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Weekly UpdatesWe, the cosigners of this response, read with great interest the article by David Lennhoff, MAI, SRA, entitled "You Can't Get the Value Right If You Get the Rights Wrong" (Winter 2009). The following comments are not an official position of the Maricopa County Assessor's Office, but are a reflection of the thoughts and concerns we have over what is being proposed in the article.
The premise of the article appears to be that single-tenant, built-to-suit (or custom) commercial real estate can be overvalued if an appraiser focuses solely on property-specific factors, rather than general market forces, to estimate market value. The article then goes on to assert that "the best support for the components of both the sales comparison approach and the components of the income capitalization approach is second-generation space." To automatically default to valuing first-generation space as if it were second-generation space ignores the market's acceptance of the property.
However, before we address the methodology suggested in the article, we must point out that anytime an appraiser suspends reality (as suggested by this article) he or she has by definition created a hypothetical condition. Hypothetical condition is defined in the Uniform Standards of Professional Appraisal Practice (USPAP) as "that which is contrary to what exists." We understand that using comparables that do not exactly mirror a subject property does not constitute a hypothetical condition; however, when you intentionally set out to value the subject under a set of conditions that do not exist there is no choice but to call this a hypothetical condition. When you utilize comparables that do not reflect the subject's condition, you must be sure to account for all of the potential differences.
We would also caution all appraisers that whenever a hypothetical condition is made, appraisers must make sure they have met the use and disclosure requirements found in USPAP. While appraisers are required under USPAP to report that the use of the hypothetical might have affected the assignment results, they are not required to report on the impact of the assumption. However, we would suggest, depending on the use of the report, that the failure to disclose the impact might render a report misleading.
The article states that all built-to-suit properties are sold or leased solely on the basis of recouping the original cost to develop and never on market conditions. We would respectfully suggest that there is a direct relationship, particularly with relatively new properties, between sale price or lease amount and the cost to develop. This relationship is not absolute, but tempered by market conditions. This is why it is important that all appraisers make sure they understand the motivation of the market and the market participants. Please do not misunderstand what we are saying here. There certainly are times where built-to-suit properties are sold or leased solely on original cost to develop ignoring market conditions, but to make a blanket statement that this is always the case appears unrealistic. This is why a market analysis is so important and why we have Standard 1-3 in USPAP.
The real question that must be answered for all single-tenant, built-to-suit properties is how have they been accepted in the market? If the property is brand new and there is nothing similar in the marketplace, then the risk that the market may not accept the subject is higher. But if the subject has been successful in the marketplace for a number of years without substantial modifications then this is a demonstration of market demand/acceptance for the property. This demand/acceptance is strengthened when there are similar properties in a marketplace continuing for a number of years as first-generation space even when these properties do not change hands. The demand/acceptance is further supported if there is new construction of similar properties. All of these factors are exactly what Standard 1-3 envisions when it states an "appraiser must, identify and analyze the effect on use and value of ... economic supply and demand ... and market area trends; and develop an opinion of the highest and best use of the real estate." This analysis is the foundation of making any appropriate adjustments for custom-developed properties.
Utility is one of the four elements of value. Utility is the ability of a product to satisfy a human want, need, or desire and generally the greater the utility a property has, the greater its value. You cannot simply assume that utility and uniqueness are inversely related from a market standpoint. The fact that a property is unique does necessarily have an impact on its value one way or the other. Measuring the utility of a unique property is not easy, but there are certainly reasonable benchmarks that can be set up to quantify this factor.
The more unique a property is, the more important it is to establish reasonable ranges that the subject's value must fall between. It is easy to get too fancy and outsmart oneself with complicated ways to measure obsolescence and superadequacy. This is one of the great values of the cost approach. The cost approach with only depreciation for wear and tear can provide a reasonable upper end of such a range quickly and easily. The bottom end of this range can also easily be established by examining second-generation space.
Second-generation sales may have a utility equal to or less than first-generation space. The original user, for whatever reason, is no longer utilizing the property. This difference in utility may be big or small, but must be recognized, quantified, and if appropriate, adjusted for. Therefore, all other factors being equal, a second-generation development sets the bottom end of the reasonable range of value. Again, utility is the key.
If the second-generation space is able to capitalize on all of the utility of the development, the difference between it and first-generation space may be minimal or nonexistent. However, if the second-generation user, for whatever reason, is not able to capitalize on the utility of the development an adjustment to reflect this difference must be attempted. To automatically default to utilizing second-generation space to value first-generation space without accounting for the potential difference in utility is like saying you must adjust the best location in town downward because no other property has the same attributes. It punishes the owner of the property for its unique nature.
We also wish to caution readers to make sure they have adequately accounted for all applicable laws and ordinances that may impact this type of work. The article specifically talks about these types of properties being valued for tax assessment purposes. Depending on the state or jurisdiction in which the assignment will be utilized there may be additional factors to consider. Courts and legislatures frequently redefine familiar appraisal terms, creating connotations that are very different from that to which the appraiser may be accustom.
For example, valuing property for tax assessment in Arizona requires the appraiser to take into consideration the subject's current use not just highest and best use. Arizona Revised Statutes state:
42-11054. Standard appraisal methods and techniques
C. In applying prescribed standard appraisal methods and techniques:
1. Current usage shall be included in the formula for reaching a determination of full cash value. (Emphasis added)
The article states the "current use value" estimate would be higher than a "value in exchange." We would suggest that depending on the particulars of the subject property, its value in use could be higher, lower, or similar to market value.
We also would like to bring to readers' attention the following courts cases, which may be of use to appraisers who are considering assignments for tax assessments.
In STC Submarine v. Department of Revenue (320 Or. 589.890 P.2d 1370 (1995)) the Oregon Supreme Court relied on and quoted twice the following statutory language: "If the property has no immediate market value, its real market value is the amount of money that would justly compensate the owner for loss of the property." To paraphrase: the market value of the current use is to be interpreted as the value in use.
In Sperry Rand v. Department of Revenue (112 Ariz. at 581, 544 P.2d at 1096) the court stated that a "special purpose building with little or no value on the market but having great value in use to the owner should not be assessed by use of the market technique but, instead, by a cost less depreciation method."
Similarly, in New York Stock Exchange Building Company v. Cantor (223 N.Y.S. 64 (1927), aff'd mem., 162 N.E. 514 (1928)) the court indicated that a "stock exchange building, which could be used only by stock exchange, had no value on the market and was to be assessed at reproduction cost less depreciation; owner's argument for zero valuation rejected."
In conclusion, while some of the ideas presented in the article have merit, we would caution the reader to be careful. First, be careful with complicated valuation methodologies that may lead you to a conclusion that more straightforward analysis will not support. Second, be careful to understand the landscape of your environment, i.e., make sure you are aware of any applicable statutes or court cases that may impact your analysis.
Charles Krebbs
Deputy Assessor
David Gillies
Deputy Assessor
Kim Kobriger, MAI
Manager Internal Audit
Michael G. Husij, MAI
Deputy Assessor
Keith E. Russell, MAI
Assessor, Maricopa County
Phoenix, AZ
Author's Response
I must say, in the 20+ years I have been publishing in The Appraisal Journal I have never had an article generate as much response as this one. It is quite gratifying that so many are reading it. I sincerely appreciate it.
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