condensed chapter 12 slides

8/6/2019 Condensed Chapter 12 Slides

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Real Estate Principles for the New Economy: Norman G. Miller and David M. Geltner

Chapter 12

Value Theory, Highest andBest use Analysis, and the

Cost Approach


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Major Topicsj Value, Price and Cost Conceptsj M

arket Price Formation from ReservationPricesj TraditionalMethods of Valuationj Newer Approaches to Valuej Highest and Best Use Defined

j Improved or unimproved (vacant)j The Impact of Option Valuej When Cost approximates market valuej Methods to estimate cost newj Methods to estimate accrued can

depreciationj Difficulties in estimating cost new and

accrued depreciationj Replacement versus reproduction cost


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Introduction to theDetermination of Value

j Value concepts always theoretical innature

j PRICE is usually factual in nature

j Value by nature is an opinionj In the absence of a perfectly

competitive market, there can be nocertainty that the value sought is

resolutely true or unchallengeablej Cost is also factual in nature


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Definitions

j Subject Propertyj Appraisalj Costj Reservation Price or Investment

Valuej Exchange Value orMost Probable

Pricej Liquidation valuej M

arket Valuej Use Valuej Going Concern Valuej Equilibrium Value


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Price and Value Formation

j The shaded area is where actualtransactions will occur and market priceswill be formed through negotiation

j The distributions of buyers and sellersneed not be equal in size


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Methods of Valuation

j Market orSales Comparison

j Cost Approach

j Income Approach

j Statistical approaches based on multiplefactor regression models with largersamples are essentially a variation on themarket/ sales comparison approach to

value


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Starting with Site Value Based onthe Highest and Best Use

j Option Value

j Definition of Highest and Best Use (H&B Use)

The reasonably probable and legal use of

vacant land or improved property, which isphysically possible, appropriately supported,financially feasible, and that results in thehighest value as of the date of the appraisal

Site Value = Current Use value +

Future Use Value/ Option Value


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Option Value (Contd.)

j The lowest improved site values are shown aboveas surface parking lots, yet these sites are worthmore than the current use value as they have the

highest option value of any of the above uses


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Improved Site Valuej Most of the time the H&B use of a property as

improved (as currently developed) is thecurrent use

j This is because the cost of construction anddemolition being higher than the cost ofconstruction alone and also the opportunitycost of time for the conversion

New market

value with a

new building

at H&B use Existing

Building

Value

Demolition

Cost andSite Prep

Lost income

during

construction


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The Steps in the Cost

Approach to Valuej Step 1: Estimate land value

j Step 2: Estimate the structure cost new Comparative-Unit Method

Indexed Cost Update Method Unit-in-placeMethod Quantity Survey Method

j Step 3: Estimate "lease-up" or absorptioncosts necessary to bring a new building upto normal levels of occupancy and use

j Step 4: Deduct accrued Depreciation


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The Steps in the Cost

Approach to Value (Contd.)j Depreciation

1. Physical

2. Functional3. Location or External

j Curable Defects

j Negative Value of Incurable

Depreciation


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Simple ExampleYou are appraising a warehouse that is 5 years old and

seems to have an effective age of 5 years. The economiclife on similar bulk warehouses is 30 years since

technology is making the bulk warehouse obsolete

quickly. The warehouse has 28 foot ceilings (low by

modern standards but incurable and still useable) and it

covers 100,000 square feet sitting on a lot of 200,000square feet with just enough parking and space for truck

docking. Similar sites cost $6 per square foot for clean

land, $3 per square foot for site preparation and asphalt

paving. Similar buildings cost $40 per square foot new

including hard costs, soft costs and normal fees. What is

the value via the cost approach ignoring functional

obsolescence and assuming no external depreciation and

assuming that such a warehouse is pre-leased prior to

construction?


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Simple Example (Contd.)

Site Value = 200,000 * ($9)

for land plus prep= $1,800,000

Cost New = 100,000 * $40= $4,000,000

Accrued Depreciation= 5/30 * $4,000,000= (666,667)

Value = $5,133,333

What if the technological changes inwarehousing had made the existing warehouseobsolete for most modern warehouse users?


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Simple Example (Contd.)

Effective Age = 20 years

Accrued Depreciation= 20/30 * $4,000,000= (2,666,667)

Value = $3,133,333

j There are more complex methods ofestimating accrued depreciation

j The Component Breakdown Method

considers the wear and tear and remaininglife of each component of the property,similar to the unit in place (component)method discussed for cost new


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Another ExampleAssume once again a 100,000 square foot warehouse that is 5

years old. The economic life is 30 years. It sits on 150,000

square feet of land, enough for truck turns and docking andwith some parking. It is multi-tenant and set up for several

different tenants. There is enough parking for 100 cars in

addition to 10 truck docking doors. There is not enough land

for more parking but there is a raw land parcel next door that

could be purchased and prepped for $10 per square foot. Thecurrent level of parking required for more labor intensive

retail distribution firms suggests enough parking be added for

50 more cars. This means 11,250 more paved area at a

finished cost of $12 per square foot or $135,000 dollars beyond

the land cost. Without the additional parking half the buildingwill remain vacant. Economic life on similar bulk warehouses

is 30 years. Warehouse has 32 foot ceilings. Similar buildings

cost $50 per square foot new including hard costs, soft costs

and normal fees. Lease up costs estimated to require $60,000

in commissions/ marketing; $50,000 in capital carry costs.


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Another Example (Contd.)

Cost new of Land = 150,000 * ($10)= $1,500,000

Cost New of Bldg. = 100,000 * $50

= $5,000,000Accrued Depreciation

= 5/30 * $5,000,000= (833,333)

Lease Up and Carry Cost= $110,000

Net Cost New = $5,776,667

What is the value via the cost approach andconsidering the extra parking required?

Could we stop here?


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j We could stop here and suggest the valueis roughly $5.776 million, but there is aproblem with parking relative to currentmarket requirements

j The property has a functional deficiency

of 50 parking spots and without thisparking will be worth much less then thenet cost new

j A present value of the lost rent over 25years based on 50,000 additional empty

square feet at $7.50 per square foot peryear net discounted at 10% is ~ $3.4dollars so the parking expansion is amust


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Cost new as is = $5,776,667

Less Functional Depreciation= (3,400,000) w/o pkg

AS IS Value = $2,366,667

Cost New Value with the additionalparking = $5,776,667Additional Parking Cost or FunctionalDepreciation = ($12 land+$10 prep)

*11,250 sq ft= (247,500)Total cost new and value as expanded

at the same rent = $5,529,167 value


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END

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