Why It Is Important To Use Correct Like-Kind Comparable Sales
Apples to Coconuts
simple substitution | why are comparable sales important
In previous blogs, we’ve discussed the three approaches to value that appraisers use to derive a value opinion. The Sales Comparison Approach, based on the principle of substitution, relies on the premise that a buyer will not pay more for a property than what he/she would pay for a property of equal or like-kind characteristics. For the approach to deliver reliable and robust results, there must be recent market activity (projections and forecasts can only do so much as we’ve seen firsthand with the Covid-19 pandemic), there must be like-kind properties, and the selection of the properties must be carried out appropriately. These sales are then adjusted. If there are no like-kind sales in the immediate market, the appraiser expands his/her search.
In a perfect world, the gross and net adjustments necessary to conclude on a price per square foot will be minimal. The Sales Comparison Approach is one of the most common approaches as not all older buildings will produce a reliable result via the Cost Approach due to the depreciation that older assets experience with age, equally not all properties will be income-producing assets. An appraisal built on a foundation of poor data results in faulty value conclusions.
you know it when you see it | Selecting Appropriate Comparable sales
To adopt a line from 1964’s Supreme Court Justice Potter Stewart; a seasoned appraiser knows a comparable sale when he sees it. It’s important to look beyond the building. “Just because a building looks similar or even identical does not necessarily mean it is a good selection for a comparable sale,” cautioned Vice President Alexander Argianas. “People often predicate buy/sell decisions that are outside of what we define as market value. Reading the fine print in all instances isn’t just important, it’s crucial.”
Recently, Argianas was called on by a client to appraise a large high-rise in downtown Chicago to assist in settling a difference in price. The building, designed as a headquarters, was to be vacant at the time of the sale and intended for use as a single-user property. Put differently, a large company was moving out of the building and another space user would be moving in. So, what do we search for? Vacant, single-user buildings for large corporate space users. In reviewing the work that was shared it was quickly evident that the comparable sales that were used to derive a value in the Sales Comparison Approach were all sales of properties that were multi-tenant buildings occupied at the time of sale. The buildings were of similar size and located in close proximity to the subject; however, using these sales as a foundation in the Sales Comparison Approach was flawed due to the leased fee position for which the purchase of these buildings was most likely predicated on.
show me the money | the present value of a dollar
In our line of work, we value the future value of a dollar every day. When the property is investment-grade or an income-producing asset, the Income Capitalization Approach is often a strong indicator and best approach to value. Income-producing properties are valued by analyzing the operating and expenses of a property and applying a market extracted capitalization rate. In other words, the net operating income of a property divided by the market extracted capitalization rate yields the value.
So how is a building used as a headquarters different than a building of similar size but with multiple tenants and multiple years left on the lease? The answer is the present value of a dollar. The remaining years on the lease have value and purchasers buy and sell the property based on the future benefits that will come from the contracted lease rents of those properties. Therefore, the owners of the properties have rights to the rate of return from the asset. The scope of our appraisal work was to determine the market value of the fee simple interest for a property that was vacant at the time of sale for a single-user entity. If we were to assume the property to be purchased for investment, a hypothetical condition, it would be for a different valuation scenario and one for which the multi-tenant, multi-occupant sale comparables would be better suited, as an entity making a purchase would expect to receive the future income.
think twice, reconcile once | critical thinking & taking your time
Good appraisers take the time to think through the value scenario at hand before running out the door to start the work. While there were many sales of similar sized buildings in the immediate vicinity, these sales were not headquarter properties. We therefore expanded our search for single tenant, vacant at time of sale buildings across the Continental United States (like-kind comparables).
Data is king and this scenario highlights just how critical it is to have access to the information you need. While we selected the best like-kind sales reflecting similar user, tenancy, and occupancy at time of sale, we took our efforts one step further by completing a regression analysis. By culling all pertinent data, adjusting, analyzing for outliers, and building a trendline, we derived an equation that when solved, provided additional support for our conclusions.
Appraisal doesn’t happen in a vacuum, sometimes there isn’t enough data. When that happens, you disclose, you qualify, and you do your best. We spend a considerable amount of time educating our clients about our methods and the rationale that goes into the appraisal because it leaves them better prepared and more knowledgeable about the field the next time, they engage an appraiser. In the current instance, we were presented with an opportunity to provide a separate rationale supported by robust data and analysis. More importantly, we had fun doing it.
If you have a CRE scenario that has you scratching your head, we’d love to scratch our heads with you. Contact us at 630.390.0113 or email us at [email protected] or complete this form. Honesty, Integrity, and Attention to Detail. We even promise to have a little fun.