August 9, 2018 – Over my 30+ year career, this question has come up every few years. When performing the Income Approach for a vacant or owner-occupied building (same thing), should there be discounting for the time and cost to lease it up?
My short answer is – Yes. However, I would say 99% of appraisers do not make such a deduction. Why not?
A few notes before I summarize a great response from an appraiser who does make the deduction.
First, America’s definition of Market Value assumes a sale occurs. Therefore, an owner-occupied property is vacant when it sells. That occupant moves out so either a new owner occupant can move in or third-party tenants can move in. I have long argued that EVERY house/condo in America sells vacant – regardless if the owner occupies it right up to closing or it is physically vacant beforehand. Of course, rental properties are the exception.
Second, the Income Approach assumes an investor owns the property and will lease it up to stabilization to third-party tenants. The Income Approach does not assume owner occupancy!
Therefore, a vacant or owner-occupied property has to be leased up to obtain stabilization that is assumed in the direct cap method of the Income Approach. Lease-up is not free and instantaneous that often. Below is the summarized response that was shared with me.
As always, I welcome your thoughts. Unlike our cultural and political world, differing opinions are welcome and will not be called ‘tone deaf’ or racist or some kind of phobic and so on:) If I get enough comments, I will do a follow up post.
(Oh, let me add that the Sales Comparison Approach will depend on what sales are used. If the comps were 100% vacant and/or owner-occupied, then the SCA already reflects such discounting for lease-up. If the comps were partially or 100% leased, then….hmmmmm….)
(Second oh….all of this is needed to determine one of the 3 highest & best use conclusion items – type of occupancy. Sometimes it is Owner Occupancy and other times it is Third-Party Tenants via an Investor owning the property.)
OK, finally to the Anonymous Appraiser Reply:
- For the purpose of our analysis, owner-occupied space is presumed vacant and subject to deductions to reach stabilized occupancy in the “As Is” Market Value.
- FIRREA requires appraisers to “Analyze and report appropriate deductions and discounts for proposed construction or renovation, partially leased buildings, non-market lease terms, and tract developments with unsold units.”
- The present value of all costs necessary to achieve stabilized occupancy (including rent loss, leasing commissions, concessions, tenant improvements, rehabilitation costs, and/or profit loss) incurred during the lease-up period must be considered in developing the “As Is” Market Value conclusion.
- ((In this particular appraisal, )) The sales utilized in the Sales Comparison Approach were all vacant or owner-occupied; therefore, no lease-up adjustment was applied to the Sales Comparison Approach.
I agree with this logic. Even for non-FIRREA appraisals.
What does the market do? Well, that is answered in the Sales Comparison Approach as prices for vacant and/or owner-occupied properties reflect how an owner values the property or an investor values it knowing s/he has to find a tenant(s).
And remember, Spend Forward, Use Forward!