Defending a Commercial Assessment Using the Three Approaches to Value

2. Defending a Commercial Assessment Using the Three Approaches to Value Jim Siebers Ed Martinez

3. Let’s Meet the Audience! Show of hands: • How many of you are involved with Assessors? • How long have you been in the appraisal industry? • 0-5 Years? 5-10 Years? • 10-20 Years? 20+ Years? • How comfortable are you with the Cost Approach?Income Approach?Market Approach? • Very, Somewhat, Not at All

4. Key Takeaways from This Presentation • How to properly collect the data required for each approach to value and where to find it • How to properly apply the three approaches to value • How the information fromthe three approaches to value can be used to defend an assessment

5. The Property:10001 Innovation Drive | Milwaukee, WI

6. Geographic Information Systems (GIS)

7. Use to Verify Parking Lot Size

8. Aerial Sketch Sketch Created Using APEX

9. Sales Comparison Approach In the sales comparison approach, an opinion of value of market value is developed by comparing properties similar to the subject property that have recently sold, are listed for sale, or are under contract (i.e. for which purchase offers and a deposit have been recently submitted)1. Source: The Appraisal of Real Estate, 13th edition, page 297

10. Sales Comparison Approach Definition: The process of deriving a value indication for a subject property by comparing similar properties that have recently sold with the property being appraised, identifying appropriate units of comparison, and making adjustments to the sales prices (or unit prices, as appropriate) of the comparable properties based on relevant, market-derived elements of comparison. Source: The Appraisal of Real Estate, 13th edition, page 297

11. Information Sources • Property Appraisal and Assessment Administration, IAAO • The Appraisal of Real Estate, 13th Edition, The Appraisal Institute • Wisconsin Property Assessment Manual, DOR • Loopnet • Xceligent • Other Assessor’s offices

12. Sales Comparison Approach – Key Points • State constitutions, statutes, and case law define market value standards for assessments • In the absence of a sale of the subject, sales prices of comparable properties are usually considered the best evidence of market value • Comparable properties are selected for similarity to the subject • Sales prices are adjusted and the market value is estimated Source: Property Assessment & Administration, IAAO, Page 153

13. Relation to Appraisal Principles 1) Supply and Demand 2) Substitution 3) Balance 4) Externalities 5) Market Analysis and Highest and Best Use

14. Required Steps – per PAAA • Definition of the appraisal problem • Data collection • Analysis of the market to develop units of comparison and select attributes for adjustment (model specification) • Development of reasonable adjustments (model calibration) • Application of the model to adjust the sales prices of comparables to the subject property • Analysis of the adjusted sales prices to estimate the value of the subject property Source: Property Assessment & Administration, IAAO, Page 153

15. Required Steps – Per The Appr of RE 13th Ed. • Research the competitive market • Verify the information • Select the most relevant units of comparison • Look for differences between comparable sale properties and the subject property • Reconcile the various value indicators

16. Sales Comparison Approach – How Used The sales comparison approach may be used to value: 1) improved properties 2) vacant land or 3) land being considered as though vacant when an adequate supply of comparable sales is available Source: The Appraisal of Real Estate, 13th edition, page 297

17. Data Sources for Sales Data • Public Records • Commercially available data from electronic reporting, multiple listing and subscription services • Published news articles in local newspapers or real estate periodicals • Interviews with market participants Source: The Appraisal of Real Estate, 13th edition, page 303

18. Recommended Adjustments • Qualitative vs. Quantitative Adjustments • Transactional vs. Property Adjustments • Transactional, Physical & Economic Adjustments – per Wisc DOR

19. Adjustment Examples • Real property rights conveyed, financing terms, conditions of sale • Expenditures made immediately after purchase • Market conditions • Location • Physical characteristics • Economic characteristics • Use • Non realty Source: The Appraisal of Real Estate, 13th edition, page 309

20. Example of Comparable Grid 02/01/2014 04/30/2014 10/18/2013

21. Comparable Grid (continued)

22. Indicated Value by Comparable Sales Approach Comparable Sales Valuation $6,152,600 $1,631,600 $4,521,000 Total Land Building

23. Reconciliation of Value by the Comparable Sales Approach After adjustments have been made: • Weigh each comparable to determine its relative contribution to the final value estimate • Determine sales comparison value Source: The Appraisal of Real Estate, 13th edition, page 175

24. The Income Capitalization Approach In the income capitalization approach, an appraiser analyzes a property’s capacity to generate future benefits and capitalizes the income into an indication of present value. Source: The Appraisal of Real Estate, 13th edition, page 445

25. So everyone wants to know: What is the “Magic Formula” for performing an Income Approach? This segment of the class will teach you what it is. For those that are too impatient to wait, I will give it to you now. But, it is like reading the last chapter of a book before you know what exactly happened to get you to this point.

26. Take PGI and subtract V&C Losses and add miscellaneous income to get to EGI. Then take EGI subtract expenses to get to NOI. If you use IRV where NOI is I and divide that by R you will get V.

27. Or, if the previous formula was too complicated … Take Rent and multiply it by the GRM to get V that way…

28. So what does this all mean? I invite you to pay attention to the next ½ hour. Reference Materials from: The New York State Board of Equalization & Assessment, now known as The New York State Department of Taxation & Finance.

29. Income Approach Direct Capitalization: The conversion of anticipated net income into present value by dividing the income of an appropriate rate which reflects the prevailing relationship of net income to selling price for comparable properties being sold in the open market.

30. The Basis for the Income Approach

31. Types of Rent • Historical Rent: Rent paid in past years • Contract Rent: Rent presently paid by agreement between the user (tenant) and the owner • Economic Rent: The rent which a property should command on the open market at any given time

33. Information Sources - Income • Newspaper-Business Journal, Ads in local paper • Owners / Tenants • Income/Expense Statements • Sales Surveys-buyers/sellers • Revaluation Surveys

34. Types of Income • Potential Gross Income (PGI) • Effective Gross Income (EGI)EGI = PGI – (Vacancy + Collection Loss) • Miscellaneous Income • Net Operating Income (NOI) NOI = EGI - Expenses

35. Potential Gross Income (PGI) A property’s economic rent at 100% occupancy

36. Effective Gross Income (EGI) The economic rent of gross income reduced by normal vacancies and uncollectable rents, plus other miscellaneous (service) income.

37. Miscellaneous Income (Services) • Parking Fees • Laundry Room Income • Vending Machine Receipts • Late Fees

38. Sources of Income Information • The owner • The property manager • The real estate agent-M.L.S. • Craigslist / Ads in the paper • Tenants • Personal property returns • Income/expense surveys • Internet web sites

39. Operating Expenses • All expenses necessary to maintain the production of income to operate a property; the difference between Effective Gross Income and Net Operating Income. • Also used to denote a category of expenses that doesn’t include fixed expense such as debt service, depreciation allowance and reserves for replacements.

40. Information Sources - Expenses • Assessors • Appraisers • Brokers • Dept. of Development • Lending Institutions • Industry & Trade Association Publications • Sales Surveys-Buyers & Sellers • Revaluation Surveys

41. Information Sources - Income and Expense • Loopnet / Internet Sources • Multiple Listing Service • Xceligent/CoStar • Appraisal Institute/Appraisers • Commercial Brokers

42. Heat/Utilities General Maintenance Insurance Trash Collection Hardware & Supplies Snow Removal Advertising Salaries Exterior Repairs Landscape Maintenance Legal & Accounting Exterminating Management Supplies Proper Operating Expenses

43. Improper Operating Expenses • Debt Service • Owner’s Business Expense • Income Taxes • Additions to Buildings

44. Operating Expenses to Watch These operating expenses need to be treated differently than the previous allowable expenses. • Reserve for Replacements • Property Taxes

45. Reserves for Replacements A Provision for recapturing future depreciation by making an allowance in the annual operating statement to provide for the replacement of shorter lived items necessary in order to sustain a projected level of income (e.g. Roof replacement, refrigerators, carpeting, furnaces, air conditioning units).

46. Property Taxes • Assessors, unlike most owners, should not consider real estate taxes to be allowable expenses and do not usually subtract from the NOI, even though taxes are a valid charge against the property. • The assessor or appraiser working with an assessor should instead account for property tax expense by including a percentage for property taxes in the capitalization rate.

47. Net Operating Income (NOI) Annual net income after operating expenses are subtracted from effective gross income. Does not include payments for principal or interest. N O I

48. Tips for Accurate Income/Expense Statements • Get last three years statements • Watch reserves for replacements when including in expenses • Check that capital expenditures are not included in expenses • Ask for an itemized list of expenses in generic categories such as general maintenance

49. Capitalization Rate • Types include: • Overall Cap rate • Summation-mortgage equity Any rate used to capitalize income. It reflects the relationship between income and value. It is calculated by the IRV formula, in which: • Rate = Income / Value • Value = Income/Rate • Income = Rate/Value

50. Information Sources - Cap Rates • Your or other Assessor’s Database • Appraisers/Appraisals • Appraisal Institute - National Market Indicators • Price Waterhouse Coopers Korpacz – Real Estate Investor Survey • Insurance Companies • Bank/Lending Institutions • Brokers- CARW