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Dcfs For Subdivision Appraisals

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Sean Heath

Freshman Member
Joined
May 21, 2003
I would like to know if there is a uniform way to complete a discounted-cash flow analysis when performing a subdivision appraisal for a construction loan. So we're all on the same wavelength, what I'm referring to as a DCF is the calculation (usually done in a spreadsheet format) to determine the present bulk value of a tract (or a particular phase of a tract) assuming its completion.

After talking to a few appraisers here in my neck of the woods in San Diego and a few construction-loan lenders, I still have a few questions.

1.) What types of expenses should be included in the DCF? Should construction interest and developer's profit be included as well?
2.) In terms of discounting, should the starting point of the holding period in the DCF be the present date, or the approximate date of completion of construction? To clarify, consider the following example: A 10-home phase is scheduled to be completed by the end of the year. However, the present date of valuation (for the underlying land) is May. Should the prospective value of the 10 homes be discounted using December as the starting point, or May?
3.) Should an appreciation (or depreciation factor) be included in the DCF as a general rule, even if the holding period is fairly short?


The Office of Thrift Supervision (OTS) apparently has their own guidelines for subdivision DCFs (OTS prefers the former scenario in item #2). However, it doens't appear that this is being followed with any regularity. Lenders have even told me that they have not been given any clear guidance from federal regulators.

What do you think? I would appreciate any input.

Thanks.

Sean Heath
The Heath Group
San Diego, CA
Tel. (858) 673-1177
E-mail: [email protected]
 

Austin

Elite Member
Joined
Jan 16, 2002
Professional Status
Certified General Appraiser
State
Virginia
The AI has a book out on appraising subdivisions and my copy is at the office. It has been a while since I did a subdivision appraisal but there is a format to follow. You lost me when you were talking about the houses on the lots. You project the sell out period and put in the expenses as they occur in time along with the sales for each period and derive a net cash flow for each period and then discount that back to the date of appraisal. The hard part is supporting the discount rate. Once you have found the rate the rest is pretty straight forward except for the guess of the sell out period. We have some upscale subdivisions around here that are 20 years old and only 20% developed. The last subdivision I appraised sold out in about 2 years. I would have thought the 1st subdivision would have sold out in about the same period. One never knows for sure. We have a lot of subdivisions around here sold at auction.
 

Paul Ness MAI

Member
Joined
Jan 14, 2002
Professional Status
Certified General Appraiser
State
Pennsylvania
There are as many DCF formats as there are subdivisions. The reason being that there are many scenarios and points-in-time where you can place a value on such a monster. Each subdivision assignment is unique and research-intensive, thus you should be sure to quote an appropriate fee. I’ll try to give my 2-cents worth for each of your points.

First, I’m assuming that when you talk about “completion” you are referring to infrastructure (grading, roads, utilities, curbing, etc) and not houses. So if you are asked to appraise a parcel of approved subdivision land prior to completion of infrastructure, there are two angles of attack. First is finding comparable sales. Second is doing a DCF which reflects sell-out less holding costs and construction costs. If construction interest is applicable in this scenario then it should be deducted as a holding cost. If you are asked to appraise a property assuming completion of infrastructure, then no hard construction costs should be deducted as they would have already been spent prior to time “0”.

Developer’s profit may or may not be deducted as a holding cost. Whichever you choose, you need to be sure to apply the correct yield rate (it should be a discount rate if you include profit as a holding cost, or an IRR if you exclude profit). It depends on the supporting data you have. If developers talk in terms of a lump “IRR” then you have better support to go that route, versus the profit and discount rate approach.

Your question of December or May is a question of completing a prospective value or not. You can do this either way. You can make it prospective with a future date or you can use a current date assuming it is completed now. Further, the answer to the question of what set of values to estimate comes from your client. It depends on how the loan(s) are structured.

The appreciation question should be answered from your market data.
 

Terrel L. Shields

Elite Member
Gold Supporting Member
Joined
May 2, 2002
Professional Status
Certified General Appraiser
State
Arkansas
In my sales projections, I first determine if the comparble developments are being built on by the subdivision owner or by other builders. Absorption time, in mho is best determined by a subdivision owner who sells the lots off rather than builds then sells on his own lot. Market absorption may be a function of how many houses the owner-builder can build and complete per year rather than how many lots they can sell.

Some subs also have a spotty history. I know one which could sell out quickly but the owner wants to pace himself because he bought the property as a tax deferrment and only wishes to sell 2 - 3 lots annually to avoid a big tax hit.

In my DCF analysis, I often use the most conservative figure, the least conservative and 10% as a benchmarket (SEC mandated discount rate for public companies disclosure on the EDGAR site)....This provides a range of values. IRR is oft the minimum, and I can then rationalize (reconcile) my final estimate within that range.

By the way, instead of using a regular spreadsheet, I use a Wordperfect table created as a mini-spreadsheet. It formats easier, and works just as well for all but the largest projects.
 
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