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Rental Agreements.
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Michigan CG
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Um,
MARKET VALUE, is what you are appraising. In order to do that one must do the research to determine Market Rents in order to opine Market Value.
Mark K
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Um...I understand MARKET VALUE.
I also understand that if the property is encumbered with a lease(s) that does not reflect market rents the property value can be significantly affected.
If an income property is known to be encumbered with a lease whose terms are not disclosed then the MARKET VALUE appraisal will have to be based on an EA (existing leases = market value rents) or a HC (no lease exists that affects MARKET VALUE).
I don't know very many situations where an appraisal report with either caveat is of much value to a lender. You can opine your MV opinion all day long but without the details of existing leases its a waste of time.
Michigan CG
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Just because a property is "encumbered" with a below market lease does not mean that the lease in place can be used to determine Market Value.
If a property is leasing units at $500/month and your market rent study shows the rest of the world is charging $1,000 are you going to use the lease in place to determine market value? If you do your results won't be credible and they certainly don't hold up in any court of law.
See USPAP Scope of Work Rule lines 407-412.
See USPAP Standard Rule 1-4 and especially look at lines 570-582.
I have some problems with the above. If you are not provided with a lease then how can you determine that the rents are market value rents? You cannot use an EA for something you know nothing about.
The participants of this thread are mostly residential appraisers and 95% of residential leases are on a yearly basis or less. Your argument seems to indicate if the rents are $500/month this year the value is $X based on those rents and if the rents are $1000/month in a year the market value is X time 2.
This is not how to determine market value of an income property.
Again, I will disagree. A Market Value opinion will include a rent survey showing what the MARKET is doing. I don't care about the under or over market lease of a subject property and don't need it to opine a Market Value opinion, especially for a residential property.
Mark K
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- Indiana
The market rent study is an integral part of the analysis of income property but since income property is valued based on the amount of income it actually produces the existing lease can have a significant effect on MV.
I don't understand the thinking that if an income property is encumbered with a below or above market rent lease this has no effect on market value, at least the definition of MV that is in my reports.
Ignoring the existing lease would not produce a credible report nor stand up in a court of law. I think it would be a real bad idea to tell a judge that market rents are $zzz/month so the property is worth my appraised value, by the way I've not taken into account the existing lease on this income property.
Your assumption that the lease is short term and at market rent is an EA. Without knowing the terms of the lease, your opinion of market value is baseless, unless you're using "short term and market rate" as your base. Personally, I won't make those assumptions. Apparently you will and this is where we will continue to disagree.
If an owner tells me that he has only a verbal lease for 6 months at $zzz/month, I include this info in the report and base my value accordingly, most often with little or no weight given to the lease.
If the owner tells me there is a written lease but he will not provide me details, I tell my client that I will not proceed with the report until I get the details or a copy of the lease. No exceptions.
George Hatch
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- California
I've never seen a 2-4 or an apartment building encumbered with leases in excess of a year. Ever.
FYI, nobody who knows what they're doing uses non-market rental terms for a short duration lease as the basis of a direct cap or GRM/GIM application.
Let's say you had a 2-yr lease at $500/month in a $1,000/month market. The appraisers who appraise income properties for a living would project the market rent and expenses and capitalize that, then they'd perform a separate analysis of the lost rents from that lease (and any others) and deduct the sum of that from the total.
If it was 5 units and the market rents were $1,000/month and vacancy/expenses were 35% it would look like this:
.$60,000 (potential market income)
-$21,000 (vacancy and expenses @ 35%)
=$39,000 (Net income)
/ .0700 (hypothetical cap rate based on comparables)
=$557,142 (results of direct capitalization @ Mkt Rents)
Now let's say that 3 of those units had below market rents stipulated by lease and those leases all had 24 more months to go - which I've never ever seen in an apartment building but let's just go with it anyway. Let's say the cumulative rent loss from these leases amounted to $1000/month between them. That means that over the next 2 years this property would lose $24,000 in gross rents.
That would be the adjustment:
$557,142 (Value by direct cap @ market rents)
- $24,000 (adjustment for property rights appraised)
$533,000 (Value of the property rights appraised.
Now compare that to directly capping the contract rents as if the bonus rents will continue indefinitely instead of for just 24 months:
.$60,000 (market rents)
-$12,000 (rent loss from leases)
=$48,000 (contract rents)
-$21,000 (same expenses)
=$27,000 (net income)
/ .0700 (cap rate)
=$385,000
Big difference between assuming a non-market lease term will continue indefinitely vs handling it as a short term situation. That's why we use market rents and make adjustments afterwards. The use of a DCF does the same thing. Nobody I know "ignores" a reported lease unless he duration is so short that it doesn't make any difference. <12 months doesn't usually make a difference in the market.
FYI, nobody who knows what they're doing uses non-market rental terms for a short duration lease as the basis of a direct cap or GRM/GIM application.
Let's say you had a 2-yr lease at $500/month in a $1,000/month market. The appraisers who appraise income properties for a living would project the market rent and expenses and capitalize that, then they'd perform a separate analysis of the lost rents from that lease (and any others) and deduct the sum of that from the total.
If it was 5 units and the market rents were $1,000/month and vacancy/expenses were 35% it would look like this:
.$60,000 (potential market income)
-$21,000 (vacancy and expenses @ 35%)
=$39,000 (Net income)
/ .0700 (hypothetical cap rate based on comparables)
=$557,142 (results of direct capitalization @ Mkt Rents)
Now let's say that 3 of those units had below market rents stipulated by lease and those leases all had 24 more months to go - which I've never ever seen in an apartment building but let's just go with it anyway. Let's say the cumulative rent loss from these leases amounted to $1000/month between them. That means that over the next 2 years this property would lose $24,000 in gross rents.
That would be the adjustment:
$557,142 (Value by direct cap @ market rents)
- $24,000 (adjustment for property rights appraised)
$533,000 (Value of the property rights appraised.
Now compare that to directly capping the contract rents as if the bonus rents will continue indefinitely instead of for just 24 months:
.$60,000 (market rents)
-$12,000 (rent loss from leases)
=$48,000 (contract rents)
-$21,000 (same expenses)
=$27,000 (net income)
/ .0700 (cap rate)
=$385,000
Big difference between assuming a non-market lease term will continue indefinitely vs handling it as a short term situation. That's why we use market rents and make adjustments afterwards. The use of a DCF does the same thing. Nobody I know "ignores" a reported lease unless he duration is so short that it doesn't make any difference. <12 months doesn't usually make a difference in the market.
CANative
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- Jun 18, 2003
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- California
Kind of like I did on my over-assessed mobile home park?
The income statements show the average space rental at Daiichi Grove Senior Mobile Home park is about $437 per month. We have rounded that up to $450 per month for ease in calculations. The allowable expenses, excluding property taxes are about 25% of income. The capitalization rate range for parks in the competing area is 6% to about 12% with a very large majority in the 9% to 10% range. We have selected 9% as a reasonable, market derived capitalization rate and added 1% for the property tax component for an Overall Rate of 10%.
Using stabilized occupancy of 98 spaces at an average space rental of $450 per month, the annual potential gross income is $529,200 ($450 x 98 spaces x 12 months.) Using 25% expenses plus an additional 5% allowance for vacancy and collection loss, the total expenses are 30%. This leaves a Net Operating Income (NOI) of $370,440 ($529,200 x .70).
Dividing the NOI by the enrolled value calculates to a capitalization rate of .0735. This is well below the capitalization rated indicated by the market. Additionally, this calculation does not include revenue loss during the period of time required to lease up the 55 new spaces, nor does it include the cost to finish construction of the park’s planned recreational center, estimated at $400,000 (there is currently a foundation and design/plans to finish the building.) This structure is considered part of the Highest and Best Use because it is an amenity expected by the market for this type of project and necessary to attract and retain tenants.
It is our opinion that the as-is, Fair Market Value of the fee simple interest of the subject property as of January 2, 2010 is not more than $2,700,000. We considered the sales comparison approach in developing this opinion but did not consider it a reliable method due to the lack of park sales considered reasonably similar to the subject property. We did provide comparable sales listings and a table of sales of mobile home parks to show a reasonable sale price per unit and to extract a market derived capitalization rate to be used in the income approach.
We have used the income approach as is the best and most reliable method when there is insufficient sales data.
Referring once again to the Profit and Loss Statement (2008 – 2010) we have used the average of the three years in reconstructing the operating statement for purposes of a more consistent annual income and expense figure. Keep in mind that the attached income and expense statement is for the 43 occupied spaces as of the lien date.
Income and expenses 2008 through 2010:
Total rents collected: $686,202 Average: $228,739
Expenses:
Maintenance and repairs: $80,913 Average: $26,071
Utilities (after reimbursement): $21,153 Average; $7,054
Insurance: $22,692 Average: $7,564
Management: $24,574 Average: $8,191
Office expenses: $11,890 Average: $3,963
Professional fees: $41,201 Average: $13,734
Taxes and licenses: $23,519 Average: $7,839
Total Expenses: $225,942 Average: $75,314 (33% of income)
Per the income and expense statement the allowable expenses, excluding property taxes, are about 33%. We think a small portion of the expenses may be overstated or may not represent strictly allowable expenses so we have used 25% expenses for valuation purposes.
Income Approach calculations:
Estimated PGI at stabilized occupancy ($450 x 98 units): $529,200
30% expenses (includes 5% V&C loss): -$158,760
Net Operating Income: $370,440
OAR (Market rate of 9% + 1% tax load): $370,440 / .10
Value indication: $3,704,400
This value indication is based on stabilized occupancy. The subject property had 43 of 98 spaces occupied. A deduction for rent losses during absorption period for the 55 new spaces must be made to reflect the as is value of the property. To date the 55 new spaces have not secured a tenant. Part of the problem is attributable to decline in market demand, a lack of a recreational facility and a change in how manufactured home dealers place new homes in a park on consignment in anticipation of a buyer who will purchase the sited home and pay space rent. We must also make a deduction for completion of the parks recreation facility as it is a component of the highest and best use.
For purposes of valuation we are assuming that a well-funded buyer of the subject property would purchase new homes from a dealer and place them on pads where they would be marketed as finished homes available for purchase. Given that the cost of a new, average quality, two section manufactured home, including transportation from the dealer and on site finish construction would likely be about $100,000 or more we think a prudent buyer would implement this plan in yearly phases to control costs and risk. An absorption rate of 10 rented spaces per year is a reasonable forecast.
Year 1 10 occupied 40 vacant -$218,000
Year 2 20 occupied 30 vacant -$189,000
Year 3 30 occupied 20 vacant -$135,000
Year 4 40 occupied 10 vacant -$ 81,000
Year 5 50 occupied 5 vacant -$ 27,000
Stabilized year 6
Deduct cost to complete recreational facility -$ 400,000
Total deductions: -$1,075,000
As is market value: $3,704,400 - $1,075,000 = $2,629,400
The income statements show the average space rental at Daiichi Grove Senior Mobile Home park is about $437 per month. We have rounded that up to $450 per month for ease in calculations. The allowable expenses, excluding property taxes are about 25% of income. The capitalization rate range for parks in the competing area is 6% to about 12% with a very large majority in the 9% to 10% range. We have selected 9% as a reasonable, market derived capitalization rate and added 1% for the property tax component for an Overall Rate of 10%.
Using stabilized occupancy of 98 spaces at an average space rental of $450 per month, the annual potential gross income is $529,200 ($450 x 98 spaces x 12 months.) Using 25% expenses plus an additional 5% allowance for vacancy and collection loss, the total expenses are 30%. This leaves a Net Operating Income (NOI) of $370,440 ($529,200 x .70).
Dividing the NOI by the enrolled value calculates to a capitalization rate of .0735. This is well below the capitalization rated indicated by the market. Additionally, this calculation does not include revenue loss during the period of time required to lease up the 55 new spaces, nor does it include the cost to finish construction of the park’s planned recreational center, estimated at $400,000 (there is currently a foundation and design/plans to finish the building.) This structure is considered part of the Highest and Best Use because it is an amenity expected by the market for this type of project and necessary to attract and retain tenants.
It is our opinion that the as-is, Fair Market Value of the fee simple interest of the subject property as of January 2, 2010 is not more than $2,700,000. We considered the sales comparison approach in developing this opinion but did not consider it a reliable method due to the lack of park sales considered reasonably similar to the subject property. We did provide comparable sales listings and a table of sales of mobile home parks to show a reasonable sale price per unit and to extract a market derived capitalization rate to be used in the income approach.
We have used the income approach as is the best and most reliable method when there is insufficient sales data.
Referring once again to the Profit and Loss Statement (2008 – 2010) we have used the average of the three years in reconstructing the operating statement for purposes of a more consistent annual income and expense figure. Keep in mind that the attached income and expense statement is for the 43 occupied spaces as of the lien date.
Income and expenses 2008 through 2010:
Total rents collected: $686,202 Average: $228,739
Expenses:
Maintenance and repairs: $80,913 Average: $26,071
Utilities (after reimbursement): $21,153 Average; $7,054
Insurance: $22,692 Average: $7,564
Management: $24,574 Average: $8,191
Office expenses: $11,890 Average: $3,963
Professional fees: $41,201 Average: $13,734
Taxes and licenses: $23,519 Average: $7,839
Total Expenses: $225,942 Average: $75,314 (33% of income)
Per the income and expense statement the allowable expenses, excluding property taxes, are about 33%. We think a small portion of the expenses may be overstated or may not represent strictly allowable expenses so we have used 25% expenses for valuation purposes.
Income Approach calculations:
Estimated PGI at stabilized occupancy ($450 x 98 units): $529,200
30% expenses (includes 5% V&C loss): -$158,760
Net Operating Income: $370,440
OAR (Market rate of 9% + 1% tax load): $370,440 / .10
Value indication: $3,704,400
This value indication is based on stabilized occupancy. The subject property had 43 of 98 spaces occupied. A deduction for rent losses during absorption period for the 55 new spaces must be made to reflect the as is value of the property. To date the 55 new spaces have not secured a tenant. Part of the problem is attributable to decline in market demand, a lack of a recreational facility and a change in how manufactured home dealers place new homes in a park on consignment in anticipation of a buyer who will purchase the sited home and pay space rent. We must also make a deduction for completion of the parks recreation facility as it is a component of the highest and best use.
For purposes of valuation we are assuming that a well-funded buyer of the subject property would purchase new homes from a dealer and place them on pads where they would be marketed as finished homes available for purchase. Given that the cost of a new, average quality, two section manufactured home, including transportation from the dealer and on site finish construction would likely be about $100,000 or more we think a prudent buyer would implement this plan in yearly phases to control costs and risk. An absorption rate of 10 rented spaces per year is a reasonable forecast.
Year 1 10 occupied 40 vacant -$218,000
Year 2 20 occupied 30 vacant -$189,000
Year 3 30 occupied 20 vacant -$135,000
Year 4 40 occupied 10 vacant -$ 81,000
Year 5 50 occupied 5 vacant -$ 27,000
Stabilized year 6
Deduct cost to complete recreational facility -$ 400,000
Total deductions: -$1,075,000
As is market value: $3,704,400 - $1,075,000 = $2,629,400
George Hatch
Elite Member
- Joined
- Jan 15, 2002
- Professional Status
- Certified General Appraiser
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- California
Eggzactly. A lot of appraisers have gotten in trouble over the years for not making these distinctions.
PS - I would usually favor a DCF for the situation you describe because it's easier to show the moving parts in each year individually. But the result will be about the same.
PS - I would usually favor a DCF for the situation you describe because it's easier to show the moving parts in each year individually. But the result will be about the same.
J Grant
Elite Member
- Joined
- Dec 9, 2003
- Professional Status
- Certified Residential Appraiser
- State
- Florida
MV references what a typically motivated buyer would pay, which would include the value of charging market rents (unless they had a personal reason not to, such as renting for a discount to a family member)
Unless a property is encumbered with a specific kind of rent agreement such as rent control, or an unbreakable long term lease (long term over 2 years), the current rents would not be the defining factor to a buyer, who will anticpate charging market rents once whatever lease is on a unit runs out.
Most buyers have a rough idea of market rents for a type/size of property and this is what they work with.
Our client wants to know market rent, what would the typically motivated buyer/owner be able to command in the market, as opposed to what the actual owner user currently is getting.
If an owner is getting above market rents it could be a fluke, or luck, or sometimes mis information given out in hopes it would raise their property value.
I have had owners give me absurd high rents that are out of line with market rents for no apparent reason....
An appraiser has to analyze owner rental statements, or lack of them, with a similar level of judgement and experience as in other aspects of research.
Unless a property is encumbered with a specific kind of rent agreement such as rent control, or an unbreakable long term lease (long term over 2 years), the current rents would not be the defining factor to a buyer, who will anticpate charging market rents once whatever lease is on a unit runs out.
Most buyers have a rough idea of market rents for a type/size of property and this is what they work with.
Our client wants to know market rent, what would the typically motivated buyer/owner be able to command in the market, as opposed to what the actual owner user currently is getting.
If an owner is getting above market rents it could be a fluke, or luck, or sometimes mis information given out in hopes it would raise their property value.
I have had owners give me absurd high rents that are out of line with market rents for no apparent reason....
An appraiser has to analyze owner rental statements, or lack of them, with a similar level of judgement and experience as in other aspects of research.
George Hatch
Elite Member
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- California
I think the point everyone is driving at is that when leases are reported - regardless of the manner of disclosures - the choice is not either/or, but how to reasonably account for both. And it is the market's reaction that counts, not the math itself. If buyers are ignoring short term leases or 1-time rent losses of less than $5000 then it is what it is.
When there are no leases then there is no legal encumbrance and the typical investor will defer to what they think they can get. Either that or they might retain the (slightly) lower rents for the purpose of avoiding increased vacancy and turnover costs.
When there are no leases then there is no legal encumbrance and the typical investor will defer to what they think they can get. Either that or they might retain the (slightly) lower rents for the purpose of avoiding increased vacancy and turnover costs.
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