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Best Practices Tips

Published On 06-12-2013 , 5:01 PM

Recently, I have reviewed some appraisals that contain elements that I would consider best practices, or at the very least, good ideas.


Fee Simple Hypothetical Condition:


When a property is leased, many clients request a report that concludes a value for the fee simple estate, as well as the leased fee interest. Some appraisers value the fee simple estate using the sales comparison approach and the leased fee interest using the income approach. Others, value both property interests using the income approach, perhaps in conjunction with the fee simple value produced by the sales comparison approach.


When a property is leased and the income approach is used to value the subject’s fee simple estate also, some appraisers are recognizing that this analysis is actually valuing the property as if it were different from reality. The fee simple valuation assumes away all contract rents/lease terms and values the property as if it were leased at market terms and with market occupancy. Some appraisers conclude that the very act of appraising the property as if it were not subject to lease contracts triggers a hypothetical condition. As such, I am seeing a growing number of appraisers include such a statement in all reports where a fee simple value is concluded along with the leased fee value.


Partitioning Rent:


Typically, a DCF is the best means to value the leased fee interest in a property, as leases have finite durations. Some appraisers use DCFs with projection periods equal to the remaining lease terms and project market lease terms for the reversionary year. Others will project five or ten years out, reflective of a typical holding period, and capitalize the subsequent year’s contract rent as the reversionary amount.


Another method I have seen uses direct capitalization, rather than yield capitalization. In so doing, these appraisers recognize that excess rents overstate value and deficit rents understate value, if capitalized into perpetuity. Instead, these appraisers apply market rent in the direct capitalization process and calculate the excess rent (or deficit rent) for the duration of the lease term(s), adding/deducting this lump sum after capitalization.


Subdivision Analysis:


Best practices for subdivisions falls into three main categories: lot prices, absorption, and expenses. Retail lot prices should be supported by actual sales in competing subdivisions, as well as prior phases within the subject subdivision, if relevant. Especially coming out of a recession with gradual normalization, any assumption of annual retail lot price increases must be supported. At best, this support trends recent lot price increases. At the very least, it should be supported by an explanation of the reasoning behind the projected price increases.


I am pleasantly surprised to see more and more appraisers supporting absorption, current and future, my means of a demand analysis. This analysis examines current and projected population growth in the market area, filtered by the portion of the population that are homeowners and can afford a home at the price point of the houses developed in the subject subdivision.


Finally, holding costs not expressed as a percentage of sale prices should be increased by CPI or some other reasonable percentage, rather than remain level, unless the sell-off will be accomplished within a year. This is particularly important if retail lot price increases are projected.




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