My head hurts. lol
Your property is at (actually probably above) stabilized market occupancy. And if you used economic rents (or if the property rents were market) then your job of MV of the Fee Simple is done I would think.
Maybe the UW won't know the difference if you cite the CA assessor's handbook (property is almost always valued Fee Simple (unencumbered.) Or at least copy and paste into an email so she'll just shut up. lol
VALUATION OF PROPERTIES NOT AT STABILIZED OCCUPANCY
General
A property in stabilized condition has reached the level of utility for which it was designed. For
income-producing property this generally means stabilized occupancy. Stabilized occupancy is a
level of occupancy that is expected to continue over the remaining economic life of the property.
A property reaches stabilized occupancy when the vacancy rate has reached a state of equilibrium
—that is, when the vacancy rate is not expected to increase or decrease dramatically over the
foreseeable future. Typically, stabilized occupancy reflects the investor’s anticipated rent loss
due to average market vacancy and tenant turnover. This is sometimes called "normal vacancy."
A lower level of occupancy resulting from conditions of supply and demand or other transitory
factors is not stabilized occupancy. Situations associated with a non-stabilized occupancy level
may include new construction prior to initial lease-up, significant loss of tenants in a soft or
overbuilt market, and properties undergoing significant renovations.
Occupancy level has a significant effect on market value. All else being equal, a property at
stabilized occupancy is more valuable than a property at a lower level of occupancy. Consider
two otherwise identical properties. One is at a stabilized occupancy of 90 percent (i.e., the normal
vacancy), the other at a non-stabilized occupancy of 40 percent. Most buyers would pay more for
the property at the higher, stabilized occupancy level. The property with the lower occupancy
level would sell for less because of the additional costs most prudent buyers would anticipate as
necessary to bring it to stabilized occupancy. If a property is at a non-stabilized occupancy level,
the market value estimate should reflect this condition.
The direct capitalization method of the income approach assumes that the income to be
capitalized is at a stabilized level and does not reflect transitory conditions. It also assumes that
the comparable sales properties from which capitalization rates or income multipliers are derived
are also operating at stabilized occupancy. Direct capitalization should only be used when these
assumptions are met.
Methods for Valuing Property Not at Stabilized Occupancy
The value of a property not at stabilized occupancy can be estimated using the following
methods:
1. Estimate a hypothetical value of the subject property as if stabilized using the
comparative sales approach and/or direct capitalization, and then deduct a market-derived
discount from the value as if stabilized to estimate the market value of the property in its
current, non-stabilized condition.
2. Use discounted cash flow analysis to directly estimate the value of the property at its
current (i.e., non-stabilized) level of occupancy. This requires estimates of the periodic
cash flows during the absorption period necessary to reach stabilized occupancy and an
estimate of the terminal, or reversionary, value of the property at the point in time
stabilized occupancy is reached.
3. Use the comparative sales approach to directly value the property in its non-stabilized
condition. This requires an adequate number of comparable sales properties that, in
addition to being comparable in terms of physical and locational characteristics, also have
a level of occupancy similar to the subject property.
Method 2 is simply an application of discounted cash flow analysis to a property not at stabilized
occupancy. Method 3 is simply a special application of the comparative sales approach. Method
1 is discussed in greater detail below.
1. Estimate a hypothetical value of the subject property as if stabilized on the valuation date
using the comparative sales approach or the direct capitalization method of the income
approach.
2. Estimate the amount of space to be absorbed. This requires an estimate of the "excess
vacancy"—that is, the difference between the current, non-stabilized level of occupancy
and stabilized occupancy. The average excess vacancy per period is half the sum of the
beginning excess vacancy and the ending excess vacancy. This assumes that the space is
absorbed uniformly during the period. The average excess vacancy is used to estimate the
rental loss.
3. Estimate the absorption period and the pattern of absorption. The absorption period is the
expected length of time required to achieve stabilized occupancy. The length and pattern
of absorption should be based on current and forecast market conditions for the subject
property.
4. Estimate the market rent for the subject property over the absorption period.
5. Estimate the rent loss for each period during absorption. This is the average excess
vacancy per period multiplied by the market rent.
6. Estimate leasing commissions and any other marketing costs associated with achieving
stabilized occupancy. The amount and payment schedule for leasing commissions may
vary depending on the conventions of the respective market.
7. Estimate the cost of landlord improvements (also called tenant improvements) paid for by
the landlord as part of the lease contract.
8. Estimate any difference in operating expenses paid by the property owner over the
absorption period relative to expenses at stabilized occupancy. The estimate of
differential expenses should take into account the structure of the lease (i.e., gross or net).
For example, under a gross lease the owner pays all operating expenses, and variable
expenses may be less than those at stabilized occupancy. In effect, lower expenses at nonstabilized
occupancy represent a "cash inflow" to the owner in this analysis.
9. Estimate the differential cash flows for each year of the absorption period (i.e., the
difference between the cash flows assuming stabilized occupancy and those during the
period required to reach stabilized occupancy, or the sum of 5, 6 7, and 8.
10. Calculate the present value sum of these cash flows using an appropriate discount rate. If
the absorption rate is properly forecast, the risk of the cash flows during the absorption
period should not exceed the risk of cash flows with a stabilized property. The present
value sum is the estimated adjustment amount. If the absorption period is short, the
adjustment could be made without discounting the cash flows; this, of course, results in a
slightly larger adjustment.
11. Subtract the adjustment amount from the estimated stabilized value of the subject
property. The result is the estimate of subject property’s non-stabilized value.
I made some of those same points. But where I had the biggest difficulty with the underwriter, was when she challenged me to show her "in writing" where fee-simple market value = stabilized.
