Partial Subdivision - Expenses to Include

[Irene Thompson]

What expenses are to be included in the DCF when appraising a portion of an existing subdivision (ie. 150 lots out of a 200 lot subdivision)? Are the financing costs (ie. interest charges) and equity return to be included? Is entrepreneurial profit to be included when not looking for the raw land value or when not appraising the entire subdivision as proposed?

I have received some feed back from the more senior commercial appraisers in our office, including the owner/MAI, but I wanted to get more input.

THANKS!

 

[PropertyEconomics]

What expenses are to be included in the DCF when appraising a portion of an existing subdivision (ie. 150 lots out of a 200 lot subdivision)? Are the financing costs (ie. interest charges) and equity return to be included? Is entrepreneurial profit to be included when not looking for the raw land value or when not appraising the entire subdivision as proposed?

I have received some feed back from the more senior commercial appraisers in our office, including the owner/MAI, but I wanted to get more input.

THANKS!

What did your "seniors" say? Id be curious to see if my thoughts are the same as theirs.

 

[Irene Thompson]

Well, I kind of wanted to know what others thought.

I already know what the guys in my office are indicating.

 

[PropertyEconomics]

What expenses do you think should be included ... lets take it that way. Im sure you told them .. perhaps you can share with us.
Remembering that you are appraising the subject to determine its raw land value ... correct?
And you say its a partial subdivision appraisal ... what happened to the other 50 lots ... again just questions to ask so we can know more about your assignment. We dont know the scope of work of your assignment nor its purpose. Its very difficult to answer the questions without the information. The guys are your office have an advantage over us .. which is why I asked my original question.
It would appear there is some disagreement in your office .. which is quite healthy I think.

 

[Irene Thompson]

Well, the situation is that we have been asked to appraise 150 lots out of a 200 lot subdivision that is existing for a loan renewal. The developer has sold the 50 lots that we are not to include. The lender wants an "as is" MARKET value of the existing remaining 150 lots as sold in a single transaction. The question is, if an investor was to purchase these lots in a single transaction, what should he be expected to pay? What the market value of these lots?

The lots are already developed; therefore, raw land is not part of the equation. Question is, under this scenario, we estimate the retail value of the lots and then deduct expenses and then discount that over the projected absorption period, which in this case is rather long due to the decreasing absorption rates in our area. Ultimately, the question is, what should be included in the expenses???

We've been going back and forth on this and all the models for subdivision analysis I've seen are relating to either appraising the entire subdivision "as complete" or using the subdivision development approach to estimate the raw land value. Either scenario is not what we're doing, so I'm trying to figure out if there is a specific model which outlines what expenses should be included and why; and, if there isn't a model, what are other appraisers out there doing???

 

[George Hatch]

The typical buyer for such an assemblage probably will have to finance it, and they probably will be including the financial profit necessary to compensate them for the lack of liquidity, risk and effort involved in taking on such a venture. There probably will be other holding costs, too, like property taxes, keeping up on any maintenance, securing the lots from trespassers, etc.. There will also be marketing costs and other costs of sales.

 

[Irene Thompson]

Mr. Hatch,

Thank you. This has been the general consensus among the appraisers in our office with respect to these expenses.

A further question I have is regarding entrepreneurial profit. Where does that fit in? Should an additional deduction be made for entrepreneurial profit on top of finance cost and equity return, either as a line item expense or as part of the built-up discount rate? One senior appraiser has indicated that the entrepreneurial profit is only relevant for estimation of raw land and that ultimately only the developer of the subdivision benefits from ent. profit.???

 

[PropertyEconomics]

Well, the situation is that we have been asked to appraise 150 lots out of a 200 lot subdivision that is existing for a loan renewal. The developer has sold the 50 lots that we are not to include. The lender wants an "as is" MARKET value of the existing remaining 150 lots as sold in a single transaction. The question is, if an investor was to purchase these lots in a single transaction, what should he be expected to pay? What the market value of these lots?

The lots are already developed; therefore, raw land is not part of the equation. Question is, under this scenario, we estimate the retail value of the lots and then deduct expenses and then discount that over the projected absorption period, which in this case is rather long due to the decreasing absorption rates in our area. Ultimately, the question is, what should be included in the expenses???

We've been going back and forth on this and all the models for subdivision analysis I've seen are relating to either appraising the entire subdivision "as complete" or using the subdivision development approach to estimate the raw land value. Either scenario is not what we're doing, so I'm trying to figure out if there is a specific model which outlines what expenses should be included and why; and, if there isn't a model, what are other appraisers out there doing???

Irene ... the real question, which I think you are asking, is what would an investor be willing to pay for this partial subdivision given that an extended holding period would be necessary. I would think that you would have to consider expenses in your discounted cash flow analysis that would be "unique" in this situation when compared with other more typical analysis.
Personally I belive you should consider entreprenuerial profit as an expense because an investor is going to expect a profit from holding this property and as such would deduct such profit from their proforma in order to determine what they are willing to pay for the property "as is". I would interview investors / developers and ask them as to their required rate of return on a property like this.

I would further do as Mr Hatch suggests and recognize expenses that may be incurred over the holding period that are unique. Security of the properties (im not sure about that one honestly), a liability insurance policy in case someone gets hurt on the property during the holding period, and naturally taxes would be deducted over the holding period.

I assume you dont have any sales of bulk lot transactions with which to compare to this property, which of course, would be the best indication of market reaction to these types of properties.

Yours is a unique situation, but one that I think we can expect to happen more and more in the coming months.
I would like to know what your collegues thought, please send me a PM if you wish.

 

[PropertyEconomics]

Mr. Hatch,

Thank you. This has been the general consensus among the appraisers in our office with respect to these expenses.

A further question I have is regarding entrepreneurial profit. Where does that fit in? Should an additional deduction be made for entrepreneurial profit on top of finance cost and equity return, either as a line item expense or as part of the built-up discount rate? One senior appraiser has indicated that the entrepreneurial profit is only relevant for estimation of raw land and that ultimately only the developer of the subdivision benefits from ent. profit.???

Irene .. I just read this post so pardon me for two posts in a row.
The "developer" in this situation has not earned any entreprenuerial profit as the development has not been successful. Entreprenuerial profit, in my opinion in this instance, is pinged on two main items 1. Can I sell it for what I say I can sell it for? and 2. Can I sell it as fast as I say I can?
Obviously the answer to the original developer is NO. I would ask your senior collegue that a buyer is essentially stepping into the role of "developer" (even though its already developed) and would expect a profit otherwise they simply will not buy. They certainly cannot afford to pay the discounted retail price because, if discounted properly, that is merely a break even proposition given the time value of money. Again I believe that EP is applicable in this situation and should be deducted in some form OR reflected in a higher discount rate. Utilization of a more normal discount rate with deduction of the EP as an expense OR utilization of a higher discount rate reflecting the risk of the investor would be necessary. I would do it both ways and compare the numbers, and again, I would discuss this with investors and developers in my area.

 

[Irene Thompson]

Indeed, we are facing more and more of these types of partial subdivision requests and the feedback I've received here, including from you, is generally in line with what I've heard; although the verdict is still out on ent. profit.

Regardless, NOW the question becomes, if we are deducting the holding expenses and discounting it all back to today, does the final value estimate become a LIQUIDATION value rather than a MARKET value. If we are appraising so many lots in a single transaction, are we to assume that the seller is under duress and therefore any such transaction would not be market value???