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Owner occupied income approach

Discussion in 'Commercial/Industrial Appraisals' started by Rick Salisbury, Feb 3, 2003.

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  1. Rick Salisbury

    Rick Salisbury New Member

    0
    Nov 25, 2002
    Professional Status:
    Certified Residential Appraiser
    State:
    Illinois
    A friend of mine gave me a consulting assignment. He owns a restaurant and asked me to review an appraisal for insurance purposes. I have run the Cost Approach and Sales Comparison Approach, but am having some trouble with the Income Approach. The subject is owner occupied, although he pays the partnership (his family) rent. The rent he pays is not useful for obvious reasons (it's about twice the going rate). Is applying market rent a legitimate method with owner occupied property or should I use his actual income and expenses? How can I accurately apply the Income Approach?
     
  2. George Hatch

    George Hatch Elite Member

    84
    Jan 15, 2002
    Professional Status:
    Certified General Appraiser
    State:
    California
    The applicability of the Income Approach in this assignment may well rest on whether there is market activity in the area for this particular property type that would suggest that the property would sell based on it's ability to produce a rental income. If all of your comparable sales were purchased by owner-users, that would indicate that the typical buyer for your property would also be an owner-user. There's a difference between an investor buying a rental income stream and an owner who has moved on to a larger building or a different business and has simply retained the subject property to rent out as additional income.

    For example, most of the rental data for churches (I'm sorry, religious facilities) I've come across are not the result of investor activity, but are usually the result of the owner-user moving up and renting the building rather than selling it. Some of these rents are more based on the tenant's ability to pay rather than the market value of the property, presmably with any deficiencies being counted in non-monetary terms. It is not surprising that most of these rental data don't relate that well to the market value of the property and are not helpful in the valuations in that market segment.

    On the other hand, if there is some indication of investor activity and some genuine market rental data for your type of building, then do the income approach. In doing so, you'll want to reconcile the actual income stream with the market rents. Since the owner is renting from himself at a siginificantly higher rental rate, the lease is primarily a tax dodge and would not normally be considered a binding encumbrance. Depending on your state's laws, that lease might not hold up in the event of a foreclosure or probate and the typical buyer could not be assured that the rental income would stay intact in the event of a sale or transfer. Depending on the definition of value you're using, the market rent is probably more relevant to the valuation than the contract rent.

    At least that's how I see it.


    George Hatch
     
  3. Paul Ness MAI

    Paul Ness MAI Member

    0
    Jan 14, 2002
    Professional Status:
    Certified General Appraiser
    State:
    Pennsylvania
    I can't add much to George's very thorough post, except to ask the question - aren't you reviewing the appraisal? What did the appraiser do in the income approach?

    If the lease is not arm's length it probably shouldn't be considered, and a valuation of the fee simple interest should be concluded. Think of this too, the cost and sales approaches most likely represent the fee simple interest (no adjustments were probably made for property rights) and you need to be consistent in the identification of property rights appraised across all three approaches.
     
  4. Tom Hildebrandt

    Tom Hildebrandt Member

    0
    Jan 16, 2002
    Professional Status:
    General Public
    State:
    North Carolina
    Ditto the other comments

    Specifically, if your job was to comment on the appraisal, by USPAP it is an appraisal review assignment. Standard Three is the appropriate standard.

    If your client asked you for some sort of advice like, is this review ok for insurance purposes since it was originally done for ( loan or tax purposes) , then my cut is you have a two part assignment. First you need to do an appraisal review to determine whether the data and analysis in the appraisal is adequate and reasonable, then you can adapt or change the value as needed to answer the appraisal consulting question, is it adequate and how should it be changed (Standard 4-5). If that is all he asked, it is consulting. If he then asks, well then give me a value suitable for insurance, it becomes a valuation assignment in which you can incoprorate all the data you deem reasonable.

    Practically you do the same thing except in the consulting case you just say the work is adequate for the insurance, in the second you say here is an adequate value for insurance.

    Have I muddied it a bit? The real question is how you define the problem, what question is your client really asking.

    Regards

    Tom Hildebrandt GAA
     
  5. Fred

    Fred Elite Member

    0
    Jan 15, 2002
    Professional Status:
    Retired Appraiser
    State:
    Virgin Islands
    Rick,
    You got me on "insurance purposes." If the intended use of the appraised value is to establish how much insurance coverage a property owner or tenant needs, then only the replacement cost new of the insured property elements is relevant.
     
  6. Tom Hildebrandt

    Tom Hildebrandt Member

    0
    Jan 16, 2002
    Professional Status:
    General Public
    State:
    North Carolina
    Steve

    I have found on these insurance appraisals, it depends on the policy terms. Some insurance policies write replacement cost new RCN), some write RCN less deprciation, ie fair market value; some want the lesser of the two.

    I always ask for the written policy terms to see what the carrier really is saying they will pay.

    This makes a difference. I had a triplex, legal non confoming on a lot in Florida. For 15 plus years I just insured it with my usual carier, for replacement cost new. After I retired from the navy and got into the appraising business, I learned that there was difference. My carrier policy was that if I rebuilt they would pay replacement cost new, but if I chose not to rebuild, they would only pay maket value. Since this was legal non conforming lot, I could not rebuild, so for 15 years I had been overpaying to get insurance payouts that would never be paid.

    Regards

    Tom Hildebrandt GAA
     
  7. Fred

    Fred Elite Member

    0
    Jan 15, 2002
    Professional Status:
    Retired Appraiser
    State:
    Virgin Islands
    Tom,
    That's my point. Start at square one and find the insurable base - if this is an insurance appraisal - before concocting theories of capitalizing income from self-leases. I am surprised to find that there is a law that does not provide a grace period for the rebuilding of non-conforming uses destroyed by "act of God." Also, insuring at market value would often be overinsuring, because that contemplates 100% of the property, whereas RCN can exclude land or deal with just those parts of the improvements threatened by the prevailing risks.

    There are all sorts of crazy people out there. RCN less "depreciation"? Like you could rebuild something from scratch to be 25% worn-out? :lol: Just hop on down to Home Depot to see if they have pre-rusted rebar or studs pre-treated with termite larvae for the underinsured. :lol: I can just picture those ads now for pre-bowed joists. :lol:
     
  8. Bill_FL

    Bill_FL Senior Member

    0
    Aug 23, 2002
    Professional Status:
    Certified General Appraiser
    State:
    Florida
    Steven,

    I liked that last statement. I have done REO appraisals where the property was trashed. They wanted to opinions of value. As is and as repaired. The underwriter called me on one and said how come the as repaired is listed as "good" condition. I explained that once it had new sheet rock, cabinets, paint, roof, siding, flooring, etc, it would be in good condition. She called back a little while later and says, "just give us the value if we repaired it to average condition."

    I asked her if she new anywhere I could get sheetrock with 5 year old paint on it. 10 year old kitchen cabinets and appliances and well worn floor covering.
     
  9. Fred

    Fred Elite Member

    0
    Jan 15, 2002
    Professional Status:
    Retired Appraiser
    State:
    Virgin Islands
    "just give us the value if we repaired it to average condition"
    :lol: :lol:

    There is a whole slew of jokes based on that idea, like the one where the kid asks - can I just do it until I need glasses.
     
  10. Tom Hildebrandt

    Tom Hildebrandt Member

    0
    Jan 16, 2002
    Professional Status:
    General Public
    State:
    North Carolina
    Steve

    The law for rebuilding non conforming properties in most NC jusridictions where I have appraised is if it is over 50% damaged, you can not rebuild the legal non-conforming structure.

    So the law is exactly the contrary of allowing to rebuild.

    Yes, we agree you must define the problem first. in USPAP terms, determine the client, the use, the definition of value and then define the relevant characteristics. We have been discussing the relationship of use and definition of value as they impact the selection of relevant property characteristics.

    Regards

    Tom Hildebrandt GAA
     
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