The Role Of An Appraiser

Culture Character Commitment

International Real Estate Appraisal, Consulting & Advisory Services

THE ROLE OF AN APPRAISER: "VALUATION TECHNIQUES FOR COMMERCIAL REAL ESTATE AMIDST A WORLD OF CHANGE"

PGP VALUATION, INC 110 SW Yamhill, Suite 200 Portland, Oregon 97204 503.226.0983 - Main

W. Grant Norling Managing Director 503.542.5416 [email protected]

Jeff Grose, MAI Managing Director 503.542.5411 [email protected]

INTRODUCTION

There is broad sweeping change in the mindset of the World economy caused by the credit crisis, economic downturn and long-term uncertainty, which is having a profound impact on the real estate market. Our job as appraisers is to interpret what is occurring in the economy including supply/demand conditions, unavailability of financing, rising unemployment and alternative investment vehicles in order to credibly estimate the value of real property. The following information provides an introduction to the commercial real estate appraisal process, and summary statements with regard to how we are adapting our analysis to the changing economic conditions. Appraisal: (noun) the act or process of developing an opinion of value; an opinion of value. (adjective) of or pertaining to appraising and related functions such as an appraisal practice or appraisal service. Appraiser: one who is expected to perform valuation services competently and in a manner that is independent, impartial, and objective. Appraisal Process 1) Define the problem Identify the real estate Identify the rights to be valued Establish the intended user of the appraisal Determine the definition of value Determine the effective date of the appraisal Identify the scope of the appraisal Establish any assumptions and limiting conditions 2) Preliminary Analysis and Data Collection 3) Highest and Best Use Analysis 4) Land Value Estimate 5) Apply the Appropriate Valuation Techniques (Cost, Income, and Sales) 6) Reconciliation of Value and Final Value Conclusion 7) Report the Defined Value Scope of Work: the type and extent of research and analysis in an assignment. The scope of work is defined by the appraiser and the client. However, the appraiser can not limit the scope of work to such a degree that is jeopardizes the reliability of the value conclusion. The most common value scenario requested is the As Is Market Value. defined below:

Market Value is

The most probable price which a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller each acting prudently, knowledgeably, and assuming that the price is not affected by undue stimulus. Implicit in this definition is the consummation of a sale as of a specified date and the passing of title from seller to buyer under conditions whereby: 1. Buyer and seller are typically motivated; 2. Both parties are well informed or well advised, and acting in what they consider their own best interests; COPYRIGHT © 2009 PGP VALUATION INC. ALL RIGHTS RESERVED

3. A reasonable time is allowed for exposure in the open market; 4. Payment is made in terms of cash in United States dollars or in terms of financial arrangements comparable thereto; and 5. The price represents the normal consideration for the property sold unaffected by special or creative financing or sales concessions granted by anyone associated with the sale.1 The scope of work may be defined by the appraiser, however, the scope of work must meet or exceed 1) the expectations of parties who are regularly intended users for similar assignments; and 2) what an appraiser’s peers’ actions would be in performing the same or similar assignment. Appraisal Reporting Options An appraiser has 3 options for written reports: Self Contained Summary Restricted Use Three Approaches to Value Cost Approach Income Approach Sales Comparison Approach

1

Office of Comptroller of the Currency (OCC), Title 12 of the Code of Federal Regulation, Part 34, Subpart C - Appraisals, 34.42 (g); Office of Thrift Supervision (OTS), 12 CFR 564.2 (g); This is also compatible with the RTC, FDIC, FRS and NCUA definitions of market value.

COPYRIGHT © 2009 PGP VALUATION INC. ALL RIGHTS RESERVED

COST APPROACH

The cost approach is based upon the principle that the value of the property is significantly related to its physical characteristics, and that no one would pay more for a facility than it would cost to build a like facility in today's market on a comparable site. In this approach, the market value of the site is estimated and added to the estimated depreciated value of the improvements. Or Replace Cost of Improvements w/ profit – Depreciation + site value = Cost Approach Value ____________________________________________________________________________ Replacement Cost New All costs to construct -Direct Cost (materials, labor, contractor overhead) -Indirect Cost (perm. financing, marketing, professional reports) Sources for Data: Developer’s Budget, Cost Comparables, Marshal Valuation, Bids (+) Profit Sufficient entrepreneurial incentive to compensate risk -Varies based on market sector Developers (10-20%) Users (5%) Sources: Market survey, alternative investments (–) Depreciation Three Types -Physical (typical wear & tear) -Functional (obsolescence due to design) -Economical (surrounding influences) (+) Land Value Cost of equivalent substitute site -Valuation techniques Sales comparison (most typical) Residual analysis = Cost Approach Value ____________________________________________________________________________ Most Applicable for: New or proposed construction Owner/user properties Special purpose properties Limited Application for: Investment properties -mostly to test financial feasibility Older construction -difficult to measure accrued depreciation

COPYRIGHT © 2009 PGP VALUATION INC. ALL RIGHTS RESERVED

COST APPROACH SUMMATION TABLE M ARSHA LL V ALUA TIO N S ERV ICE CO ST ESTIM ATE Dir ec t Co sts

$ 1,665 ,5 05

In dire ct Costs

$ 651 ,5 50

T ot al Co s ts

$ 2,317 ,0 55

Per Sq uar e Fo ot

$18 8.84

CONCL UDED DIRECT & INDIRECT IM PROV EM ENT COS T

$ 2,317 ,0 55

P e r Sq uar e Foot

$18 8.84 20.0% of Imp ro veme nt Cost & Lan d V alue

Ent re pre n e ur ia l Pr ofit

$ 699 ,4 11

Re plac e m e nt C os t Ne w

$ 3,016 ,4 66

DEPRECIATION Cur able De pr eciation

$0

Mar ket Extr action Me th od Ef fec tiv e A ge

5 Y ea rs

Total Eco no mic L ife % De pr ecia te d

4 5 Y ea rs 4 .0 %

S ubtotal

($ 120 ,6 59)

Tot al De pr e ciat io n

( $1 20,65 9)

De pr e ciat e d Re place m e n t Cos t

$ 2,895 ,8 07

Site V alue

$ 1,180 ,0 00

V ALUE INDICAT IO N BY THE COS T A PPROA CH

$ 4,075 ,8 07

Round e d

$ 4,080 ,0 00

P e r Sq uar e Foot

$33 2.52

Cost Approach in a Declining Market Many new projects are not financially feasible. The lease-up or absorption/sell-out of a project becomes extended. Many projects appraised 18 months ago that are nearing completion are no longer profitable due to extended marketing periods. Replacement cost becomes a less reliable indicator of market value. Land value assumptions change. In an active construction market, land is purchased for immediate development. If a development parcel is purchased now, the buyer’s assumption would be to hold until development is feasible. Additional holding costs may require a downward adjustment to the land sales that sold in 2007.

COPYRIGHT © 2009 PGP VALUATION INC. ALL RIGHTS RESERVED

INCOME APPROACH

In the Income Approach a property’s capacity to generate income is analyzed, which is in turn capitalized into an indication of present value. Two fundamental methods are used in this approach, Direct Capitalization and Yield Capitalization, which are described below: Direct Capitalization Method - The advantages of direct capitalization are that it is simple to use, easy to explain, often expresses market thinking, and provides strong market evidence of value when adequate sales are available. Direct capitalization is most commonly applied by applying an overall capitalization rate to relate value to the entire property income (i.e., net operating income). Yield Capitalization Method - This method is typically referred to as a Discounted Cash Flow Analysis. Market supported assumptions and projections are made for future changes in occupancy, rents, income, and expenses to arrive at periodic cash flow. The property’s eventual reversion is also estimated, incorporating anticipated changes in the property and market conditions. The resulting cash flows are discounted to a present value indication using an appropriate market supported yield rate. _________________________________________________________________________ Direct Capitalization – Most Commonly Used The following steps create a basic outline of the income approach: • • • • •

Estimate income Estimate Vacancy and Expenses Derive an estimate of Net Operating Income (NOI) Derive a capitalization rate from a) market sales, b) band of investment analysis Divide the NOI by the Capitalization rate to estimate the value

The fundamental principle in this approach if anticipation. The anticipated risk associated with the income stream is implicit in the cap rate. A basic Income Approach is: Potential Income – Vacancy = Effective Gross Income Effective Gross Income – Expenses = NOI NOI /Capitalization Rate = Value ______________________________________________________________________ Limitations—The limitations of this approach include: Lack of recent, directly comparable rental rates Lack of market transactions from which to derive a reliable capitalization rate Common Mistakes—Common mistakes made by market participants include: • Understanding the difference between current income and potential income and between fee simple and leased fee value • Estimating appropriate expenses • Understanding the structure of the leases in order to measure appropriate expense reimbursements when applicable • Deriving an appropriate capitalization rate based upon the risk factors of the property COPYRIGHT © 2009 PGP VALUATION INC. ALL RIGHTS RESERVED

DIR EC T CAP ITALIZATION S UMMATION TAB LE Sq uar e Fe e t

M ar k e t Re n t PSF

M on thly Re nt

Ann ual Re nt

S uite 7 07 - 5 ,0 00 SF

5,00 0

$ 24.00

$10 ,000

$1 20,00 0

S uite 7 37 - 1 ,4 00 SF

1,40 0

$ 26.00

$3 ,033

$ 36,40 0

S uite 7 43 - 5 ,8 70 SF

5,87 0

$ 24.00

$11 ,740

$1 40,88 0

Tot al Re nt al Inco m e

12,27 0

$ 24.23

$24 ,773

$2 97,28 0

$3 ,782

$ 45,38 6

In com e Ite m s Re nt al Inc om e

Additiona l/Ot he r Inc om e Expense Reimbu rsemen ts Tot al Ad ditiona l/Ot he r Inco m e

$3 ,782

$ 45,38 6

POTENTIAL GROSS INCO ME (PGI)

$ 27.93 /S F

$342,666

V ac ancy & Cr e dit Lo s s Rental Inco me

5%

$1 ,239

A dditiona l/Other Inco me

5%

$189

$2,26 9

5 .0 %

$1 ,428

$ 17,13 3

Tot al

$ 14,86 4

EFFECTIV E GROSS INCOM E (EGI)

$ 26.53 /S F

Est im a te d Expe ns e Ite m s

% o f PGI

% of EGI

T ota l

Per S F

Real Es ta te Taxe s*

5.9%

6.2%

$20 ,232

$1 .6 5

In sur an ce*

1.1%

1.1%

$3 ,681

$0 .3 0

Commo n A re a Mainten anc e*

6.3%

6.6%

$21 ,473

$1 .7 5

Mana geme nt Fee

3.1%

3.3%

$10 ,580

$0 .8 6 $0 .1 5

Reserv es Tot al

0.5%

0.6%

$1 ,841

16 .9%

17 .8 %

$57 ,806

$4 .7 1

NET OP ERATING INCOM E ( NOI) V aluat ion of Incom e

$ 21.82 /S F NOI

Div ided b y

Ca p. Rate

Eq uals

V alue

$ 267 ,726

÷

6 .5 0%

=

$4,1 18,86 8

ESTIM ATED V ALUE ( ro unde d)

$325,533

$3 35.78 /S F

$267,726

$4,120,00 0

* Reimbur sab le e xpens es

Income Approach in a Declining Market The Income Capitalization Approach is the best measure of value for income-producing investment properties. One challenging task in the current economy is accurately estimating market rents, which requires the appraiser to measure the impacts that softer market conditions are having on rents. Without a doubt, the most difficult and important modifications to our appraisals are occurring in the capitalization and discount rate analysis. Due to the drastic decline in investment sales over the past year, it takes a lot of creative analysis to reasonably estimate current capitalization rates. We look in the rearview mirror on past transactions, consider current listing and review national trends in order to provide the most reasonable estimate.

COPYRIGHT © 2009 PGP VALUATION INC. ALL RIGHTS RESERVED

SALES COMPARISON APPROACH

The Sales Comparison (Market) Approach is based on the principle of substitution, which asserts that no one would pay more for a property than the value of similar property in the market. In this approach, the subject property is compared directly with other recent sales of similar properties in the marketplace. This comparison is typically accomplished by extracting “units of comparison,” for example, price per square foot, and then adjusting these units of comparison for the comparable sales for differences between the subject and each comparable. The reliability of an indication found by this method depends on the quality and quantity of the comparable data found and the ability of the appraiser to make reasonable and supportable adjustments. In active markets with a large number of sales that are physically similar comparables, this approach is generally a good indicator of value.

Sources of Comparable Data








Buyer Seller Brokers Public records Professional data companies Multiple listing services Other appraisers

Typical Units of Comparison











Price/SF of gross building area Price/SF of net building area Price per unit (apartments, self storage, hotels, health care) Price per seat (restaurants and theaters) Price per door (truck terminals and distribution centers) Price per boat slip (marinas) Price per parking space (parking decks) Price per hole (golf courses) Price per lane (bowling alleys) Price per lot or pad (subdivisions, mobile home parks, RV parks)

Most Applicable for: Owner/user properties Special purpose properties Any property (retail, office, etc.) where sufficient data is available Sales Comparison Approach in a Declining Market Limited sales activity is making the sales approach more difficult. Investment sales are off 60% to 80%. As much as 50% of those sales now include assumed debt. The factors affecting value and pricing have changed. This includes buyer’s assumption on the future. For example, capitalization rates at 6% and investors IRR of 15% imply substantial increases in income over a holding period. With flat rents, higher vacancy costs to ownership, difficulty financing, the conditions in which sales took place in 2007 are much different that they are today. Appraiser now need to do a better job interviewing brokers, analyzing active listings, and drawing a conclusion from possibly older sales prior to 2007.

COPYRIGHT © 2009 PGP VALUATION INC. ALL RIGHTS RESERVED

Helping You Achieve Your Goals! Our Services Portfolio Valuations Nationwide and International Single Asset Valuations Retail Industrial Office Multifamily Partial Interest Valuations Business Valuations Consulting Specialties Appraisal Reviews Tax Appeals Corporate Advisory Services Insurance Valuation Lease and Cost Analysis Arbitration Litigation Support Financial Feasibility Studies Condemnation Discounted Cash Flow Analysis Specialized Valuation Advisory Groups Hotels & Motels Self Storage Manufactured Home Parks Market Rate Apartments Tax Credit Apartments Golf Courses Residential Condominium development/conversion Assisted Living Subdivisions Rural Properties Net Leased Properties

“PGP’s technology platform is cutting edge. Their ReportBuilder software creates a uniform, easy-to-read report which greatly assists us in aggregating the appraisal data in our underwriting templates.” - Steve Powell, COO and Principal of Situs PGP Valuation Offices Atlanta Boise Boston Calgary Carlsbad Chicago Dallas Detroit Edmonton Halifax Honolulu Irvine Las Vegas Los Angeles Phoenix Portland Sacramento San Diego Seattle

Toronto Vancouver, BC Vancouver, WA Victoria Winnipeg

Creating

Opportunities

Quietly and confidently, PGP Valuation Inc has become one of the largest and most successful real estate appraisal firms in the industry, able to complete assignments around the world.

COPYRIGHT © 2009 PGP VALUATION INC. ALL RIGHTS RESERVED