Having spent the past few years being the Chief Appraiser for a bank that, by the time I left, had acquired seven failed banks from the FDIC during the credit crisis, I started becoming a collector. Of course you can imagine the types of appraisals that had been engaged by the failed banks, but more importantly, I was able to work with some of the best appraisers in our market areas doing new appraisals trying to figure out the crazy real estate deals that these banks had done. The result was a need to find some meaningful ways to analyze, understand and support several unique and interesting valuation problems, and also some more common ones. I found a fellow collector in my friend and mentor Jeffrey A. Johnson, MAI, one of the top appraisers in the Twin Cities, who has spent his entire career creating and collecting just such examples.
The result was a book that we published (appraisalpracticebook.com) that contains examples of techniques and methods employed by real world appraisers to solve unique appraisal challenges using quantitative methods to support their opinions. And now we've decided to showcase a few examples from the book.
The first example is from the sales comparison approach, and relates to adjustments for differences in office finish for industrial properties. Not to have too cursory of a review, but in the sales comparison approach we search, find and verify recent sales of properties similar enough to the subject to be called and analyzed as comparables. If a comparable is an exact twin of the subject, then we wouldn't need to go any further. If not, then we make a comparative analysis of each comparable sale and the subject property.
If the subject and comparable differ significantly in a particular feature, then one makes an adjustment to the sale price of the comparable to reflect the features differing contributions to value for the comparable and the subject. There are two methods to accomplish this:
- Additive Model:
- Indication of Subject Value = Sale Price of Comparable – Contributing Value of Comparable Feature + Contributing Value of Subject Feature
- Multiplicative Model:
- Indication of Subject Value = Adjustment Factor X Sale Price of Comparable
In the additive model, it is the difference of the feature's value contribution to the subject, less that of the comparable, the difference of which is added to the sale price of the comparable.
In a multiplicative model the adjustment factor is the ratio of the value contribution of the subject feature divided by the value contribution of the comparable's feature.
So how does one come up with these adjustment factors? How does one support these adjustment factors?
The amount of office finish space in an industrial building appraisal is a variable for which we commonly see an adjustment made. Some industrial buildings, such as a manufacturing plant, may have a relatively small amount of office space. Other industrial buildings such as a flex or office/showroom property may even have a majority of its space finished as offices.
When a new industrial building is built it generally costs more for a greater amount of office finish space. This cost differential is an often used rationale as the basis for the adjustment that is made, and this is our first example.
Example 1 – Office Finish Adjustment – Cost Basis
The subject appraisal assignment was to estimate market value for an existing industrial office/warehouse property. The appraisal was used for refinancing purposes. The property appraised consisted of a 5.34 acre site improved with a 108,000 square foot office/warehouse building that was built in 1968 with an addition in 2005.
The subject property has a finished area of approximately 20% of net rentable building area. The comparables have finished area ranging from 7.5% to 40%. The table below summarizes the adjustments made to each sale based on the differences of finished area.
The appraisal theory behind this technique is that market value is related to replacement cost. That is, the greater the cost for buildings with higher percentages of office space, the greater the market values of those buildings. In the above chart, the appraiser first estimates the likely cost per square foot for the subject building, given its 20% level of office finish.
The same replacement cost is estimated for Sale #1, for example, which is a building with only 7.5% office finish. By dividing the estimated replacement cost of the subject by that for Sale #1, we see that such a building as the subject would have a likely cost of about +9% greater; thus an upward adjustment of +9% is reasoned to estimate market value.
This approach is viewed as a good technique of attempting to measure value differences for properties with varying degrees of office finish. One should be aware that this is a linear model and it may not apply if there is a large degree of difference in the subject and comparable buildings. This technique is considered to best measure small differences.
Finally, since this method uses cost differences to measure market value differences, one must be aware of any functional or external obsolescence issues.
Look for more examples like this from Jeffrey and I in the blog section of the Appraisal Buzz Website.
Find out more about Tony Lesicka on his author page HERE. You can read more about Jeffrey Johnson on his author page HERE. Look for more upcoming examples in our blog section or visit appraisalpracticebook.com to find out more about their book.