Office Property Appraisal and the Proper Valuation Techniques, Part 3
In the third part of our look into the appraisal of office building properties, we will focus on some important issues related to the selection of comparable rental properties within the Income Approach. In order to have a reliable valuation, it is important to select comparable properties that could be substituted as an alternative to the subject property. Not every office space is the same and it is important for the appraiser to select comparable properties that are similar to the subject in terms of expense structure, quality, condition, and utility.
It is common to find office properties that are close to each other in proximity, but are not comparable to each other in any other way. For example, in downtown business districts of some metropolitan areas it is common to have several different types of office properties. One office property may consist of a recently completed Class A LEED-certified high-rise office building while another office property two blocks away may consist of a single-family residential home built in 1925 that was converted into an office building. Both of the properties are close in proximity but it would be unlikely that both properties could be used as comparables in the same valuation due to their differences.
Another important consideration when choosing comparable office properties is expense structure. The expense structure of a lease determines who is responsible to pay the real estate expenses, including the real estate taxes, insurance, management, utilities, janitorial, repairs and maintenance. It is possible that the lease may be on a full-service (gross) basis with the owner paying all the expenses related to the real estate, a NNN (triple-net) basis with the tenant responsible for all the expenses related to the real estate, or a modified-gross basis with tenant responsible for some expenses and the owner responsible for some expenses. If the subject property is currently leased, the best comparables would be properties with the same expense structure as the subject. Any differences in lease structure would have to be accounted for through expense adjustments.
If either of these issues is overlooked within the Income Approach, it could limit the reliability of the valuation. It is important that an appraiser consider all the factors that make up an office building market when selecting comparable rentals. If one factor is ignored, it could have a significant impact on the subject property’s valuation. For more explanation on appraisal methodology, visit our website at www.commercial-appraisers.com.