BUSI 352. Review & Discussion Questions: Answer Guide 7. Lesson 7: Appraising Waterfront Residential Properties Review & Discussion Questions

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1 BUSI 352 Review & Discussion Questions: Answer Guide 7 Lesson 7: Appraising Waterfront Residential Properties Review & Discussion Questions 1. (a) The natural boundary is the property line for properties fronting rivers, lakes, or streams. According to Black s Law, a natural boundary is any formation or product of nature (as opposed to structures or erections made by man) which may serve to define and fix one or more of the lines inclosing an estate or piece of property, such as a watercourse, a line of growing trees, a bluff or mountain chain. In BC, the Land Act defines natural boundary as the visible high water mark of any lake, river, stream or other body of water where the presence and action of the water are so common and usual, and so long continued in all ordinary years, as to mark on the soil of the bed of the body of water a character distinct from that of its banks, in vegetation, as well as in the nature of the soil itself. (b) For lands fronting tidal waters, the property boundary is generally identified as the high water mark defined at high tide. (c) Upland waterfront land is located above the high water mark. (d) Foreshore refers to the land below the natural boundary that is between the high and low watermarks of streams, rivers, lakes, and the ocean. In Canada, the foreshore is primarily publicly owned and therefore subject to governmental control. This means that the public retains the privilege to access the foreshore. This is in contrast to areas of the United States, where foreshore is privately owned and therefore property owners have more rights to protect their land and to build facilities for water access. (e) Midden refers to the heap or stratum of refuse (broken tools, shells, ashes, etc.) normally found on the site of an ancient settlement. 2. (a) Total area refers to the entire area of the property. This includes non-usable areas such as steep topography, rocky terrain, or potential flood plain. Effective area or usable area is the portion of the lot that supports its highest and best use and carries far more value (stars) than areas in less intensive use. (b) Submerged land applies to all lands lying below the mean high water mark of tidal or inland waters (includes rivers). UBC Real Estate Division 2015

2 Guide 7 Page 2 of 7 A water lot is submerged land that has been legally surveyed, or designated by a less formal metes and bounds description. Water lots are created to provide specific rights of use to defined water lot areas. The uses vary from navigational, industrial, and aquaculture. For residential and recreational water lots, uses may include: Marinas, private moorage Pleasure craft storage Clear view aesthetics and environmental protection Boat launching ramps Swimming, beach-related Providing an extension to uplands: Wharves and docks Piers (supporting a building structure or decking) Houseboat sites and year- round live-aboards (c) Both accretion and dereliction are ways that a waterfront property gains land, but the process of each differs. Accretion is the gradual and imperceptible increase in land area by natural causes, e.g., by alluvial deposits resulting from movements of a river course or of the sea. Accretion can be caused by the washing up of silt or sand. Whereas, dereliction exposes new land from the sea when water retreats or recedes from a change in a river's course. If dereliction is natural, then the new land belongs to the upland owner. (d) Littoral rights refer to common law rights of owners whose properties abut an ocean, sea, or lake. The rights include the right to reasonable use of the water, the right of access, and the right to dig channels or wharf, out to navigable waters in a manner that does not interfere with free navigation. Riparian rights are similar rights, but refer to a river or stream, and are rights shared with all other riparian owners on the river or stream. That is, the owner is entitled to reasonable use so long as that use does not diminish the rights of other owners. Both rights dictate the possibility of building piers or boat houses, as well as fishing and boating. Riparian rights may involve use of water for irrigation. (e) Most oceans of the world are subject to tides. Tides cause the water level to rise and fall, and the difference between the high and low water is the tidal range. The larger the tidal range, the stronger the tide. For a property fronting tidal waters, the property boundary is defined as the high water mark defined at high tide. Non tidal waters do not respond strongly to tidal forces and although they may have small tides, their tides are not strong enough to be taken into consideration when navigating. For properties fronting rivers, lakes, or streams, the property line is the natural boundary. 3. The pressures of limited supply combined with increasing demand can lead to market changes for waterfront properties. Properties that were formerly not desirable, due to quality of waterfront or distance from urban centres, may become in demand. The shortage of waterfront lands may force prospective buyers to seek out property farther and farther afield from their desired regions, and/or reduce the attributes they require.

3 Guide 7 Page 3 of 7 Further supply constraints are created through government conservation policies and controls on development to protect water quality and the environment. Government policies and controls are continuously changing, which means that property that was previously desirable may no longer be desirable. For example, a waterfront property development close to the water may be subsequently prohibited by setback requirements for floodplains or septic fields or both. If the new regulations only allow construction near the rear of the lot, then the subject s view will be of the backyards and outbuildings of the other similar properties. This will require an adjustment relative to the neighbouring properties. 4. If values per front foot or per acre decrease as total size increases, this indicates diminishing returns to scale. Once the market has enough land to meet the utility needs of the highest and best use, then the price of additional land falls off rather fast. This was clearly evident on the stars map presented in the lesson. As the stars become more spread over the additional frontage or acreage areas, the rate per front foot or acreage (likely both) decrease. The relationship between decreasing values relative to size or diminishing returns to scale is depicted by the curved line referred to as a land curve. Small lots are worth a lot more per acre or front foot; larger lots are worth comparatively less. 5. Direct comparison is the best method when evaluating waterfront properties and the attributes considered may be the: real property rights conveyed; motivation of vendors and purchasers sale conditions; timing of transaction market conditions; economic conditions at time of sale; physical characteristics of the land and any improvements to the land and/or on the water fronting the land; legal aspects and regulatory issues land use, riparian rights, and flood zones; availability of financing (often more challenging for secondary homes or recreational properties); non-realty components wheeled docks and boats; and risk factors currency, financial, regulatory, and environmental. However, where limited market comparables, leasehold situations and different improvements may complicate the analysis, the alternative, advanced valuation methods may be useful. These are covered in a later question. 6. Limited market data and the unique nature of these properties make comparative analysis difficult, whether quantitative or qualitative. Appraisal judgement and knowledge of the market are key; the appraiser needs to identify those site characteristics that are important to prospective purchasers, but also recognize potential for extraordinary development requirements and construction costs, as well as possible impacts of ongoing operating and maintenance costs for unique sites. 7. Highest and best use: At issue here is whether this property can be considered a residential/recreational property or if it is effectively a commercial operation. The distinction will depend on the circumstances and specific property details which we do not have. A key issue will be the primary use, whether it is fundamentally a residential/recreational property (with some bonus revenue) or if it is primarily a commercial property (with a bonus dwelling). This will require analysis of the market and the motivations of this owner and other buyers and sellers. CRA Scope of Practice: If this is primarily a residential/recreational property, with some commercial benefits as a bonus, then it likely falls within the CRA designation s scope of practice. However, if it is deemed a commercial property, then it is out of scope, requiring an

4 Guide 7 Page 4 of 7 AACI co-signature or declining the assignment. The determination of this highest and best use is also outside of scope, so the CRA should consult with an AACI to assist with the highest and best use conclusion. (If ever in doubt, contact AIC s Counselor of Professional Practice get an expert opinion before getting into potential hot water)! Another consideration is that depending on the client s intended use, it may be possible to separate out these commercial elements. For example, if the client is a lender seeking an appraisal for financing purposes, and he or she requests that only the residential aspect be appraised, then the CRA may be able to use a hypothetical assumption/extraordinary limiting condition to exclude these problem elements. This of course depends on the property s highest and best use and the available appropriate comparables for the assumed use (review Lesson 1 for details). 8. Highest and best use: the highest and best use as improved is likely the current use the ongoing use of the lot as a recreational dwelling. However, the highest and best use as if vacant will be different, as the current dwelling cannot be rebuilt. This means the current use is effectively temporary, lasting only as long as the cottage is standing. If it burnt down or was otherwise made inhabitable, that use cannot continue. The next more valuable use would have to be explored. This presents risk to a potential buyer and this risk is likely seen in a reduction of its market value. Direct comparison: if you have sale comparables that are similarly affected, then you have a market indication of the how buyers view this issue. This offers strong, supportable evidence for the subject s market value. Alternatively, if you do not have these comparables, then you will have to attempt an adjustment for this issue a very difficult appraisal problem, as it will likely be difficult to isolate and quantify this factor from market sales. You may have to deal with this issue qualitatively. 9. Several alternative valuation methods have been advanced for the valuation of water lots. These reflect the limited availability of market data for direct comparison. The methods outlined in the lesson are: Direct Comparison Approach Zoning Method Overall Method Extraction Method Percentage of Upland Method All are based on traditional appraisal approaches, albeit modified and adapted to fit the situation relevant to the valuation of water lots. All attempt to maximize objective analysis and minimize subjective inputs to the valuation process. All reflect the underlying principles of economics and value that form the foundation of appraisal analysis. All reflect the fact that to have value, a thing must have utility. One of the primary principles in the valuation of water lots is to determine the utility of the water lot, then address its value. Many of the methods rely on at least one other for its inputs or analytical components. The direct comparison approach is an application of the traditional direct comparison approach learned in introductory appraisal courses. The problem with its application in the valuation of water lots is that there are rarely comparable sales of water lots that can be used for this approach. However, the direct comparison approach is used as a part of other methods once rental or sales data can be extracted or abstracted from the limited market data that does exist. The zoning method requires that the value of the water lot be already established by direct comparison or other means. It then provides a formula for allocating the overall value of the water lot to its component parts, based upon the assumption that the most valuable quarter of the water lot

5 Guide 7 Page 5 of 7 is the one adjacent to the upland, and the least valuable is the quarter furthest from the water lot. It may be a useful method to estimate value of a water lot that is not adjacent to the upland. The overall method is application of the direct comparison approach, valuing a water lot not as a separate entity, but as a component of a real estate parcel that also includes upland. The extraction method requires two applications of the direct comparison approach one in the overall method to estimate the market value of a combined water lot and upland sale, and the other to estimate the market value of the upland only. By subtraction, one can extract the market value of the water lot. This approach can be applied directly to the subject property, or these extracted water lot values may then be analyzed as comparables for the valuation of the subject property. The percentage of upland method, again, is a modification of the direct comparison approach. The value of upland is estimated using the direct comparison approach, and then the sales of water lots or combined upland and water lot parcels are also analyzed. The data is compared in order to establish a percentage relationship between the market value of the water lot and its neighbouring or adjacent upland. Alternative methods not discussed in this lesson (with further details provided in the CPD 121 Submerged Land Valuation course): The fill cost method is essentially the cost approach applied to the valuation of a water lot. The upland value is estimated by applying the direct comparison approach. Then, the cost to convert the water lot into upland is deducted to give an indication of the water lot s value. The capitalization method employs the direct comparison approach and the income approach. The subject s net income is estimated via comparison to other water lot leases, and then an appropriate capitalization rate is estimated, again through comparison techniques. Then the income approach is applied to capitalize the net income attributed to the water lot into an indication of its market value. The residual method is an application of the income residual approach whereby the income a property can generate is allocated to its component parts. Once the requirements of the building and the land have been satisfied, the remaining or residual income is attributable to the water lot. This residual income is then capitalized, using an appropriate rate, to indicate the market value of the water lot by itself. This approach may also be used to "generate" water lot comparable data to be used in a direct comparison analysis. The utility method is a combination of direct comparison (to establish the upland value) and percentage method to establish the relationship in value between water lot and upland, and is also somewhat reflective of the zoning method; although for the latter, value declines not because of distance from the upland, but because of decreasing utility of the water lot.

6 Guide 7 Page 6 of The table presented below calculates the indicated percentage relationship between the value of the water lot and that of its neighbouring upland. Sale No. Location Sale Price of Water Lot Size of Water Lot - SF Water Lot Sale Price Per SF Neighbouring Upland Rate (per SF) Percentage Relationship Water Lot to Upland 1 Deer Pit $64, ,560 $0.22 $ % 2 St. John s $11,200 2,140 $5.23 $ % 3 Fernando s Hideaway $8,400 6,000 $1.40 $ % 4 Moose Point $7,560 35,000 $0.22 $ % 5 Green Bay $11, ,333 $0.05 $ % 6 Nowhere s Nook $500 5,520 $0.09 $ % 7 Baileys Arm $7, ,000 $0.07 $ % 8 Mongoose Bay $11, ,300 $0.05 $ % 9 Owl s Tooth $6,360 55,000 $0.12 $ % 10 Clippety Clop $15,000 68,890 $0.22 $ % This data indicates a range of 15% to 35% as the percentage relationship of the market value of water lots compared to neighbouring upland. This indicates a typical ratio of approximately 25%. This estimate is useful because, as challenging as it may be to appraise a waterfront (upland) property, the valuation of a water lot is typically much more difficult. Where water lot market value data is scarce or non-existent, the percentage of upland method allows the appraiser to estimate the water lot value as a simple percent of the value of the adjoining parcel of land. This is an approximation that should be applied judiciously and supported with more direct market evidence wherever possible. However, it can serve as a starting point in a valuation and a useful rule-ofthumb as a check of the reasonableness of a value conclusion. 11. The following are some examples how riparian rights may impact the value of water lots and waterfront properties. First, riparian rights may impact the size of the water lot. The water lot may decrease in size if there is significant accretion to the adjacent upland or if dereliction (receding waters) exposes new land. Second, riparian rights may impact the use of the water lot. The upland owner may own or control land access to the water lot, thus restricting its use. Plus, the upland owner has access to adjoining water as a basic right thus impacting the exclusivity of use of the water lot. Particularly for inland waters, rivers, streams, and lakes, riparian rights restrict the rights of the individual in favour of the rights of the many with respect to water flow, quality, etc. Any of these rights that impact the use, or exclusivity of use, of the water lot impact the value of the water lot. Note: For a more in-depth analysis, refer to the recommended reading by F.M. Cunningham.

7 Guide 7 Page 7 of To interpret market information and determine waterfront land value, appraisers need information regarding: Physical attributes: Location and lifestyle View and orientation Water quality Lot size and topography Water vehicle access and docking Economic and financial data: Leased- fee, leasehold, going concern Legal or regulatory information: Zoning and health regulations Legal and non-conforming/ grandfathered properties Access issues First Nations and archaeological sites Riparian rights/littoral rights Defining property boundaries Common sources include: land title office transaction information MLS records survey and subdivision plans local government records including zoning by-laws and community plans Crown (public) land management ministries First Nations administration offices professional real estate practitioners property assessment agencies 13. There are two issues here that are intertwined: (a) Decreasing returns to scale: larger lots are worth less than smaller lots, simply because the usefulness of the lot is spread over a larger area. The narrow waterfront access is the most intensively used portion of this property and thus carries the majority of its market value. The rest of land does not add much value more is better, but not better by the same dollar value per acre. (b) Unusable land: this is further complicated by the site s topography, where only a quarter or less of the lot is usable in any way, and very little of the waterfront is accessible. The site could be appraised by applying a $/acre or $/frontage foot in comparison to fully usable sites, then applying an adjustment. However, this may be difficult to substantiate or support with market evidence. A better method is to appraise the lot based on its effective area, or usable area. With roughly three-quarters of the property steep and rocky, and 80% of the waterfrontage likely inaccessible, orthophotos and GIS may be helpful in determining the effective size. The subject can then by directly compared to other fully usable large lot properties (or also adjusted for effective area). The effective size calculation accounts for the topography; using other large acreages accounts for decreasing returns to scale. This results in an accurate, fair, and consistent evaluation of market value for this waterfront property.