional vs. Property Adjustments

• Transactional, Physical & Economic Adjustments – per Wisc DOR

Adjustment Examples

• Real property rights conveyed, financing terms, conditions of sale

• Expenditures made immediately after purchase

• Market conditions

• Location

• Physical characteristics

• Economic characteristics

• Use

• Non realty


Example of Comparable Grid

04/30/2014 02/01/2014 10/18/2013

Comparable Grid (continued)

Indicated Value by Comparable Sales Approach

Comparable Sales Valuation $6,152,600 $1,631,600 $4,521,000 Total Land Building

Reconciliation of Value by the Comparable Sales Approach

After adjustments have been made:

• Weigh each comparable to determine its relative contribution to the final value estimate

• Determine sales comparison value


The Income Capitalization Approach

In the income capitalization approach, an appraiser analyzes a property’s capacity to generate future benefits and capitalizes the income into an indication of present value.


So everyone wants to know: What is the “Magic Formula” for performing an Income Approach?

This segment of the class will teach you what it is.

For those that are too impatient to wait,

I will give it to you now.

But, it is like reading the last chapter of a book

before you know what exactly happened

to get you to this point.

Take PGI and subtract V&C Losses

and add miscellaneous income

to get to EGI.

Then take EGI subtract expenses

to get to NOI.

If you use IRV where NOI is I and divide that by R you will get V.

Or, if the previous formula was

too complicated …

Take Rent and multiply it by the GRM

to get V that way…

So what does this all mean?

I invite you to pay attention

to the next section.

Reference Materials from: The New York State Board of Equalization & Assessment, now known as The New York State Department of Taxation & Finance.

29

Income Approach

Direct Capitalization:

The conversion of anticipated net income into present value by dividing the income of an appropriate rate which reflects the prevailing relationship of net income to selling price for comparable properties being sold in the open market.

The Basis for the Income Approach

31

Types of Rent

• Historical Rent: Rent paid in past years

• Contract Rent: Rent presently paid by agreement between the user (tenant) and the owner

• Economic Rent: The rent which a property should command on the open market at any given time

33

Information Sources - Income

• Newspaper-Business Journal, Ads in local paper

• Owners / Tenants

• Income/Expense Statements

• Sales Surveys-buyers/sellers

• Revaluation Surveys

• Appraisals

• Appeals

• Internet (craigslist)

34

Types of Income

• Potential Gross Income (PGI)

• Effective Gross Income (EGI) EGI = PGI – (Vacancy + Collection Loss)

• Miscellaneous Income

• Net Operating Income (NOI) NOI = EGI - Expenses

35

Potential Gross Income (PGI)

A property’s economic rent at 100% occupancy

36

Effective Gross Income (EGI)

The economic rent of gross income reduced by normal vacancies and uncollectable rents, plus other miscellaneous (service) income.

37

Miscellaneous Income (Services)

• Parking Fees

• Laundry Room Income

• Vending Machine Receipts

• Late Fees

38

Sources of Income Information • The owner

• The property manager

• The real estate agent-M.L.S.

• Craigslist / Ads in the paper

• Tenants

• Personal property returns

• Income/expense surveys

• Internet web sites

• Appeals

• Appraisals

39

Operating Expenses

• All expenses necessary to maintain the production of income to operate a property; the difference between Effective Gross Income and Net Operating Income.

• Also used to denote a category of expenses that doesn’t include fixed expense such as debt service, depreciation allowance and reserves for replacements.

40

Information Sources - Expenses

• Assessors • Appraisers and Appraisals • Appeals • Brokers • Dept. of Development • Lending Institutions • Industry & Trade Association Publications • Sales Surveys-Buyers & Sellers • Revaluation Surveys

41

Information Sources - Income and Expense

• Loopnet / Internet Sources

• Multiple Listing Service

• Xceligent/CoStar

• Appraisal Institute/Appraisers

• Commercial Brokers

• IREM (Institute of Real Estate Managers)

• BOMA (Building Owners Management Association)

Statute 70.47 (7)(af)

43

Proper Operating Expenses

• Heat/Utilities

• General Maintenance

• Insurance

• Trash Collection

• Hardware & Supplies

• Snow Removal

• Advertising

• Salaries

• Exterior Repairs

• Landscape Maintenance

• Legal & Accounting

• Exterminating

• Management

• Supplies

44

Improper Operating Expenses

• Debt Service

• Owner’s Business Expense

• Income Taxes

• Additions to Buildings

• Depreciation

• Extraordinary Expenses

Operating Expenses to Watch

These operating expenses need to be treated differently than the previous allowable expenses.

• Reserve for Replacements

• Property Taxes

46

Reserves for Replacements

A Provision for recapturing future depreciation by making an allowance in the annual operating statement to provide for the replacement of shorter lived items necessary in order to sustain a projected level of income (e.g. Roof replacement, refrigerators, carpeting, furnaces, air conditioning units).

Property Taxes

• Assessors, unlike most owners, should not consider real estate taxes to be allowable expenses and do not usually subtract from the NOI, even though taxes are a valid charge against the property.

• The assessor or appraiser working with an assessor should instead account for property tax expense by including a percentage for property taxes in the capitalization rate.

48

Net Operating Income (NOI)

Annual net income after operating expenses are subtracted from effective gross income. Does not include payments for principal or interest.

N O I

49

Tips for Accurate Income/Expense Statements

• Get last three years statements

• Watch reserves for replacements when including in expenses

• Check that capital expenditures are not included in expenses

• Ask for an itemized list of expenses in generic categories such as general maintenance

50

Capitalization Rate

Any rate used to capitalize income. It reflects the relationship between income and value. It is calculated by the IRV formula, in which:

• Rate = Income / Value

• Value = Income/Rate

• Income = Rate/Value

Types include: • Overall Cap rate • Summation-

mortgage equity

51

Information Sources - Cap Rates

• Your or other Assessor’s Databases (the market)

• Appraisers/Appraisals

• Appraisal Institute - National Market Indicators

• Price Waterhouse Coopers Korpacz –

Real Estate Investor Survey

• Insurance Companies

• Bank/Lending Institutions

• Brokers- CARW

52

Industry Trade Associations & Publications • Natl. Assoc. of Industrial & Office Prop.(naiop.org)

• International Association of Assessing Officers

• Urban Land Institute (uli.org)

• Building Owners & Managers Assoc. (boma.org)

• Institute of Real Estate Management (irem.org)

• International Council of Shopping Centers (icsc.org)

• Society of Industrial & Office Realtors (sior.com)

• Appraisal Institute

Search Tips

Keep Digging!

58

IRV

• Income: Either Gross, Effective Gross, or Net Operating Income (NOI)

• Rate: Either Gross Income Multiplier (GIM) or Capitalization Rate

• Value: Market Value

I

R V

Income Valuation $6,189,000 $1,631,600 $4,557,400 Total Land Building

63

Sale/Lease Internet Sites

• www.loopnet.com

• www.carw.com

• www.mlswis.com

http://www.loopnet.com/

http://www.carw.com/

http://www.mlswis.com/

64

Key Economic Indicators & Industry Links to Real Estate

• John Lohre www.JWLohreLLC.com • Pension Real Estate Association – Links to many major real estate associations

• www.prea.org • Bloomberg Investments

• www.bloomberg.com • Bond Rates, Key Economic Indicators

• www.smartmoney.com

http://www.jwlohrellc.com/

http://www.smartmoney.com/

Miscellaneous Tips • Know your Industry/Market

– What vacancy & collection loss are you using?

– What expense rates are you using?

– Is Property management a necessary expense?

• Being Uniform doesn’t mean being the same

• Develop Your Contacts-i.e. appraisers, banks, other assessors, brokers

• Does your sales-validation process include inspections?

• Commercial neighborhoods not always bounded geographically

• Work smarter not just harder - get involved

67

Commercial Lease Terms Defined

• Full Service Gross: (Owner) pays all operating expenses including janitorial

• Gross Lease: The landlord (owner) pays all operating expenses except janitorial

• Modified Gross Lease: Same as above with a tax stop clause for example

• Net Lease: The tenant (lessee) pays all taxes, insurance, and operating expenses (longer term)

• Percentage Lease: Usually a fixed minimum rent plus a % rent based on gross sales in excess of a certain amount

Space Measurements

• Gross Area: Measured from outside wall to outside wall.

• Usable Area (Leasable Space): Area occupied exclusively for individual tenants. Public area like restrooms and lobbies are excluded

• Rentable Area: Includes usable area plus restrooms, lobbies, public corridors and utility closets but excludes stairs, elevators & air shafts.

• Load Factor: Rentable Area/Usable Area

69

Gross Income Multipliers (GIM) - Outline

• Defined

• Assumptions

• Benefits

• Limitations

• Converting GIM’s Into Income Approach & Vice Versa

70

Gross Income Multiplier Defined

• The relationship (ratio) between sales price (value) and either Potential Gross Income or Effective Gross Income in income producing properties. It is used to estimate value as a multiple of annual gross income

• These relationships are not to be intermingled i.e. consistency in the method of computing

71

Gross Income Multiplier Assumptions

• Highest & Best Use of the property will not change over the remaining economic life

• Property will remain rented at a constant rate with no unusual vacancy factor

• Comparable market influences

• Competitive with one another

• Have similar operating expenses & utility.

• Need a sufficient amount of sales and rental data on the same property type

72

Gross Income Multiplier Benefits

• Relatively easy to use

– Divide sale price by annual income

• Works well in an area of homogeneous properties

• Provides easy to analyze benchmarks

73

Does not allow for:

• Abnormal physical deterioration

• Unusual operating expenses

• Significant differences in age & zoning

• Makes no adjustments for land area and time

Gross Income Multiplier Limitations

74

Valuing using GIM’s

• Market Rent

• Market GIM

• Market Value

Cost Approach

In the cost approach, a property is valued based on a comparison with the cost to build a new or substitute property. The cost estimate is adjusted for the depreciation evident in the existing property.


Cost Approach

Definition: A set of procedures through which a value indication is derived for the fee simple interest in a property by estimating the current cost to construct a reproduction of (or replacement for) the existing structure, including an entrepreneurial incentive; deducting depreciation from the total cost; and adding the estimated land value. Adjustments may then be made to the indicated fee simple value of the subject property to reflect the value of the property interest being appraised.


Cost Service Tools

Cost Methodologies

Calculator “Square Foot Method” • Average square meter, square foot and cubic foot costs

for typical buildings. • Costs are classified by class and quality of construction.

Segregated Cost Method • Separate consideration to all of the major construction

assemblies or systems (groups of components) of a building

• Vary the quality level for individual components

What the Costs Contain

Calculator “Square Foot Method”

• Final Cost to the owner from the general contractor

• Represents completely finished buildings in the physical or hard construction sense, but not necessarily completely finished projects

• All material and labor costs include all appropriate local, state and federal sales or GST taxes, etc.

How is data collected?

Marshall & Swift

• Monitors the factors that drive the cost of construction and tracks actual building component

• Gathers wage rates from all major labor trades and studies crew sizes and productivity rates for the personnel necessary for the installation of components.

• We collect specific costs for labor, materials and installed components, establishing the “Building by Component” and “Building by Example” methods of estimating.

Who uses it?

•

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Determining Occupancy

Office buildings are buildings designed for general commercial occupancy, including administrative government and corporate uses, and are normally subdivided into relatively small units.

Determining Building Class

Class C buildings are characterized by masonry or reinforced concrete (including tilt-up) construction. The walls may be load-bearing, i.e., supporting roof and upper floor loads, or non-bearing with open concrete, steel, or wood columns, bents or arches supporting the load.

Determining Quality

• First, to judge quality, it is suggested that the cheapness or expensiveness of materials or components be observed.

• Second, see if workmanship is at a level normal to the type and grade of material used.

• Third, and most important, the user should consider the amount of the various components typical for its class.

Determining Quality con’t

• Observe cheapness or expensiveness of materials


• See if workmanship is at a level normal to the type and grade of material used.


User should consider the amount of the various components typical for its class.

• Look for more than the average number of windows, doors and plumbing fixtures

• An asphalt cover on a hip roof with large overhangs may be average, however the extra quantity causes the building to have above average cost.

• Overall size and complexity of the structure should be considered. Small structures will tend to have higher unit costs than very large ones.

Selecting Initial Cost

• Define your class of construction followed by quality. Use descriptions to best identify ingredients used in your structure.

Refinements

• These adjustments influence costs to a greater degree than other components.

Refinements con’t

• Current Cost Multiplier adjusts for time

• Local Cost Multiplier adjusts for local labor and materials.

Depreciation

• Select the correct Life expectancy followed by the effective Age to determine Physical depreciation of structure

Simple Calculator Report

• Basic entries used to generate cost report

Detailed Segregated Cost Report • Detailed entries used to generate cost report

Cost Valuation $6,781,400 $1,631,600 $5,149,800 Total Land Building

Final Reconciliation of Values

Reexamine the entire appraisal process to confirm:

• Consistent application of the approaches applies (comparables used and adjustments calculated)

• The highest & best use conclusions upon which each approach is based

• The defined value estimated in each approach

• The real property interests being appraised

Final Reconciliation of Values

• Appraisal judgment and proper application of appraisal techniques are critical in final reconciliation

• The appraiser uses reconciliation criteria to form a meaningful, defensible, and credible final value conclusion. The appropriateness of the approaches, the accuracy of the data and calculations, and the quantity of sufficiency of the evidence presented are considered relative to the specific appraisal problem.

Reconciliation Criteria

• Reexamine appraisal for accuracy, consistency and logic

• Appraiser relies on professional experience and judgment

• Appraiser weighs the relative significance, applicability and defensibility of each value indication

• Relies most heavily on most appropriate approach

Reconciliation Criteria - continued

Reconciliation requires:

• Appraisal judgment

• Careful, logical analysis of procedures that lead to each valuation indication

• Appropriateness, accuracy and quantity of evidence are the criteria with which an appraiser forms a meaningful, defensible final opinion of value.

Final Defense of Value

• All approaches can be explained to Board, Court etc. after reconciliation

– Preparing the reconciliation will be helpful when summarizing the case

• All three approaches may or may not point to the same value conclusion

– If they do not, the appraiser should explain why and present additional evidence if applicable

Comparable Sales Valuation $6,152,600 $1,631,600 $4,521,000 Total Land Building

Income Valuation $6,189,000 $1,631,600 $4,557,400 Total Land Building

Cost Valuation $6,781,400 $1,631,600 $5,149,800 Total Land Building

Value Conclusion

1/1/14 Value

Board of Review

• If you have “open book” keep it open as long as possible

• Talk to Other Assessors during preparation

• 70.47 (7) (af) Use it to your advantage

• Prepare each case as if you’re going to Circuit Court

• Markarian Hierarchy - Wisconsin

• Go with confidence - you usually have better information than the objector

Contact Information – Jim Siebers

• [email protected]

• (262) 780-3212

• Former Assessor – 30 years of experience

• Marshall & Swift Product Manager – 2 years experience

Contact Information – Steve Miner

• [email protected]

• (414) 286-3103

• City of Milwaukee Chief Assessor

• 22 years assessment experience

Thanks for participating!

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