Partial Subdivision - Expenses to Include

[PropertyEconomics]

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???

Irene .. Im not sure I would deduct "holding" expenses. I dont think the cost of the loan should be included if you are referring to interest expenses and the like. Market value assumes a cash transaction much the way you dont consider all of the interest paid on a home when you value it. I remain thinking that either EP or a higher discount rate would be necessary to reflect current market conditions. Risk must be reflected in some manner or a combination of both.
Thinking this through a bit, is your seller a willing seller? Does the bank own this property? If market value of the property as it sits, considering the holding period, reflects a liquidation then doesnt that become market?
Unless specifically asked to do so, I would not consider the seller under duress but rather what does the market reflect the property is worth? We are back to a similar situation as and REO neighborhood. If those sales are the norm, they become the market, even though they also meet the classic definition of liquidation. Again I would measure the market and what is happening with other similar properties and how other developer / investors are treating their investments.
I have three or four of these subdivisions in my market, and thus far, there have been no liquidations. In two of the subdivisions the owner/investors are strong enough to carry the properties through this down period. In the others, well only time will tell.

 

[Scott Lanz]

I would be checking with the use of EI built into the discount versus a line item expense from a regulatory standpoint with your client. When I was taking the bank I was working for through the federal examination, they wanted EI as a line item.

I use entrepreneurial incentive (expected profit) instead of entrepreneurial profit (actual profit).

To your last question. I think making a distinction between the two values would be prudent. At this point, you are asking questions that may be best answered from market participants.

Making an assumption that the seller is under duress is not a question I can answer, that may be something you need to work out with your client on your SOW.

 

[PropertyEconomics]

I would be checking with the use of EI built into the discount versus a line item expense from a regulatory standpoint with your client. When I was taking the bank I was working for through the federal examination, they wanted EI as a line item.

I use entrepreneurial incentive (expected profit) instead of entrepreneurial profit (actual profit).

To your last question. I think making a distinction between the two values would be prudent. At this point, you are asking questions that may be best answered from market participants.

Making an assumption that the seller is under duress is not a question I can answer, that may be something you need to work out with your client on your SOW.

Scott you bring up an interesting question that I have been pondering regarding this assignment ... Im not so sure I wouldnt include two values in the report showing one as market under conditions requsite to a normal market sale in this market and one as a liquidation nearly assuming the worst case scenerio. The client would have then the information they need to make a complete informed decision.
What would you think of including two values and labeling them separately?

I further like your distinction regarding incentive vs profit. I believe I will start using this term as well. Its a very good point.

 

[Dennis J. Black ASA IFAS]

Profit is not an expense.

The anticipated "profit" is a component of the equity yield rate.

 

[Ken B]

Obviously, we first develop an opinion of average retail price per lot and reasonable absorption. We then determine reasonable expenses.

Expenses will be carrying costs and selling costs. We deduct expenses from revenue to indicate net revenue before profit. Typical carrying costs are taxes, insurance, HOA fee, and a small contigency fee. Typical selling costs are sales commission and closing costs. We do not deduct interest expense as the interest rate is a component of the discount rate. Deducting expenses from gross revenue, we develop net revenue before profit.

We then deduct a reasonable profit which reflects the profit an investor would expect given the lower risk associated with selling off the already developed lots. It is typically lower than the profit we consider a developer would expect for the development of raw land. While some may insist on deducting interest expenses, if you do so, you should consider an equity dividend rate rather than a discount rate when discounting net revenue after profit to a present value.

FTR, we (I) have done quite a few appraisals on partially developed subdivisions in the past year.

 

[PropertyEconomics]

Obviously, we first develop an opinion of average retail price per lot and reasonable absorption. We then determine reasonable expenses.

Expenses will be carrying costs and selling costs. We deduct expenses from revenue to indicate net revenue before profit. Typical carrying costs are taxes, insurance, HOA fee, and a small contigency fee. Typical selling costs are sales commission and closing costs. We do not deduct interest expense as the interest rate is a component of the discount rate. Deducting expenses from gross revenue, we develop net revenue before profit.

We then deduct a reasonable profit which reflects the profit an investor would expect given the lower risk associated with selling off the already developed lots. It is typically lower than the profit we consider a developer would expect for the development of raw land. While some may insist on deducting interest expenses, if you do so, you should consider an equity dividend rate rather than a discount rate when discounting net revenue after profit to a present value.

FTR, we (I) have done quite a few appraisals on partially developed subdivisions in the past year.

Kenneth,
Im just curious as to what you are seeing in the way of lower risk? I realize the risk associated with the development has been aborbed but at the same time I would think the risk on both return on and return of the investment in these market times are pretty high. Are you finding these risks reflected in the retail value of the lots at present and already accounted for, thus your comment of lower risk?

 

[Irene Thompson]

Kenneth,

We had the Appraisal Institute over-night us Don Emerson's new publication Subdivision Valuation:
http://www.appraisalinstitute.org/store/p-115-subdivision-valuation.aspx
which is completely in line with your method. I sure hope you're working toward your general certification! This publication makes it clear that if financing costs and equity return are considered, then we are going into mortgage analysis; therefore, these should not be deducted.

The book also goes into entrepreneurial incentive vs. profit, which is clearly the way to go. Scott Lanz nailed it there.

It's an interesting read which goes into much better analysis than a Lovell's Subdivision Analysis from 1993, especially with respect to bulk lot sales.

I must say this is the first time I've used this site for discussions and I've been very impressed with the wealth of knowledge among the users. I'll definitely spend more time looking through this site in the future.

Much appreciated!
Irene

 

[PropertyEconomics]

Kenneth,

We had the Appraisal Institute over-night us Don Emerson's new publication Subdivision Valuation:
http://www.appraisalinstitute.org/store/p-115-subdivision-valuation.aspx
which is completely in line with your method. I sure hope you're working toward your general certification! This publication makes it clear that if financing costs and equity return are considered, then we are going into mortgage analysis; therefore, these should not be deducted.

The book also goes into entrepreneurial incentive vs. profit, which is clearly the way to go. Scott Lanz nailed it there.

It's an interesting read which goes into much better analysis than a Lovell's Subdivision Analysis from 1993, especially with respect to bulk lot sales.

I must say this is the first time I've used this site for discussions and I've been very impressed with the wealth of knowledge among the users. I'll definitely spend more time looking through this site in the future.

Much appreciated!
Irene

Irene,
I tried to hint in my posts that bulk lot sales, in my opinion, are very risky in markets like we current are experiencing, and Im still very curious as to the risk Kenneth is seeing with respect to discounts for bulk subdivision purchases. I dont have any market evidence, because we havent been hit as hard as other parts of the country yet, however, I would just surmise that investors are in the market to get very good deals at this point or they will pass looking for the next homerun. Holding costs would quickly evaporate any future profits and as such I would think the discount quite severe on these properties.
Interviewing market participants would be very key in my mind as would searching high and low for bulk lot transactions anywhere you may be able to find them to measure the discount.

Its good to have you on the forum.

PE

 

[Curtis West]

Why an equity dividend rate?

While some may insist on deducting interest expenses, if you do so, you should consider an equity dividend rate rather than a discount rate when discounting net revenue after profit to a present value.

Just curious; what is the logic for considering an equity dividend rate (which is an equity capitalization rate) rather than a discount rate (which is a yield rate) when discounting net revenue after profit to a present value?

 

[PropertyEconomics]

Just curious; what is the logic for considering an equity dividend rate (which is an equity capitalization rate) rather than a discount rate (which is a yield rate) when discounting net revenue after profit to a present value?

If you are deducting the costs of the mortgage, then that which remains is the equity return not the NOI. If you are using equity as your measure of income it stands to reason you would use and equity dividend rate (ie equity capitalization rate) to convert the "income" to value.

Not something I think any of us are recommending by the way.