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 the vacant office premises. Verify that the market base rent is $15.50 using the comparable lease data and calculations of the value of the tenant inducements. Apply a rate of 10% per annum, compounded monthly. 10 2. Calculate a stabilized level of net operating income for the subject property. Clearly indicate how all components of net operating income (NOI) are determined. 10 3. Estimate the market value of the subject property by the income approach using direct capitalization as a technique. 10 4. Estimate the market value of the subject property by the direct comparison approach. 10 5. Adjust the market values from Questions 3 and 4 to reflect the facts that: C C the subject property is experiencing extraordinary vacancy compared to the comparables. Assume a discount rate of 10% per annum, compounded monthly in your calculation of the present value of the extraordinary vacancy; and the subject property will require a tenant improvement allowance of $30 per square foot and a leasing commission of two months rent to lease its vacant space. In adjusting the market value of the subject property to account for leasing inducements, there are two assumptions that can be made: first, assume that the comparables have similar levels of inducements required to lease vacant space as the subject, so an adjustment is only necessary for vacancy that is extraordinary; second, this vacant space will be leased up over 12 months and therefore the tenant inducements will be paid over this time, and are not all payable immediately. Use the static method to calculate the value of the penalty. 5 6. Reconcile the two approaches for a final estimate of value, giving reasons if more emphasis was placed on one of the approaches than the other. 55 Marks 1.1
SUMMARY OF SALIENT FACTS Property Identification Municipal Address: Location: Legal Description: Site Area: Improvements: Official Plan Designation: Zoning: Highest and Best Use: 80 Industrial Court, Beaver Bay, Canada Situated on the north side of Industrial Court; south of Chipmunk Avenue and east of Moose Road Concession 5, Part of Lots 4 and 5, Town of Beaver Bay, Regional Municipality of Wooddam 2.16 acres (.87 hectares) Four-storey office building Industrial/Commercial Prestige Office/Industrial Existing Utilization The subject property is located in the south central area of the Town of Beaver Bay. More particularly, the subject is situated on the north side of Industrial Court, a short distance east of Moose Road. The closest major intersection is Reindeer Avenue and Chipmunk Avenue. The subject property is situated approximately one mile north of Seals Avenue, which is the boundary for the neighbouring city of Muckluck and Beaver Bay. Characteristics of the Micro-Market The subject neighbourhood is the industrial and office area lying on both sides of Racoon Avenue between Seals Avenue on the south and Chipmunk Avenue on the north. The area west of Racoon Avenue was about 75% built up by the early-1990s with development continuing east and northeastwards in the late 1990s. Due to changes in planning policies, a number of office buildings are included in the more recent development. As with other industrial areas in the Greater Beaver Bay Area, development activity has all but ceased in this area and there are numerous vacant speculatively-built properties available for lease or sale. Sales activity is almost non-existent although several leases have been entered into over the past year. In summary, the industries in this area are showing the effects of the current recession, although perhaps not as severely as other parts of the established, older, heavy industry. Physical and Functional Characteristics The Site Lot Dimensions: South 294.29 feet (89.7 metres) West 368.64 feet (112.36 metres) North 192.37 feet (58.63 metres) East 397.47 feet (121.15 metres) Lot Area: 2.16 acres (.87 hectares) 2 94,090 sq.ft. (8,741.28 m ) Topography: Essentially level, although the landscaped areas slope downward gently from the building. Subsoil Conditions: Assumed to have adequate load-bearing capacity to support the existing improvements. 1.2
Services: All usual urban services, including paved streets with curbs and pedestrian sidewalks, storm and sanitary sewers, street lighting, hydro, gas lines, telephone service, water mains, police and fire protection, refuse collection, fire hydrants etc. Assessment and Taxes: Total Assessment $1,069,100.132900 (Mill rate) = $142,083 The Building Age: Approximately two years old Building Areas: Gross Floor Area - 84,329 sq.ft. (7,834.5 m ) Net Rentable Area - 78,499 sq.ft. (7,292.8 m ) Storeys: Four Exterior Finishes: Reflective, pre-engineered, insulated metal panels, and tinted plate glass Parking Facilities: 177 spaces, including 66 which are semi-enclosed under the building MARKET VALUATION DATA Occupancy Status The subject property is currently leased to three tenants, which together occupy 61,208 sq.ft. (5,686.4 2 2 m ) on the first three floors of the building. One unit containing 17,291 sq.ft. (1,606.4 m ) on the fourth floor is vacant. Therefore, the occupancy status of the building is presently 78% of total NRA. The rent roll in Table 1 shows the terms and conditions of each tenants' lease. Table 1: Rent Roll Options Type Unit Lease Start End To NRA Basic Market of No. Term Date Date Renew (sq.ft.) Rent Rent Lease 101 05 00 1-11-10 31-10-15 Nil 12,674 $14.50 $15.50 Net 05 00 1-11-15 31-10-20 $17.75 201 05 00 1-12-12 30-11-17 1x5 RTBN 21,697 $13.50 $15.50 Net 301 03 00 14-04-11 13-04-14 Nil 26,837 $15.00 $15.50 Net 14-04-14 13-04-16 $18.00 401 N/A N/A N/A N/A 17,291 N/A $15.50 N/A Comparable Lease Data A number of office projects located in the competitive area were investigated in order to help form an opinion of the current market rental value of the subject property. In particular, data concerning three leases was obtained. Lease No. 1 A recent lease pertaining to 6,000 sq.ft. of space in a building which is very comparable to the subject property, except for being somewhat superior with respect to location. A five-year lease was negotiated at the rate of $15 per square foot net. A leasehold improvement allowance of $30 per square foot was reportedly granted. 1.3
Lease No. 2 A recent lease pertaining to 8,000 sq.ft. of space in a building which is slightly superior to the subject property, mainly in respect of location. The terms of this lease were $14.75 per square foot net for the first five years and $18.60 per square foot for the second 5 years of the 10-year term. A net rent-free period of six months, in addition to an allowance of $25 per square foot was granted. Lease No. 3 A recent lease pertaining to 15,000 sq.ft. of space was leased in a building which is considered to be very comparable to the subject property. The terms were $13.50 per square foot net for the first five years, $16.50 per square foot for years six to ten, and $17.50 per square foot for years eleven to twelve. A tenant allowance of $35.00 per square foot was granted. Vacancy Rate The current vacancy rate as a percentage of total NRA is 22%. This corresponds to 16% of total potential revenue. The long-term average annual vacancy rate for the subject property is estimated to be 5%. This figure is slightly higher than the norm in view of the large amount of office space which exists in Beaver Bay, and the expected amount of time it will take to absorb the majority of this stock of space. It is necessary to adjust market values for the extraordinary vacancy which actually exists in the property. Assume it will take 12 months for the vacant space to be leased. Net Operating Income--Subject Property Under net lease arrangements, all operating expenses are ultimately paid by the tenants. However, the landlord would incur the pro-rated expenses applicable to any vacant space. Market rent for the vacant space is to be based on the most recent lease in the subject property pertaining to unit 201, as well as the market data from the three leases negotiated in comparable buildings. The long-term vacancy allowance is to be based on 5% of potential gross income. Parking revenue is earned from the 66 parking spaces which are semi-enclosed. The current monthly rate is $50.00 per space. Operating expenses are borne entirely by the tenants but payable by the landlord in respect of the vacant premises. The current level of operating costs is $6.95 per square foot per year and taxes are about $1.81 per year. An allowance for structural repairs of 1.5% of effective gross income is deemed appropriate. 1.4
Table 2 2013 Budgeted Statement of Operations Total Potential Basic Rent $1,112,667 Parking $39,600 Recovery Income Operating Costs $545,568 Taxes $142,083 POTENTIAL GROSS INCOME $1,839,918 Vacancy $91,996 EFFECTIVE GROSS INCOME $1,747,922 OPERATING EXPENSES Recoverables Operating Costs $545,568 Taxes 142,083 Total Recoverables $687,651 Non-Recoverables Structural Maintenance $26,219 Total Non-Recoverables $26,219 TOTAL OPERATING COSTS $713,870 NET OPERATING INCOME $1,034,052 Comparable Sales Comparable #1 Closing Date: Eights months ago Sale Price: $20,807,000 Legal Description: Town of Beaver Bay, Regional Municipality of Wooddam, Block 8, Plan M-2029 Instrument No.: 633784 Site Area: 3.38 acres Net Rentable Area: 114,018 sq.ft. Price per square foot of NRA: $182.48 Net Operating Income: $1,772,756 per annum Capitalization Rate: 8.52% Location: Physical: Income: Date of Sale: Superior to subject (10% adjustment) Reasonably comparable to subject Reasonably similar to subject Superior market conditions than today (10% adjustment) This property is improved with a five-storey office building. The building is multi-tenanted and was 98% leased at the time of the sale. The building is one-year old and contains 33 executive underground parking spaces in addition to 442 surface parking spaces. 1.5
Comparable #2 Closing Date: Four months ago Sale Price: $14,500,000 Legal Description: Concession 4, Part Lot 11, City of Woodchuck Instrument No.: 684888 and 684889 Site Area: 3.54 acres Net Rentable Area: 96,325 sq.ft. Price per square foot of NRA: $150.53 Net Operating Income: $1,341,250 per annum Capitalization Rate: 9.25% Location: Physical: Income: Date of Sale: Slightly superior to subject (5% adjustment) Very similar to subject Very similar to subject Fairly similar market conditions to today This sale pertains to a suburban office project. The development is comprised of a relatively new (five years old) office tower containing a total rentable area of 96,325 sq.ft. At the time of the sale the vacancy level was about 9%. The building is six-storeys high. Comparable #3 Closing Date: One month ago Sale Price: $18,900,000 Legal Description: Part of Lots 4 and 5, Plan 65M-2139, Town of Woodchuck Instrument No.: Not registered yet Site Area: 3.19 acres Net Rentable Area: 118,000 sq.ft. Price per square foot of NRA: $160.16 per square foot Net Operating Income: $1,701,000 per annum Capitalization Rate: 9.00% Location: Physical: Income: Date of Sale: Superior to subject property (15% adjustment) Comparable to subject property Inferior to subject property (10% adjustment) Current This sale pertains to a relatively new, seven-storey office building. The property is still in its initial lease-up, although it was 83% leased at the time of sale. The building has surface and deck parking for 415 vehicles. 1.6
Answer Guide Beaver Bay Office Building Marks: 10 1. Market Rent Lease 1 2 3 Term certain (years) 5 10 12 Base rent, $/SF 15 14.75/18.60 13.50/16.50/17.50 Tenant improvement allowance, $/SF 30 25 35 Free rent, months 0 6 0 Base rent over term certain, $ 75 166.75 185 Value of free rent, $ 0 7.38 0 Base rent paid over term certain, $ 75 159.37 185 Average paid per year, $ 15 15.94 15.42 Annual amortization payment for TIs at 8.01 4.15 5.26 j 12=10% per annum, $ Effective rent, $ 6.99 11.79 10.16 Value of tenant inducements, $ 8.01 4.89 5.26 Lease 1 - market base rent = $6.99 + $8.01 = $15 Lease 2 - market base rent = $11.79 + $4.15 = ($15.94 120) / 115 = $16.63 Lease 3 - market base rent = $10.16 + $5.26 = $15.42 Market base rent is between $15 and $16.63 per square foot. Assuming no free rent in our analysis, the market base rent for the vacant space in the subject property is estimated to be $15.50 per square foot. 1.7
10 2. Adjusted Net Operating Income Total Potential Basic Rent Unit 101 ($14.50/sq.ft. 12,674 sq.ft.) $183,773 Unit 201 ($13.50/sq.ft. 21,697 sq.ft.) $292,910 Unit 301 ($15.00/sq.ft. 26,837 sq.ft.) $402,555 Unit 401 ($15.50/sq.ft. 17,291 sq.ft.) $268,011 Parking Income $ 1,147,249 66 spaces @ $50 per month/per stall $39,600 Potential Recovery Income Operating Costs ($6.95/sq.ft. 78,499 sq.ft.) $545,568 Tax Assessment $142,083 Potential Recovery Income $687,651 POTENTIAL GROSS INCOME $1,874,500 Vacancy 5% of Potential Gross Income $93,725 EFFECTIVE GROSS INCOME $1,780,775 Operating Expenses Recoverable: Operating Costs $545,568 Taxes $142,083 Total Recoverable Expenses $687,651 Non-Recoverable: Structural Maintenance (1.5% of Effective Gross Income) $26,712 Total Operating Costs $714,363 NET OPERATING INCOME $1,066,412 1.8
3. Income Approach 5 The range of capitalization rates produced by the three comparable sales is 8.52% to 9.25%. However, based on the ranking of the subject property's investment characteristics versus those of the sale properties, this range was narrowed to 8.52% to 9.25%. Sale No. 2 was determined to be the most comparable sale, but still slightly superior to the subject property, such that a capitalization rate of 9.5% is considered appropriate. 5 Value = NOI Overall Capitalization Rate = $1,066,412.095 = $11,225,389 rounded to $11,225,000 10 4. Direct Comparison Approach The following chart summarizes the adjustment process associated with the direct comparison approach. Sale No. 1 Sale No. 2 Sale No. 3 Price per square foot of NRA $182.48 $150.53 $160.16 Time Adjustment -10% 0 0 Time Adjusted Price $164.23 $150.53 $160.16 Location Adjustment -10% -5% -15% Physical/Functional Adjustment 0 0 0 Earnings Potential 0 0 +10% Net Adjustments -10% -5% -5% Adjusted Sale Price $147.81 $143.00 $152.15 Comparable 2 required the least adjustment and represents the most reliable indication of value, indicating a price per square foot of NRA of $143 per square foot for the subject property. The other two sales indicate unit prices of $147.81 and $152.15 per square foot respectively. In view of the characteristics of the subject property in relation to these indicators, a unit rate of $145 per square foot of NRA is considered to best represent the value of the property. Therefore, the market value of the property is, calculated as follows: Total NRA : $78,499 sq.ft. Price per square foot: $145/sq.ft. 78,499 $145/sq.ft.: $11,382,355 Rounded to: $11,400,000 10 5. Building Size 78,499 SF Stabilized Vacancy (5%) 3,925 SF Current Vacancy 17,291 SF Excess Vacancy 13,366 SF Average annual excess vacancy ( 2) 6,683 SF Average monthly gross rental loss: (6,683 SF ($15.50 + $6.95 + $1.81)) 12 $13,511 Average monthly leasing inducements: Total Lease Commissions (13,366 SF $15.50 2/12) 34,529 1.9
Total Tenant Inducements (13,366 SF $30) 400,980 Total $435,509 Per month $36,292 Average total monthly cost ($13,511 + $36,292) $49,803 PV of $49,803 per month at j = 10% for 12 months (in advance) = $571,205 12 Summary Income Approach Direct Comparison Market Value $11,225,389 $11,382,355 less PV of Penalty! 571,205! 571,205 $10,654,184 $10,811,150 Rounded to $10,650,000 $10,810,000 5 6. Reconciliation Although the pertinence of investment criteria is reflected within the direct comparison approach, the direct capitalization test better simulates the thought processes of a typical investor. As a result, reliance is placed on this latter approach and the market value of the subject property estimated to be $10,650,000. 55 Total Marks 1.10