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
Sketch Created Using APEX Aerial Sketch
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, 13 th 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. Source: The Appraisal of Real Estate, 13 th edition, page 297
Information Sources Property Appraisal and Assessment Administration, IAAO The Appraisal of Real Estate, 13 th 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 13 th 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 Source: The Appraisal of Real Estate, 13 th edition, page 297
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 Source: The Appraisal of Real Estate, 13 th edition, page 303
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 Source: The Appraisal of Real Estate, 13 th edition, page 309
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 Source: The Appraisal of Real Estate, 13 th edition, page 175
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. Source: The Appraisal of Real Estate, 13 th edition, page 445
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.
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. 29
The Basis for the Income Approach
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 31
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) 33
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 34
Potential Gross Income (PGI) A property s economic rent at 100% occupancy 35
Effective Gross Income (EGI) The economic rent of gross income reduced by normal vacancies and uncollectable rents, plus other miscellaneous (service) income. 36
Miscellaneous Income (Services) Parking Fees Laundry Room Income Vending Machine Receipts Late Fees 37
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 38
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. 39
Information Sources - Expenses Assessors Appraisers and Appraisals Appeals Brokers Dept. of Development Lending Institutions Industry & Trade Association Publications Sales Surveys-Buyers & Sellers Revaluation Surveys 40
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) 41
Statute 70.47 (7)(af)
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 43
Improper Operating Expenses Debt Service Owner s Business Expense Income Taxes Additions to Buildings Depreciation Extraordinary Expenses 44
Operating Expenses to Watch These operating expenses need to be treated differently than the previous allowable expenses. Reserve for Replacements Property Taxes
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). 46
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.
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 48
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 49
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: Types include: Overall Cap rate Summationmortgage equity Rate = Income / Value Value = Income/Rate Income = Rate/Value 50
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 51
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 52
Search Tips
Keep Digging!
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 58
Income Valuation $6,189,000 $1,631,600 $4,557,400 Total Land Building
Sale/Lease Internet Sites www.loopnet.com www.carw.com www.mlswis.com 63
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 64
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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
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 67
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
Gross Income Multipliers (GIM) - Outline Defined Assumptions Benefits Limitations Converting GIM s Into Income Approach & Vice Versa 69
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 70
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 71
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 72
Gross Income Multiplier Limitations Does not allow for: Abnormal physical deterioration Unusual operating expenses Significant differences in age & zoning Makes no adjustments for land area and time 73
Valuing using GIM s Market Rent Market GIM Market Value 74
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. Source: The Appraisal of Real Estate, 13 th edition, page 377
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. Source: The Appraisal of Real Estate, 13 th edition, page 378
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.
Marshall & Swift How is data collected? 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?
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
Determining Quality con t See if workmanship is at a level normal to the type and grade of material used.
Determining Quality con t 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
Value Conclusion 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 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 james.siebers@msbinfo.com (262) 780-3212 Former Assessor 30 years of experience Marshall & Swift Product Manager 2 years experience
Contact Information Steve Miner sminer@milwaukee.gov (414) 286-3103 City of Milwaukee Chief Assessor 22 years assessment experience
Thanks for participating!