Tag Archives: Market Value

MARKET VALUE ‘AS IS’ MUST CONSIDER EXISTING LEASES

February 21, 2019 – Every once in awhile the same question arises from several people in different parts of the country.  I wonder if people attended the same seminar and were told the same (erroneous) information.  Or just plain coincidence.

The topic du jour is bank/credit union clients asking appraisers to ignore existing subject leases and appraise Fee Simple Estate only.  There are two main scenarios to deal with – one where such a request is not acceptable and one where it is.

Scenario #1 – The subject has one or more arm’s-length leases in place that are not all month-to-month or say expire within a month.  I just use one month as technically the appraisal will be done by then and the tenants could be removed in that time period (assuming such is legal).  In this case, Market Value ‘As Is’ MUST be of the Leased Fee Interest.  The subject must be appraised as it legally and physically stands today.  If the bank/credit union would also like to know the Fee Simple Estate value, then this can be provided IN ADDITION TO Market Value ‘As Is’ of the Leased Fee Interest.  I would call this additional value Hypothetical Value of Fee Simple Estate.  A Hypothetical Condition is needed as this value assumes the existing leases are not in place.  Now, if the subject is leased to a single tenant and that tenant is purchasing the property…we go to…

Scenario #2 – The subject is leased to a single tenant who is purchasing the property.  Obviously, when the purchase occurs the lease goes away.  Or at least for us appraisers, it is ignored because now it is no longer arm’s-length.  The bank/credit union’s request for Fee Simple Estate only is now acceptable.  With a bit of a twist though….Market Value ‘As Is’ would still be of Leased Fee Interest.  However, this value is not needed.  Why?  Because the loan is not being made until the property is purchased.  Therefore, the appraiser provides a Prospective Value as of say a month or two in the future (whenever a closing is projected to occur).  An Extraordinary Assumption is needed to say that we assume the purchase will occur and the lease will be extinguished in the stated timeframe.  What about the requisite Market Value ‘As Is’ that FIRREA requires?  Well, on the day the property is purchased and the loan is closed, the appraiser’s Prospective Value is now Market Value ‘As Is.’  And now FIRREA is satisfied and all is good in Appraisal Land:)

((As an aside, Scenario #2 is useful when a zoning change is in process.  Until it occurs, Market Value ‘As Is’ must consider the subject as currently zoned.  I encourage banks not to make the loan until the zoning change occurs.  This way an appraiser can provide a Prospective Value ‘Upon Zoning Change’ with a future date and not have to deal with Market Value ‘As Is.’  But, if the loan is being made today, then two difference scenarios must be valued.  Once again, the value difference might not be that much.))

There are likely some other less common scenarios that arise.  But, the above two seem to take care of the vast majority of transactions.

I will quickly mention one scenario that provides an example of why Market Value and Market Value ‘As Is’ are not always the same.

The subject is leased to a single tenant with say 3 or 6 months left on the lease.  The owner or a buyer is going to occupy the property once the lease expires and the tenant has moved out.

In non-bank/cu appraisals, Market Value could likely just ignore the existing lease.  We could argue that market participants don’t care about the next 3-6 months of the tenant being in place.  They know they will occupy the property very soon.  This is ok for Market Value.

However, for a bank appraisal under FIRREA, this is not acceptable.  The lease is in place and Market Value ‘As Is’ is of Leased Fee Interest and the lease must be part of the value.  Obviously, if the rental rate happens to be at market, then there is no difference in value between the Leased Fee Interest today and the hypothetical Fee Simple Estate today.  If contract rent is above or below market, then there is a difference in these two values.  Admittedly, it is likely to be a small amount.  But, it MUST be included in the Market Value ‘As Is’ conclusion.  In this case, Market Value and Market Value ‘As Is’ differ.  And this is one of several examples where USPAP and FIRREA differ.

As with FF&E, please do not pull the ol’ ‘this is absorbed in rounding and thus is not added or deducted’ routine.  Make the addition or deduction to get to Market Value ‘As Is’ and move on.

Please contact me if you have any questions.  Any other scenarios worth me addressing.  et al.  Thanks for taking the time to read my blog:)

The Mann

 

NATIONAL TENANTS ARE RISKIER THAN THE MARKET ACKNOWLEDGES

August 12, 2016 – 24+ years of being a reviewer, I continue to find it preposterous that appraisers use a 0% vacancy rate when valuing properties with long-term leases to national tenants.  Have we not seen enough bankruptcies and vacant big boxes and restaurants and drug stores to finally acknowledge a 5%-10%+ vacancy rate is warranted for these properties?  I have always argued that national tenants are riskier, not less risky, than local tenants.  Why?  Because they have better lawyers!  They can use bankruptcy or a number of ways to get out of leases.  If I sign a lease, I have no chance of getting out of it.  Dollar General signs a lease and they can get out of it.

Yesterday, Macy’s announced the closing of 100 stores.  Today, Ruby Tuesday’s announced the closing of 95 restaurants.  Logan’s Roadhouse filed for bankruptcy this week and will close 18 restaurants.  WalMart and Target have announced store closures this year (BTW, WalMart is pricing their closed stores at about 20% of the project costs to build them just 2-3 years ago….yes appraisers, price equals value…NOT!  It is likely the same appraisers who valued these at $3.5mm in 2013/2014 will appraise them today at $700,000!  They will laugh and call it job security.  America really needs to place liability on appraisers like they do in Europe – the full value that the appraiser concludes at they can be sued for!).

Of course, the ridiculous reply the vast majority of appraisers provide is ‘The market does not deduct any vacancy or expenses, so that is why we don’t.’  As you know, I have long argued that it is not our job to reflect the market.  Reflecting the market simply provides Market Price and anyone in the public can do that nowadays.  Market Value is not Market Price and value is not based on prices unless the market is in equilibrium – which is almost never.

Per Mann’s Axiom – If the market says it is so, it isn’t!  The market is almost always wrong.  Studies have shown that investors have overpaid for properties by around 20% for almost 30 years now.  These are the smartest investors in the world.  Why are they so far off in what they pay?  I believe prices are inflated for two reasons – 1) Investors significantly underestimate potential vacancy, and 2) Investors underestimate expenses.  The studies have shown that actual returns are 20% below expected returns.  Obviously, the market’s expectations are, and have always been, wrong – way wrong!

Appraisers who want to use 0% vacancy and 0% expenses for national tenant properties can continue to play this game and provide Market Price.  Many clients simply want that.  It is what keeps REITS and CMBS and Wall Street and national appraisers making their fees.  But, these prices are not indicative of value.  Clients deserve to know the underlying value of these properties.  They already know what the prices are – without hiring an appraiser to provide a Confirmation Report.  Real appraisers will deduct realistic vacancies and expenses and conclude a real market value.

Will the real estate appraisers please stand up….

 

CAN WE END THE DEBATE ON VALUING NATIONAL TENANT RETAIL BUILDINGS

June 29, 2016 – Some people have bucket lists.  I guess I was born to have a list of pet peeves:)

For 25+ years, I have tried to get our industry to identify the correct interest when appraising an existing apartment complex or any property with arm’s-length leases.  It has always been Leased Fee Interest, not Fee Simple Estate.  I can say that finally the majority of appraisers have come to recognize this.  The ‘urban myth’ that we were taught (i.e. if leases are less than 12 months long and/or contract rents are at market, then the interest being appraised is Fee Simple Estate) is almost eradicated.

For 30+ years, I have identified the kitchen and laundry appliances (and any additional common area items that might be in a club house or such) in apartment complexes as FF&E.  Til this day, many appraisers still think refrigerators, stoves/ranges, dishwashers, washing machines, and dryers are real estate!  As a lady on TV many years ago said – Stop The Insanity!

Another item I have been shouting about for almost 25 years is the appraisal of drug stores, big box retailers, and other buildings leased to national tenants.  Capitalizing these leases does NOT yield Market Value of real estate only.  I may have been the only Chief Appraiser that required that the Market Value of Real Estate not exceed the Cost Approach indication with the additional value reflected by the Income and Sales Comparison Approaches having to be identified as an Intangible Asset.  I admit that even allowing the Cost Approach indication to represent real estate value is being way too generous.  These companies usually pay way above market for the land and the cost to build the improvements is absurd – I have seen costs for these basically shell buildings be more than medical office!

FIRREA and FDICIA require that 1) Market Value be of real estate only, and 2) LTV be calculated on Market Value of real estate only.  We all know a shell retail building is not worth $300 or $400/sf as most drug stores have appraised at for 20+ years.  Excluding the inflated land purchase price and using the real value of the land, these properties are lucky to be worth $100/sf in most markets.  Yet, I am sure the vast majority of financial institutions have used the incorrectly stated Market Value provided by appraisers to calculate LTV and base their loan on.  This is similar to those institutions that used, or may still use, Going Concern Value to calculate LTV.

Can we say violation of numerous federal regulations….but I digress.

All of this leads me to two recent articles that I believe finally end this absurd debate.  I highly recommend you find the following articles:

David Charles Lennhoff, CRE, MAI, ‘Valuation of Big-Box Retail for Assessment Purposes: Right Answer to the Wrong Question,’ Real Estate Issues (Volume 39, Number 3, 2014): 21-32.

Stephen D. Roach, MAI, SRA, AI-GRS, ‘Is Excess Rent Intangible?’ The Appraisal Journal (Spring 2016): 121-131.

In my opinion, both authors prove beyond a shadow of a doubt that the excess rent present in almost all drug store, and similar leases, is not indicative of the market value of real estate.  They use both theory and real data to prove their points.  Mr. Roach sums up the logic better than I have ever seen (from page 125 of his article):

  • “By definition, the real estate (a property) can produce market rent, but no more.
  • By definition, excess rent exceeds market rent.
  • By definition, excess rent is created by the contract, not the real estate.
  • By definition, a contract is an intangible asset; it’s not real estate.
  • Therefore, excess rent is intangible.

Each step in the argument is based on long-accepted definitions and concepts of the terminology.”

I challenge all of the Chief Appraisers in the country to step up and require appraisals of these properties to appropriately indicate the Market Value of REAL ESTATE ONLY with the huge additional amount above this figure being termed Intangible Value (or something similar).  It is time both appraisers and lending institutions provide the correct value and LTV.

Plus, this will make the lives of us reviewers easier – it has been frustrating to lower the values 50%-75%+ all of these years!  Of course, we could simply order these appraisals from the two authors above and have slam dunk reviews forever:)

 

FF&E – FIRREA vs. USPAP

January 7, 2016 – Below is a question I received followed by my reply.  Happy New Year to all.

George – Hope your holidays were great and 2015 is finishing off strong.  I was hoping to get your opinion on an item below.

It’s just how non-realty items are reported in the appraisal report. No change at all in the new USPAP – I’ve just been inconsistent in how I treat it. Sometimes I show a $ allocation, sometimes I don’t and just say it is included in the value and has a positive effect on value. Either way, I’m always clear on whether non-real property items are in the value or not.

So just trying to nail down exactly what is right or what USPAP expects. I’ve seen personal property treated many different ways and some appraisers still don’t say anything about it… USPAP doesn’t say much on the topic.

Thanks for any input!

As stated in Standards Rule 1-4, part (G): When personal property, trade fixtures, or intangible items are included in the appraisal, the appraiser must analyze the effect on value of such non-real property items.

My question is what is the extent of “analyzing the effect on value?” For instance, in a multifamily property with appliances necessary for continued operation, do we need to actually state the estimated amount that the appliances contribute to value or is it sufficient to note that the market value includes all personal property items which contribute to the market value?  If the value needs to be broken down and allocated between real property and non-real property items – can the allocation be stated once near the beginning of the appraisal report or does the allocation have to be every place where there is a market value stated?

Just curious because I have heard several versions and I didn’t really see any Advisory Opinions on the topic.

============  MY REPLY ============================

Your question only exists because the ASB and AI and others won’t specifically address the various differences between USPAP and FIRREA.
The bottomline is USPAP does NOT require a value on the FF&E.  Albeit, it would probably help all clients to know such.  More info cannot hurt.
However, FIRREA DOES require values be allocated to FF&E and Business/Intangible Assets so that the appraiser provides the ONLY required value per FIRREA – Market Value As Is of REAL ESTATE ONLY.
So, when doing an appraisal for a Federally-Related Transaction, you MUST provide a value for the non-realty items.  It has been that way since 1990/1991.
Where you place it….well that is up to you.  But, technically, when you state Market Value As Is (as well as Upon Completion and Upon Stabilization) it should just be the Real Estate Only number.
However, 99%+ of appraisers state Market Value INCLUSIVE of FF&E and Biz Value and then have some kind of footnote or wording in parentheses saying ‘the above includes $1,400 of FF&E’. Something like that.  They let the Bank do the math to get to the real estate only number.
So, you can do it that way and you will be in line with your peers.  As I always tell appraisers though, if you want to stand out from the crowd provide what your client really needs, and in this case, state MV without the FF&E and Biz Value and then let the footnote say how much the FF&E and Biz Values are worth.

The reason banks need the Real Estate Only number is it is Federal law (FDICIA of 1991) that LTV must (!) be calculated on this number only.  Any MV number that includes FF&E and/or Biz Value is worthless to a bank!

Now, for non-Bank clients you can forget all of the above.  However, I still recommend providing the separate values.
I hope this helps.

Market Value As Is is not always the same as Market Value

August 24, 2015 – I had this email exchange with a review appraiser today.  This is one of the situations where Market Value As Is and Market Value can differ.

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George,

I have a question regarding an appraisal that I am reviewing if you have a moment to help me out.  I am overthinking this and now can’t decide which is correct.
Background info:  The property is a large (100,000 SF) multi-tenant industrial building.  The client asked for “as is” and “as stabilized” values in the engagement letter.  The building is currently 30% vacant and the appraisal estimates stabilized to be 15%.  The appraisal also states that the building will achieve stabilization within the year.  Four of the tenants have rent increases within the next 12 months.  The appraisal utilizes the current rent roll at current rent levels, but increases the four tenants to their future rate.  In addition, rent for the vacant space is estimated at market levels.  Using these parameters, PGI is estimated.  Vacancy is set at 15%, expenses are subtracted.  The appraisal then has two below the line expenses for tenant improvements (assuming a 10-year amortization) and leasing commissions.  The resulting figure is capitalized into a value which the appraisal calls “as is”.  The appraisal further states that this is also “as stabilized” because the property will be stabilized within the year.
Here is where I feel that I’m over thinking this.  I know that the Income Approach is based on the principle of anticipation and that future income is to be considered.  So is the “as is” value the rent roll at current rent levels with no consideration toward the rental of the vacant space and no bumps in rates for the 4 tenants?  Or is the application noted above correct give the anticipation of future benefits?
I find it hard to believe that the “as is” and “as stabilized” can be the same value since the property is not currently stabilized.  However, given the principles of the Income Approach I can also see how this could be so.
Sorry for the long email.  I would appreciate any guidance you can give me on this.  I value your input.
On a side note, I have enjoyed reading your website and blog; very informing.
Thanks!
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Hi ABC,

Thanks re the blog….appreciate it.
Regarding the As Is Value, the appraiser is wrong.  For a Market Value appraisal (non-Bank client), s/he may be right or wrong.
As Is means just that.  Deductions MUST be made for leasing commissions to go from 30% to 15% vacancy.  TI for that same space.  And lost income during the 12 months the space is leased.  And of course discounted for time.
The December 2010 Interagency Guidance states the following:

Partially Leased Buildings – For proposed and partially leased rental developments, the appraiser must make appropriate deductions and discounts to reflect that the property has not achieved stabilized occupancy. The appraisal analysis also should include consideration of the absorption of the unleased space. Appropriate deductions and discounts should include items such as leasing commission, rent losses, tenant improvements, and entrepreneurial profit, if such profit is not included in the discount rate.

I tell appraisers MV As Is different from Market Value.  In a general MV appraisal, MAYBE (only maybe) might the market not make deductions if they think all will be fine within a year.  Personally I would make deductions if buying your subject property, but optimistic investors may not.
However, for As Is appraisals the deductions MUST be made.
I think it would be fun for you to ask the appraiser for a list of names and numbers of people s/he talked to that said in a case like this they would not make any deductions for LC, TI, and rent loss.  Simply say you would like to talk to market investors and better understand their viewpoint:)  I seriously doubt you will be provided with a list of such contacts.
I hope this helps.
George