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Quantitative vs. Qualitative Adjustments

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Since two properties are usually not identical, especially in commercial real estate, it is essential for an appraiser to make adjustments within the Sales Comparison Approach. The adjustments made by the appraiser should imitate the market. For example, adjustments could include location, size, and topography for a property, if these are characteristics that the average buyer in the market would consider when making a purchase. Appraisers can use either quantitative or qualitative adjustments (or a combination of both).  Generally, quantitative adjustments consist of making either percentage or dollar adjustments to account for the differences between the subject and the comparable sales. Qualitative adjustments require the appraiser to rank the comparable sales in terms of inferiority/superiority to the subject. Each of these techniques has its own weaknesses and strengths.

Quantitative adjustments are considered useful because they provide an actual quantifiable and measurable adjustment. Since the adjustment is quantified, it is more objective in nature than a qualitative adjustment. The result is a more scientific and precise analysis of the comparable data. However, the major weakness of the quantifiable adjustment is that it is rare to find the data to support quantitative adjustments. For example, the most common way to find a quantitative adjustment is to use a paired data analysis. In this analysis, two properties are compared two each other that are similar in all their attributes besides the one difference being analyzed. An example would be two lots that are identical except that one lot is a corner lot while the other is an interior lot. If the corner lot is $10,000 and the interior lot is $8,000, the appraiser could conclude a corner lot adjustment of $2,000, or 25%.  The problem is that there is not typically enough data to provide paired sales for all the required adjustments for the subject property.

On the other hand, the biggest weakness of qualitative adjustments is that they are more subjective in nature because they do not include direct quantification. However, their biggest strength is that they match the typical behavior of most market participants. It is often more common for the typical buyer to compare property attributes on a scale of superior or inferior than to calculate market-derived adjustment factors. Both types of adjustments have their own strengths and weaknesses and when determining the applicability of using quantitative or qualitative adjustments the appraiser needs to consider the dependability of the market data in support of an adjustment and how market participants would make similar adjustments. Due to the imperfect nature of the real estate market, the judgment and experience of the appraiser is always a factor in determining what type of adjustments to use.

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The Unfinished Office Park

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Almost every larger town has one - the unfinished development project that was put to a halt during the economic recession. As the bottom fell out of the market, developers were caught with half-finished projects and a falling demand for commercial space. The result was a distressed property and an unusual appraisal project.  Today’s post will take a look at an example of one way to approach the appraisal of a partially finished development project. The example focuses on using a retail sellout analysis to find the value of a partially completed office park development that includes two completed office buildings, two “shell” office buildings, and four pad sites for new construction.

The retail sellout analysis is a type of discounted cash flow where the retail values are determined through market research, and then discounted over an appropriate period, at a market-extracted discount rate. This process is crucial because of the time value of money, which is based on the premise that money currently in hand is more valuable than money in the future. The first step of the analysis is to determine the retail values of the subject property’s individual components. For the office park development example this step would include completing Sales Comparison and Income Approaches for each of the office buildings on an individual basis. In our example, this step may require the use of different comparables for the completed office buildings and the “shell” office buildings. (We will assume all the buildings are of similar size and construction) Additionally, the pad site’s retail values would need to be estimated using the Sales Comparison Approach.  Since it would be difficult to determine which pad site would sell first, it is common to find the average price per pad site and use the average in the discounted sellout.

The next and often most difficult step, is to determine the most likely absorption of each of the developments components. This step requires a study of the subject’s market and research into the sellout of similar projects. In the office park example, we could conclude that either one pad site or one office building would sell per quarter indicating a sellout period of two years. After the absorption rate is determined, it is necessary to estimate the appropriate deductions for expenses such as sales costs, commissions, title insurance, D.O.C stamps, marketing/advertising, real estate taxes, etc. during the sellout period.  The quarterly expenses would be deducted from the quarterly income.

Next, a discount (yield) rate would be extracted from the market. The final two steps would include discounting the net income stream for each period and adding the present values of the income stream for a total present value of the project.  To complete our example, the present value of the eight quarters of the sellout period would be totaled to find the present market value of the subject office park.

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The Religious Facility Appraisal – Part IV

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In our fourth and final segment of The Religious Facility Appraisal series we will look at the reliability of using the Income Approach in the valuation of Religious Facilities. Religious facilities are not frequently leased on the open market, making it difficult to retrieve accurate income data. Additionally, religious facil­ities are not usually purchased as income-producing properties; therefore, the Income Capitalization Approach is not typically used in finding the market value of a religious facility. Although the Income Approach is not usually used to find the market value of a religious facility, it is possible to use the Income Approach as a test of feasibility/reasonableness. Religious facilities produce income from their membership in order to cover their expenses. This income stream can be used to help determine financing for a lending institution.

A possible mortgage loan amount can be es­timated analyzing this income stream based on the current market conditions. Financ­ing is based on the ongoing market conditions, which can be applied to the religious facilities current or proposed income stream in order to estimate a reasonable loan amount. The appraiser can then use current loan-to-value ratios to determine a probable value estimate. It is important not to consider this an actual value estimate, but instead a check for values determined in the Sales Comparison and Cost Approaches. Additionally, this method can be helpful for lenders hoping to determine a suitable loan amount.

This series on The Religious Facility Appraisal has shown that all three of value approaches can be applicable to religious facil­ities. Due to the special-use characteristics of the religious facility the Cost Approach is often time the most reliable indicator of value. Additionally, the Sales Comparison Approach is a viable value approach but can have some weaknesses due to the wide variance in characteristics of religious facilities. The Sale Comparison Approach requires well thought out and market supported adjustments to account for commonly found differences in the age/condition and quality/features of religious facilities. Finally, it is uncommon to be able to use The Income Approach to produce a reliable value for a Religious Facility but the approach can sometimes be used as additional support for the other two approaches.  The Income approach may also be used to help a lending institution determine a loan amount. This concludes our series on Religious Facilities.  For more explanation of appraisal methodology, visit our website at www.commercial-appraisers.com.

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The Religious Facility Appraisal – Part IV

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In our fourth and final segment of The Religious Facility Appraisal series we will look at the reliability of using the Income Approach in the valuation of Religious Facilities. Religious facilities are not frequently leased on the open market, making it difficult to retrieve accurate income data. Additionally, religious facil­ities are not usually purchased as income-producing properties; therefore, the Income Capitalization Approach is not typically used in finding the market value of a religious facility. Although the Income Approach is not usually used to find the market value of a religious facility, it is possible to use the Income Approach as a test of feasibility/reasonableness. Religious facilities produce income from their membership in order to cover their expenses. This income stream can be used to help determine financing for a lending institution.

A possible mortgage loan amount can be es­timated analyzing this income stream based on the current market conditions. Financ­ing is based on the ongoing market conditions, which can be applied to the religious facilities current or proposed income stream in order to estimate a reasonable loan amount. The appraiser can then use current loan-to-value ratios to determine a probable value estimate. It is important not to consider this an actual value estimate, but instead a check for values determined in the Sales Comparison and Cost Approaches. Additionally, this method can be helpful for lenders hoping to determine a suitable loan amount.

This series on The Religious Facility Appraisal has shown that all three of value approaches can be applicable to religious facil­ities. Due to the special-use characteristics of the religious facility the Cost Approach is often time the most reliable indicator of value. Additionally, the Sales Comparison Approach is a viable value approach but can have some weaknesses due to the wide variance in characteristics of religious facilities. The Sale Comparison Approach requires well thought out and market supported adjustments to account for commonly found differences in the age/condition and quality/features of religious facilities. Finally, it is uncommon to be able to use The Income Approach to produce a reliable value for a Religious Facility but the approach can sometimes be used as additional support for the other two approaches.  The Income approach may also be used to help a lending institution determine a loan amount. This concludes our series on Religious Facilities.  For more explanation of appraisal methodology, visit our website at www.commercial-appraisers.com.

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The Religious Facility Appraisal – Part III

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In our third segment of The Religious Facility Appraisal series we will take a look at the most common value approach used for religious facilities, The Cost Approach. Due to the fact that religious fa­cilities are special-use properties, they are often ap­praised by the Cost Ap­proach. In this approach, a replacement cost new is developed. Cost data can be found in valuation services or you can use ac­tual cost information. From the replacement cost new, the appraiser then estimates accrued depreciation. Ob­taining dependable depreciation information for religious facilities is required for a reliable value estimate.

The most dependable technique for finding accrued depreciation is to use market data. In this technique, the appraiser ex­tracts the depreciation from comparable sales. Since new religious facilities sell infrequently, the available sales can be good indicators of ac­crued depreciation. For example, if you had a sale with an estimated cost of the improvements new of $150,000 and a current contributory value of the improvements of $90,000 this would represent $60,000 of physical depreciation. If the sale was 10 year olds it would represent a total depreciation of 40% and a depreciation rate of 4% per year.   Extracting physical depreciation rates from several sales usually can provide an accurate yearly depreciation rate that can be applied to the subject. It may also be possible to use the age/life method of depreciation, which involves dividing the estimated effective age by the estimated economic life.

Other forms of depreciation to consider in this approach are functional and external obsolescence. Functional obsolescence is not usually found in reli­gious facilities. These facilities are usually constructed for their in­tended use and their design meets the requirements of the membership. It is more common to have external obsolescence in a religious facility. Ex­ternal obsolescence in religious facilities can be caused by economic conditions, environmental concerns, and population demo­graphics. Adding the functional and external obsolescence to the physical deterioration equals the total accrued depreciation.

When the total accrued depre­ciation is subtracted from the replacement cost new, the result is the depreciated value of the im­provements. This denotes the contributory value of the im­provements to the total property value. Finally, the land value estimate would be added to the depreciated value of the improvements to provide the value of the subject property.

Overall, the Cost Approach can be a reliable indicator of value for a religious facility. The Cost Approach eliminates a lot of the issues found in The Sales Comparison Approach including the variances in design, age, and quality. The next segment in this series will see if it is reasonable to use the Income Approach to value a Religious Facility.

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The Religious Facility Appraisal – Part II

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In our second segment of The Religious Facility Appraisal we will take a look at several things that need to be considered when using The Sales Comparison Approach in the valuation of a religious facility. The development of the Sales Comparison Approach for a Religious Facility can be difficult due to several factors that may include the availability of comparable data, differences in use and design of comparable sales, and discrepancies in quality/features of comparable sales. However, there is still an open market for religious facilities, especially in larger metropolitan areas, that makes the Sales Comparison Approach a viable valuation option.

It is possible in some active markets to compare religious facilities on feature-by-feature basis; however, it is not typical to be able to use this approach due to the vast array of religious facilities with different uses, design, and quality. Therefore, one of the key elements of The Sales Comparison Approach for a religious facility is determining a valid unit of comparison. When the sale comparables are similar to the site in terms of quality, size, age and condition it is common to use a sale-price-per-seat as the unit of comparison. However, the varying characteristics of most religious facilities often make the use of a sale-price-per-seat unit problematic. If this is the case, it is often easier to use sale-price-per-square foot as the unit-value indicator. Additionally, due to varying land sizes between the subject and the comparables, it is often helpful to extract the land value estimate from each comparable sale. Extracting the land value eliminates the need for floor-area-ratio adjustments (which can vary significantly).

Two of the most important adjustments to consider are for quality/features and age/condition. The quality and features of a religious facility are often based on its membership, indicating there can be wide differences in quality and features between religious facilities within the same market. In order to accurately make an adjustment for quality/features it is necessary to compare the cost new of the sale to the cost new of the subject on a per-square-foot basis. This comparison can be used to derive a percentage adjustment for the comparable sale.

Another important adjustment to consider is an adjustment for age/condition.  Religious Facilities are usually built for particular users with a long-term intended use; therefore, sales of newer, functional church facilities are not common due to their special-use characteristics. Due to the lack of newer religious facilities, the need for age and condition adjustments is common. One method for making this adjustment requires comparing a sale’s estimated total depreciation with the estimated total depreciation for the subject. This comparison can be used to derive a percentage adjustment for the comparable sale. While there is typically a need for several adjustments, adjustments for quality/features and age/condition are of upmost importance to accurately value a Religious Facility within the Sale Comparison Approach.  The next segment in this series will take a look at what things should be considered when using the Cost Approach in the valuation of a Religious Facility.

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The Religious Facility Appraisal – Part I

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Individuals and congregations have many reasons why they may need an appraisal of a religious facility including new construction, financing, a potential sale or purchase, insurance purposes, or asset valuation tied to a number of financial decisions. While religious facilities may not sell on the open market as often as other property types, there are still a number reasons that can lead to the sale of a religious facility including a changing neighborhood, a growing or shrinking membership, or facilities whose physical life has generally ended. These factors indicate the need for the appraisals of religious facilities.  However, the appraiser has to answer some important questions when appraising this unique property type.

In the highest and best use analysis of a religious facility, factors such as the need for a church in an area, available parking, fixed seating, and neighborhood characteristics all must be considered by an appraiser. Furthermore, church leadership and members are important factors when considering the highest and best use of a currently operating religious facility. Depending on these factors, the highest and best use of the facility could be the continued use of a religious facility or an alternative use that is better suited for the surrounding area.

Religious facilities are typically considered a special-use property built for a specific purpose. While sometimes alternative uses do exist, religious facilities are typically most efficient when fulfilling their intended use. Due to the special-use characteristic of religious facilities, often times a value-in-use may be required by the client. However, if the intended use of the appraisal is related to financing purposes for a federally-insured transaction, the appraiser must include a market value. In this case, factoring in alternative uses may become a critical part of the appraisal. It is important for the appraiser to ensure the type of value is consistent with the intended use of the appraisal.

The difference between value-in-use and market value is key when looking at a religious facility’s highest and best use. In fact, examining the value-in-use often helps in determining the financial feasibility of a religious facility. If the value-in-use shows that the religious facility is operating economically, the appraiser has shown that the religious facility is a financially-viable option.   If the use as a religious facility is the highest and best use conclusion, the appraiser will have to take into account the unique characteristics of religious facilities in the property valuation. In the next post we will take a look at how a religious facility can be valued in each of the valuation approaches.

Florida State Homes Article

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Chris Rolly of Commercial Investment Appraisers was featured in an article with Florida State Homes.  Check out the link below for the full interview.

 http://www.floridastatehomes.com/articles/interview-with-chris-rolly

 

 

 

http://www.floridastatehomes.com">Florida Homes is the one of the top sites for http://www.floridastatehomes.com">Florida Homes For Sale, including http://www.floridastatehomes.com/orlando/east">Orlando FL Homes For Sale, condos, multi families, and townhouses for sale. Florida Homes also services http://www.southcarolinahomes.com">South Carolina Real Estate and http://www.northcarolinahomes.com">North Carolina Real Estate.

 

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A common mistake – What to do with “extra” land

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Improperly handling excess and surplus land is a common mistake among inexperienced appraisers. When a property has “extra” land that is not required to accommodate the subject improvements, it is important to identify whether then land is considered excess land or surplus land. The decision is critical to providing an accurate and reliable value conclusion in the appraisal report. Excess land can be separated and sold off as a distinct property while surplus land cannot be separated and sold off. When a property has excess land, it is essentially two separate properties and the value of the excess land needs to be reported as a separate value.  

When completing a highest and best use analysis for a commercial property it is imperative that the appraiser makes the correct distinction between excess land and surplus land. Excess land may even have a different highest and best use than the rest of the property. However, surplus land will not have a separate highest and best use from the rest of the property. If excess land has a separate highest and best use, it might need its own set of comparable data.

Let’s consider an example of a property with “extra” land. The example property is a ten-acre lot that has a mixed-use zoning located off a heavily-traveled commercial roadway. The zoning allows for a number of uses including retail, office, and multi-family residential.  The property is currently improved with a multi-family development that is fully supported by eight acres, indicating the property has two acres of “extra” land. The “extra” land is located along the subject’s road frontage along the heavily-traveled commercial roadway and could be easily separated and sold off, indicating that it is excess land. Based on the subject’s mixed-use zoning the excess land could be developed with a retail improvement to take advantage of its frontage and access from a heavily-traveled roadway.  The excess land would actually have a different highest and best use than the rest of the land and needs a separate set of comparable data. A review of the market may indicate that the excess land has a higher unit value indicator than the rest of the property. In this example, the property would have a higher value conclusion if an appraiser properly identified the “extra land” as excess land. An inexperienced appraiser may have incorrectly identified then land as surplus land and used the same unit value indicator for the entire property, leading to a lower overall value conclusion.  For more explanation on appraisal methodology, visit our website at www.commercial-appraisers.com.

Commercial Appraisal Report Format Changes For 2014

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The Appraisal Standards Board, which develops, interprets, and amends the Uniform Standards of Professional Appraisal and Practice (USPAP), has adopted a revision for the 2014-2015 USPAP that will reduce the number of narrative report options available for real property appraisals. Currently, the narrative report options for real property appraisals include Self-Contained, Summary, and Restricted-Use reports. The two options presented in the 2014-2015 edition of USPAP will be the Appraisal Report and the Restricted Appraisal Report. The Appraisal Report will have the same standards as the current Summary Appraisal Report; and the Restricted Appraisal Report will have the same standards as the current Restricted-Use Appraisal Report.

The current Restricted-Use Appraisal report is the most condensed narrative report format, presenting limited analysis related to how the appraiser reached their value conclusion. This report option is typically reserved for an intended user who has a strong knowledge of the property being appraised.  Additionally, this report option can only be used when there is only one intended user for the report. The Summary Appraisal report is the most commonly used narrative report, and summarizes the analysis appraiser used to reach their value conclusion. Finally, the most comprehensive narrative report currently available is the Self-Contained Appraisal Report which shows all of the analysis used by the appraiser to reach their value conclusion. The current Self-Contained and Summary Appraisal will not be available in the 2014-2015 USPAP.

The new Appraisal Report option will indicate the minimum level of reporting necessary for an assignment with multiple intended users, or for an assignment were a client needs further understanding of the appraiser’s rationale and conclusions. It will be the most applicable report option when the client does not have specified knowledge of the subject property. While this report option institutes a minimum level of information, the appraiser must determine if additional detail or explanation is required based on the needs of the client.

In its Rational for adopting these changes, The Appraisal Board states “The edits adopted are intended to improve consistency among the Standards. In addition, the Board received many comments over the years suggesting elimination of the Self-Contained Appraisal Report option.”

The reduced number of report options will make selecting the appropriate report option easier for the client. The Restricted Appraisal Report will be the best option for a report with a single intended user who has a strong knowledge of the subject property, while the Appraisal Report will be the best option for a report with multiple intended users or a client who does not have in-depth knowledge of the subject property.  Commercial Investment Appraisers stays up to date on USPAP guidelines.  For more explanation on appraisal methodology, visit our website at www.commercial-appraisers.com.