Tag Archives: CRE

Mann Overboard

GUEST POST – BY JOHN CULBERTSON, CCIM, CRE, SIOR

MAY 5th – Happy Cinco de Mayo!  Below is from John Culbertson, CCIM, CRE, SIOR of Cardinal Partners.  He can be reached at jculbertson@cardinal-partners.com.

John gave me permission to reprint this.  I totally agree with his take on this subject.  I don’t only post things I agree with – I  am open to anything that makes people think.  Of course, non-political, non-religious, no insults, et al.  I hope you find John’s thoughts of use as you hear people all over saying work from home is here to stay and office buildings are in big trouble, et al.

Stay safe.

The Mann

Dear El Cardinale,

As people get used to Zooming and working from home in their pajamas, do you think the way we work has changed forever?

– Homer

Dear Homer,

You are right in that we are likely to make some tweaks to our work habits because of the unprecedented order to work from home. However, I don’t think this will change the way we will work in the future.

To start, new habits are hard to form. Research shows it takes 21 days of conscious, enthusiastic, and consistent effort before a new habit is formed. I’m what I call a habit cultivator, and I know how difficult it is to create new ones. To some extent, the degree to which our working habits change will be tied to how long it is before the all-clear whistle blows.

There also are other factors to consider.


  • The fiefdom. The physical office is where the boss is, and he or she often likes his or her fiefdom. The person that pays your salary likes to see employees busy at work. Your employer also has a huge commitment to that fixed cost of the office that they don’t want to see wasted.



  • Long-term commitment of office space. Office leases are usually seven years long on the short end, with facility expenses usually being one of the top three expenses for any company, this represents a sunk cost that the company is going to want to use as an asset.



  • Lack of suitable infrastructure. I have an Asian client that is struggling now in part because they don’t have a lot of experience with working from home. Their residential areas do not have adequate bandwidth, and homes tend to be smaller, meaning less space for an office. I suspect they will return to working from an office setting as soon as their government allows it.



I view what’s happening now akin to when one takes a sabbatical. There are some occupations and cultures where every three years or so people are expected or offered the chance to take a month-long sabbatical. Some people study or conduct research in another country, while others may simply check out of their daily routine. When they come back, they may be refreshed or rejuvenated, and they may have new ideas. But typically the way they work hasn’t drastically changed.

By the way, Microsoft disagrees with me – here is a link to a deeper dive. But I am an Apple guy 😉

My suggestion is to enjoy this unexpected sabbatical that has been thrust upon us and to look forward to returning to a new normal with some new ideas and a fresh outlook.
 

 

Reviewer Thoughts & Tips

ABOVE MARKET LEASES CANNOT INCREASE REAL PROPERTY VALUE

January 17, 2020 – I addressed this issue in a June 29, 2016 post.  It is sad that almost 4 years later appraisers still do not separate the value of national tenant leases (almost always significantly above market) between Real Property Value and Intangible Value.

Recent examples I have encountered have been extreme.  A proposed c-store ground lease had the land valued at $1,000,000 (based on numerous nearby land sales) and the lease valued at $4,300,000.  Therefore, Prospective Value ‘Upon Completion’ (of the sitework) was $1,000,000 and Intangible Value was $3,300,000.  Several ground leases to fast food restaurants weren’t as extreme.  But, still the Intangible Value was over 100% of the Real Property Value.

Although I care less what the market does (See Mann’s Axiom), it is a common argument appraisers like to make when they are arguing that FF&E in Apartments aren’t separately valued by market participants (find me a Balance Sheet that does not have a Short-Lived Assets category…recent purchase contract I reviewed had FF&E separately discussed and one even placed a value on these items!) or national tenant leases sell based on the contract rent, et al.  However, I came across the following standard wording in annual reports of several REITs:

Purchase Price Allocation
When we acquire real estate, we allocate the purchase price to: (i) the tangible assets acquired and liabilities assumed, consisting primarily of land, improvements (including irrigation and drainage systems), buildings, horticulture, and long-term debt, and, if applicable, (ii) any identifiable intangible assets and liabilities, which primarily consist of the values of above- and below-market leases, in-place lease values, lease origination costs, and tenant relationships, based in each case on their fair values.

 

So, that eliminates that argument:)  In fact, the market does allocate value to above market rent to intangible assets.  Case closed on this issue.

What was surprising to me was they also allocate the amount of value due to below market rent to (I assume) liabilities.  That is interesting.

My post from 2016 is below.

Happy New Year to all.  May 2020 be a great year for you.

The Mann

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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:)

 

Reviewer Thoughts & Tips, Unlisted1

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:)