SAMPLE CASE STUDY. Big Smoke Office Building

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1 SAMPLE CASE STUDY Big Smoke Office Building PURPOSE: Find the current market value of the subject property DATE OF APPRAISAL: February 1, 013 GENERAL OBJECTIVES 1. To introduce the types of leases and tenancies which would commonly be found in a office building.. To introduce the various types of revenue and expense items which have to be accounted for in this type of property. 3. To introduce the concept of market renting premises in an office building. 4. To review the direct comparison approach. 5. To review the method of deriving a capitalization rate from comparable data. SPECIFIC INSTRUCTIONS 1. Using two units of comparison, prepare the direct comparison approach.. Prepare the income approach, using the direct capitalization method. 3. Reconcile the two above-noted approaches into a final estimate of value and discuss your conclusions. SUMMARY OF SALIENT FACTS Property Identification Municipal Address: Location: 154 Townsend Street Big Smoke, Ontario Northeast corner of Townsend Street and Thorne Street, two blocks north of the original downtown core Site Description Legal Description: Configuration: Area: Zoning: Official Plan: Topography: Services: Highest and Best Use: Lots 1 and Plan 54R-1554 and part of lots 1 and, south of Colborne Street, Plan 614, City of Big Smoke Irregular 3.38 acres (1.37 hectares) CBDC - Central Business District Commercial Zone City Centre At grade with surrounding streets and properties Full municipal services Continuation of existing use 1.1

2 Building Description General Description: A six-storey office building, with main floor retail uses Gross Floor Area: 108,768 sq.ft. (10,104.9 m ) Net Rentable Area: 94,581 sq.ft. (8,786.9 m ) Date Completed: 1996 Building Classification: Class B (Note: Office buildings are often categorized by class, with newer buildings classed as "A" and older or less well located as "B" and "C"). Characteristics Of The Macro Market Big Smoke is an industrial city located about 100 km west of Toronto. The current population of the City of Big Smoke is approximately 84,000. The main local employment source for the population is in manufacturing (43%). The recent construction of a 900,000 sq.ft. (83,613.1 m ) automobile assembly plant which will ultimately employ about 900 persons, has given a significant boost to the manufacturing sector of Big Smoke. While residents of Big Smoke are primarily employed locally, high housing prices in Toronto, have encouraged people working in the Greater Toronto Metropolitan area to live in Big Smoke. Characteristics Of The Micro Market The subject property is located on the northerly fringe of downtown Big Smoke, about two blocks north of the original business district (Main Street). It is located in the main financial core of the city, and is one of the prominent office developments in the area. No new major office developments are proposed for Big Smoke's City Centre at the present time. The only proposed developments are for residential (condominium) use on two large sites, a short distance to the east of the subject property. The location of the subject property in Big Smoke would, by virtue of the size of the community, render the property of interest to only local or regional investors, and therefore not to national and international investors. Physical And Functional Characteristics The Building The subject property is a six-storey, mixed-use building, containing a single level underground parkade as well as a surface parking lot, the latter being located directly east of the building. The grade level of the building has a large footprint, containing a gross area of about 3,958 sq.ft (,5.78 m ). The majority of the ground floor space, 18,306 sq.ft. (1, m ) is leased to retail tenants, while the balance of the space consists of the building's lobby. Each of the five office floors above the main floor has a gross floor area of about 16,96 sq.ft. (1, m ), for a total of 84,810 sq.ft. (7, m ) and have a net rentable area as presently leased and subdivided of 76,75 sq.ft. (7,086.1 m ). The below grade level parking garage provides 31 parking spaces. The surface parkade provides 40 spaces. 1.

3 Construction Details Foundation: Exterior Walls: Roof: Floors: Windows: HVAC Office Tower: Main Floor: Elevators: Lighting: Plumbing: Fire Protection: Interior Finishes Main Floor: Office Areas: Loading Facilities: Yard Improvements: Condition and Utility: Reinforced concrete foundation. Concrete block and steel frame, clad with brick veneer. Flat built-up roof with tar and gravel finish. Reinforced concrete. Aluminum framed double glazed (thermopane) windows. Heating - 3 1,666,000 BTU/hr gas-fired hot water boilers. Air-conditioning ton "Carrier" compressors with a single chiller tower. Individual roof-mounted HVAC units serving each of the main floor tenants. Two 19 person/3,000 lb capacity elevators serving all floors including the underground parkade. Recessed fluorescent lighting in the office areas, pot lighting in the lobbies. Men's and women's washrooms and drinking fountains are located on all floors. Sprinklers on main floor only. There is a fire alarm and emergency lighting back-up system. Public areas have quarry tile floors, stippled plaster ceilings, indirect perimeter fluorescent lighting, recessed incandescent pot lights, and 4 feet 1 feet (1. metres 3.66 metres) square skylights. Lay in acoustic tile ceilings with recessed fluorescent lighting. Perimeter of demising walls have textured wallpaper. Individual tenant finishes vary. A single loading dock, equipped with a leveller, served by a depressed ramp running off of Thorne Street. Granite pavers and planters. A recent inspection did not reveal any structural, mechanical, or design features which would have any adverse affect upon the value of the property. The building was observed to be in an excellent state of repair, considering its age. Revenue And Expense Analysis Occupancy Status The ground floor of the subject property is currently leased to four retail/commercial tenants (Refer to the floor plan). The details of each tenants' lease is summarized on the rent roll which is found in Table 1. In addition, there is also one vacant unit containing 1,544 sq.ft. ( m ) of leasable area. This space became available three months ago, when the former beauty salon's lease expired and was not renewed. The five office floors are presently 90% leased to two tenants, namely, a division of the local government, and The Big Smoke Insurance Company. One unit on the sixth floor, containing 7,68 sq.ft. ( m ) is currently vacant. This space has been vacant for two months, and became available when the Big Smoke Insurance Company renewed its lease but chose to downsize by 7,68 sq.ft. ( m ). Leasing Policy The landlord's current leasing policy is to write all new leases on a net absolute basis, where the tenant pays basic minimum rent plus its proportionate share of operating costs and taxes. Operating costs include a 15% administration fee prior to being recharged to the tenants. The exception to the net lease format, is the occupancy agreement pertaining to the Government's leased premises. This tenant has a semi-gross lease, where the landlord is responsible for the operating costs and taxes 1.3

4 associated with the 009 base year. Operating costs in 009 amounted to $.50 per square foot and taxes were $3.5 per square foot. All of the retail tenants and the Government have options to renew, where the renewal rent is to be negotiated, but based on the fair market rental value for the premises at the time of renewal. RETAIL FLOOR PLAN 1.4

5 Table 1: Rent Roll Unit Lease Lease Duration Option To Basic Rent Market Rent Tenant Name Area Posr. Code No Term Start End Renew Unit P.A. Unit P.A. 1 Donuts R Us Café ,18 1 6, CN Munchies Variety Store , , CN 3 Vacant NIL 1,544 N/A N/A ,79 CN 4 Bon Voyage Travel , ,00 CN Travel ,400 Company ,600 5 Dollars & Cents Trust , ,576 CN Company 00 Government , ,800 OG General Office , Government , ,800 OG General Office , Government , ,800 OG General Office , Big Smoke Insurance NIL 15, ,440 ON General Office , Big Smoke Insurance NIL 5, ,70 ON General Office , Vacant NIL 7,68 N/A N/A ,80 ON CRU SPACE OFFICE SPACE TOTAL SPACE 18,306 sq. ft. 76,75 sq. ft. 94,581 sq. ft. OG - Office/Semi-Gross Lease CN - Commercial Net Lease ON - Office Net Lease - Rent To Be Negotiated POSR - % of Sales Rate Vacancy The current vacancy rate as a percentage of NRA is 10%. The long-term average annual vacancy rate for Big Smoke is estimated to be 5% of total potential revenue. Current Rent Levels The main floor retail tenants are presently paying rents of $15 to $ per square foot, as shown on the rent roll. With respect to the office tenants, rents range from $8 to $10 per square foot. The real estate market is currently in a depressed state. Therefore, the office and retail markets are a "tenants" market since the demand for both these types of space is currently somewhat soft. However, the subject property has fared fairly well in that it 1.5

6 only has one vacant retail unit and one vacant office unit, amounting to about 10% of the total rentable space in the building. With respect to retail rents, it is noted that market rents for this type of space are usually best determined by an analysis of the rents within the building itself. If recent leases have been negotiated in the subject property, these are the best indication of market rents since retail space tends to have value-influencing characteristics which are unique to the property itself. Based on the two most recent retail leases in the subject property, the market rent of the vacant unit is estimated to be $18 per square foot. Market rents for office space are also best determined with recent lease transactions in the building itself. However, office rents tend to be very competitive from one building to the next, and as such market rents should be estimated by taking lease transactions in other buildings into consideration as well. Table shows the results of a survey undertaken in those buildings deemed to be most competitive to the subject property. Table : Office Rent Survey BUILDING GRA Age VACANT SPACE ASKING RENT NAME sq.ft. % $ Term Ranking City Centre 74, ,130 15% $ B+ Trump Tower 117, ,000 40% $ A CN Tower 5, ,700 11% $ B Payton Place 45, ,700 6% $ B Royal Plaza 93, ,500 % $ A The Trump Tower is the newest office development in Big Smoke, but leasing has been slow. The asking rent is artificially high. The asking rents in the CN Tower and Payton Place are reportedly close to recently achieved rates. The City Centre and Royal Plaza are among the best buildings in town, but have recently suffered from increasing amounts of vacant space. The most recent lease in the subject property pertains to Big Smoke Insurance. As of December, 01 this tenant pays $8.00 per square foot on 15,680 sq.ft. and $10.00 per square foot for 5,97 sq.ft. The competitive buildings which are most comparable (CN Tower and Payton Place) indicate rents of $10.00 per square foot and $10.50 per square foot. As a result, a market rent of $10 per square foot is considered appropriate for unit 610 which contains 7,65 sq.ft. Percentage Rent Two of the main floor, retail tenants are required to pay percentage rent in addition to basic rent and their proportionate share of CAM and taxes. Percentage rent for these tenants is calculated as shown in Table

7 Table 3: Percentage Rent Calculations Donuts R Us 010 Actual 011 Actual 01 Actual 013 Projected Retail Sales $1,068,715 $1,091,36 $1,039,693 $1,060,000 Breakthrough Volume $1,043,600 $1,043,600 $1,043,600 $1,043,600 Overage Rent $5,115 $47,76 0 $16,400 6% POSR= % Rent $1,506 $,866 0 $984 Munchies Retail Sales N/A $36,408 $543,606 $500,000 Breakthrough Volume N/A $434,880 $65,30 $65,30 Overage N/A % POSR N/A * The breakthrough volume in each case is the annual rental divided by the percentage of sales rate. (POSR) Recovery Income The occupancy costs which are rechargeable to the tenants according to the terms and conditions of their respective leases are common area operating costs (CAOCs) and realty taxes. As previously noted, the CAOCs are subject to a 15% administration fee (included in the rates), which is a standard practice for buildings such as the subject property. In the current operating and fiscal year, common area operating costs are being billed on the basis of $3.10 per square foot with respect to the office tenants and $4.30 per square foot in respect of the retail tenants. In terms of realty taxes, each tenant is separately assessed, and pays accordingly; the average tax billing is about $3.30 per square foot. The relatively low level of CAOCs is considered to be quite a benefit to the competitive position of the subject property. Other buildings are quoting CAOC costs as high as $5.00 per square foot. Parking Revenue All underground parking spaces are leased to tenants of the building on a reserved, non-allocated basis. Of the 31 spaces, 165 of these generate income at a monthly rate of $ The balance of the parking spaces are free in that they are included in the monthly rent for the leased premises. Thirty of the forty surface parking spaces are also leased to tenants, at a rate of $30 per month. All other spaces are designated for visitors. Miscellaneous Revenue This source of income is generated by the landlord from performing special maintenance services for the tenants, telephone commissions from payphones, and miscellaneous other areas. In the current operating and fiscal year, miscellaneous revenue is expected to amount to $5,000. This revenue source tends to fluctuate somewhat from year to year. 1.7

8 Non-Recoverable Expenses This category of operating expenses represents those costs which remain the covenant of the landlord, in the context that they are neither contractually, administratively, nor otherwise rechargeable to the tenants. Capital Expenditures The ownership and operation of investment real estate commands consideration of on-going capital improvements which cannot be passed through to the tenants. These expenditures would include major structural and mechanical repairs and costs related to common area improvements and periodic upgrading of the building. No major capital expenditures are considered necessary in the foreseeable future, however, an allowance should be made for unforeseen circumstances. As a result, an allowance of 1% of effective gross income is considered suitable for a structural maintenance allowance (treated as a non-recoverable expense). Comparative Statement of Operations A comparative statement of operations comparing historic, actual performance for the two previous years, and the budget for the current year is shown in Table

9 Table 4: Comparative Statement of Operations 013 Reconstructed 1 Revenue/Expense Item 011 Actual 01 Actual Budget OPERATING REVENUE 3 Potential Basic Income $1,00,785 $1,031,55 $1,07,390 4 Percentage Rent $, Parking Income $8,48 $85,33 $90,000 6 Miscellaneous Income $4,854 $6,31 $5,000 7 Potential Recovery Income - Operating Costs $99,6 $319,60 $315,169 Realty Taxes $74,163 $90,53 $31,117 8 TOTAL POTENTIAL REVENUE $1,684,77 $1,73,961 $1,750,660 9 Vacancy Allowance $15,617 $4,93 $87, EFFECTIVE GROSS INCOME $1,669,155 $1,708,09 $1,663,17 11 RECOVERABLE OPERATING EXPENSES 1 Operating Costs $99,6 $319,60 $315, Realty Taxes $74,163 $90,53 $31, TOTAL RECOVERABLE EXPENSES $573,785 $610,15 $67,86 15 NON-RECOVERABLE OPERATING EXPENSES 16 Structural Maintenance $1,560 $6,35 $16, Base Year Costs - Government $70,480 $70,480 $70, TOTAL NON-RECOVERABLE $83,040 $76,805 $87,111 OPERATING COSTS 19 TOTAL OPERATING COSTS $856,85 $886,957 $914,397 0 NET OPERATING INCOME $81,330 $81,07 $748,730 Comparable Sales Data The following office building sales as shown in Table 5 are considered to be fairly comparable to the subject property and, therefore, give an indication of the current rates of return and price per square foot on which suburban office buildings are selling. 1.9

10 Table 5: Comparable Sales Factors Sale 1 Sale Sale 3 Instrument No Registration Date Sept 6, 01 February 15, 01 January 8, 013 Date of Transaction Aug 15, 01 December 011 November 01 Consideration $4,700,000 $4,950,000 $7,600,000 Net Rentable Area 47,150 sq.ft. 55,000 sq.ft. 101,300 sq.ft. Price per square foot of NRA $100 $90 $75 Gross Floor Area 58,900 sq.ft. 66,000 sq.ft. 119,534 sq.ft. Price per square foot of GFA $79.80 $75.00 $63.58 No. of Storeys Age Condition Recently renovated Average Very good Classification Class B+ Class B Class B+ Vacant Space 5% 10% 3% Office Rents $8 - $10 per square foot $10 - $14 per square foot $8 - $13 per square foot Retail Rents $15 per square foot (Main $15 - $0 per square foot N/A floor bank) Net Operating Income $450,50 (00) $504,900 (001) $798,000 (00) Income/Expense Ratio 40% 4% 48% Capitalization Rate 9.58% 10.% 10.5% Time Values have decreased by Values have decreased This is a current about 5% since date of this by an estimated 15% transaction sale since the date of this sale Location Inferior to subject (10%) Comparable Inferior to subject (10%) Physical/Functional Superior to subject (15%) Comparable Comparable Earnings Comparable Inferior to Subject (10%) Comparable 1.10

11 SOLUTION TO SAMPLE CASE STUDY: Big Smoke Adjustment Process for Comparable Sales Sale No. 1 Sale No. Sale No. 3 Price per square foot of $ $79.80 $90.00 $75.00 $75.00 $63.58 NRA/GFA Time Adjustment -5% -15% 0 Time Adjusted Price $95.00 $75.81 $76.50 $63.75 $75.00 $63.58 Location Adjustment +10% 0 +10% Physical/Functional -15% 0 0 Adjustment Earnings Potential 0 +10% 0 Net Adjustments -5% +10% +10% Adjusted Sale Price $90.5 $7.0 $84.15 $70.13 $8.50 $69.94 Capitalization Rate 9.58% 10.0% 10.50% Cap Rate For Subject Greater than 9.58% Less than 10.0% Less than 10.50% Property (Slightly Superior) (Inferior) (Inferior) INCOME APPROACH: DIRECT CAPITALIZATION Based on the three comparable sales, the indicated capitalization rate for the subject property was determined to fall between 9.58% and 10.%. Based on the direct comparison approach following, Sale # appears to be most similar in value. On balance, a capitalization rate of 9.75% is considered appropriate for the subject property. Therefore, the market value of the property by the direct capitalization approach is calculated as follows: Adjusted Net Operating Income: $748,730 Overall Capitalization Rate: 9.75% Capitalized Value (748,730/.0975): $7,679,8 Rounded to $7,700,000 The above-noted capitalized value reflects a "normal" vacancy allowance for the subject property. Therefore, it is necessary to adjust for the extraordinary vacancy which actually exists in the property, calculated as follows: Actual Vacancy Loss: 7,68 sq.ft. ($10 + $ $3.30) $15,099 1,544 sq.ft. ($18 + $ $3.30) 39,56 $164,65 Less: Typical Vacancy Allowance 87,533 Extraordinary Vacancy $77,09 If it is assumed that it will take 4 months to lease-up the space, the extraordinary vacancy loss is $77,09 4 = $3,1.17 per month. However, the vacant space will be gradually filled up over this time, and the last 1.11

12 months will have considerably less than $3,1.17 worth of vacancy. An average extraordinary vacancy per month can be found by dividing $3,1.17 by, or $1, Assuming a discount rate of 10% per annum, compounded monthly, and 4 payments of $1, (in advance), the PV of the extraordinary vacancy is $35,095. Therefore, the market value is as follows: Capitalized Value $7,679,8 Less: PV of Extraordinary Vacancy 35,095 $7,644,187 Rounded to $7,640,000 DIRECT COMPARISON APPROACH Based on the three comparables sales, the indicated market value of the subject property on a price per square foot of NRA basis was estimated to fall within the range of $84 to $90 per square foot and $70 to $7 per square foot of GFA (see Table 5). Placing more weight on Sale No., the market value of the subject property is considered to be $85 per square foot of NRA and $70 per square foot of GFA. Therefore, the market value of the subject property by the direct comparison approach is calculated as follows. (Note that the adjustment for the extraordinary vacancy in the property must also be reflected in this approach.) Based on NRA Based on GFA NRA/GFA 94,581 sq.ft. 108,768 sq.ft. Price per square foot $85.00 $70.00 Market Value $8,039,385 $7,613,760 Less: Extraordinary Vacancy Allowance 35,095 35,095 Net Market Value $8,004,90 $7,578,665 Rounded To: $8,000,000 $7,580,000 RECONCILIATION AND FINAL ESTIMATE OF VALUE Since office buildings are income-producing properties, the sale prices on which they transact are primarily a function of the current and future earnings which can be expected to be generated by the property. As a result, the valuation approach which is considered most pertinent in respect of this property of this property is the income approach. As a result, most emphasis would be put on the indication of value resulting from this approach. Therefore, in conclusion, the current market value of 154 Townsend Street, Big Smoke, Ontario is estimated to be: $7,640,000 (SEVEN MILLION, SIX HUNDRED AND FORTY THOUSAND) The direct comparison approach supports this indication of value. As previously discussed, this approach represents a way of establishing a benchmark value, more than anything. The unit of comparison most commonly used is net rentable area because this is the area which generates the income and is, therefore, the more practical figure on which to base value. (It is noted that the value based on the NRA of the property is closer to the value produced by the income approach.) 1.1

13 Note that the discounted cash flow method is actually the best way to value a multi-tenanted income producing property, due to its ability to handle changing income levels during a certain period of time. This approach is usually undertaken together with the direct capitalization method in valuing income-producing properties. 1.13

SAMPLE CASE STUDY. Beaver Bay Office Building

SAMPLE CASE STUDY. Beaver Bay Office Building SAMPLE CASE STUDY Beaver Bay Office Building Marks PURPOSE: Find the current market value of the subject property. DATE OF APPRAISAL: July 1, 2013 SPECIFIC INSTRUCTIONS 10 1. Estimate the market rent of