The Unique Appraisal: Case Studies in Appraising Special Purpose Properties Presented by: Arthur L. Schwertz, MAI Senior Managing Director Valbridge Property Advisors Walter D. Carney, MAI Senior Managing Director Valbridge Property Advisors Matthew Lubawy, MAI, CVA, CMEA Senior Managing Director Valbridge Property Advisors Objectives • How do I know if I am competent to accept the assignment? • How do I gain competency to complete the assignment and why should I? • How do I handle special purpose properties in relation to eminent domain assignments? • How do I handle special purpose properties with complex cash flows? • How do I handle the really unusual assignment? Are You Competent? • Nuclear Reactor Simulator • Waterpark and Amusement Park Nuclear Reactor Simulator Facility Am I Competent? Initial Reaction, “Heck No!” Talk to your potential client. In this case, they wanted the real estate appraised to its highest and best use to satisfy SEC regulators in constructing a lease between subsidiaries – Simulator equipment was all moveable (not part of real estate). Quickly became a highest and best use study in which a conclusion of a mixeduse retail/office building was reached (i.e. a pretty run-of-the-mill appraisal). Yes, we are competent. Nuclear Reactor Simulator Facility Why go to this much trouble to land a “run-of-the mill” appraisal? Really Cool Inspection! Higher Fee! The fee for this assignment was 260% higher than our Typical Small Office Appraisal Fee assignment at the time of engagement. How many people can put on their qualifications that they have appraised a “Nuclear Reactor Simulator Facility”? Waterpark/Amusement Park Am I Competent? Initial and Correct Reaction, “Heck No!” Disclosed to Client lack of Competency but also detailed steps we would take to gain competency. Client hired us. Waterpark/Amusement Park How does one become competent? • Read! Search Lum Library for articles, texts, etc. • Consult Trade Organizations Just about every special purpose property has a related trade organization Amusement Parks - International Association of Amusement Parks & Attractions Water Parks – World Waterpark Association • Consult Other Appraisers - Search Appraisal Institute Directory by Property Type Why Take On the Special Purpose Property Assignment? Main Reasons for taking on the Special Property Assignment 1. Keeps things interesting. Never boring. Never stop learning. 2. Higher Fees. Contact Info Arthur L. Schwertz, MAI Senior Managing Director [email protected] Arthur Schwertz on LinkedIn 504.830.3880 Phone 504.830.3870 Fax 512 N Causeway Blvd Metairie, LA 70001 Special Use Property In Eminent Domain Presented to the Appraisal Institute – AI Connect August 5, 2014 Austin, TX Prepared and Presented by: Walter D. Carney, MAI Valbridge Property Advisors Session Objectives 1. Cover the standards – what determines property taken by eminent domain is special purpose/use: a) Common Terms b) Definitions and Rulings c) Federal and State Statutes 1) Rules of Evidence 2) Rules of Civil Procedure d) Federal and State Case Law e) Special Statutes Walter D. Carney, MAI Session Objectives 2. Explain/Discuss: a) “Just” and “Fair” – why are these foundational rubrics in special purpose b) The role of “Indemnity Principle” in “Just” and “Fair” and special purpose c) Why the “hypothetical” buyer and seller are not quite so hypothetical in special purpose/use, eminent domain assignments Walter D. Carney, MAI Session Objectives 3. Present case studies (case law) from various jurisdictions 4. Discuss accepted value-based doctrines and valuation approaches/methods 5. Characterize the roles of the appraiser and the attorney in eminent domain and in the special purpose/use property assignments Walter D. Carney, MAI Common Terms Appraisal Literature – Examples Special Purpose Property: “A limited market property with a unique physical design, special construction materials, or a layout that restricts its utility to the use for which it was built; also called a special-design property. (Dictionary of Real Estate Appraisal, 5th Edition) Walter D. Carney, MAI Common Terms Appraisal Literature – Examples “Many limited-market properties [examples stated] …include structures with unique designs, special construction materials, or layouts that restrict their functional utility to the use for which they were originally built. These properties usually have limited conversion potential and, consequently, are also called specialized, special-use, special purpose, or special design properties. (The Appraisal of Real Estate, 14th Edition) Walter D. Carney, MAI Jurisdictional Definitions and Rulings Illinois: “Special-purpose” buildings are designed for a particular or specific use, whereas “special use” were not so designed originally, but at the time of valuation were put to “special use.” City of Chicago v George F. Harding Collection, 70 Illinois App 2nd 254, 257 (1st District 1965) Walter D. Carney, MAI Jurisdictional Definitions and Rulings New York: Specialty Purpose Property Four-Part Test 1. “The improvement must be unique and must be specially built for the specific purpose for which it was designed; 2. There must be a special use for which the improvement is designed and the improvement must be so specially used; 3. There must not be no market for the type of property and no sales of property for such use; and 4. The improvement must be an appropriate improvement at the time of the taking and its use must be economically feasible and reasonably expected to be replaced.” Walter D. Carney, MAI Jurisdictional Definitions and Rulings New York: Specialty Purpose Property Four-Part Test “Further, the specialty must be a structure uniquely adapted to the business conducted on it or use made of it, and it cannot be converted to other uses without the expenditure of a substantial sum of money.” County of Suffolk (NY) v Van Bourgondien, 47 N.Y. 2d 507, 419 N.Y.S. 52 392 N.E.2d (1979) Walter D. Carney, MAI Jurisdictional Definitions and Rulings California: “Special use or special purpose property is property that, because of its uniqueness, has no relevant market for purpose of comparable sales.” (Condemnation Practice in CA) Walter D. Carney, MAI Jurisdictional Definitions and Rulings California: “’Non-profit,’ special purpose property means property which is operated for a special nonprofit, tax-exempt use such as a school, church, cemetery, hospital, or similar property. ‘Non-profit, special use property’ does not include property owned by a public entity.” (California Code of Civil Procedure 1235.155) Walter D. Carney, MAI Federal and State Statutes US Constitution 5th and 14th Amendments • The “Just Compensation Clause” “…nor shall private property be taken for public use, without just compensation.” The U.S. Supreme Court has held that the federal government (together with each state by Due Process of the 14th Amendment) has the power of eminent domain, the power to take property for “public use.” Walter D. Carney, MAI Federal and State Statutes Rules of Evidence or Evidence Code • Governs rules of evidence in federal, state, and territorial court systems: if, when, how, and for what purpose the legal case may be placed before the trier of fact. Walter D. Carney, MAI Federal and State Statutes Rules of Evidence or Evidence Code • California Evidence Code, Div. 7, Ch. 1, Articles 1 to 3 Division 7. Opinion Testimony and Scientific Evidence Chapter 1. Expert and Other Opinion Testimony Article 1. Expert and Other Opinion Testimony Generally (800-805) Article 2. Evidence of Market Value of Property (810-824) Article 3. Opinion Testimony on Particular Subjects (870) Walter D. Carney, MAI Federal and State Statutes Rules of Evidence or Evidence Code • California Evidence Code, 823 Notwithstanding any other provision of this article, the value of property for which there is no relevant, comparable market may be determined by any method of valuation that is just and equitable. Walter D. Carney, MAI Federal and State Statutes • California Evidence Code 824 (a) Notwithstanding any other provision of this article, a just and equitable method of determining the value of nonprofit, special use property, as defined by Section 1235.155 of the Code of Civil Procedure, for which there is no relevant, comparable market, is the cost of purchasing land and the reasonable cost of making it suitable for the conduct of the same nonprofit, special use, together with the cost of constructing similar improvements. The method for determining compensation for improvements shall be set forth in subdivision (b). Walter D. Carney, MAI Federal and State Statutes Rules of Evidence or Evidence Code • California Evidence Code 824 (b) Notwithstanding any other provision of this article, a witness providing opinion testimony on the value of nonprofit, special use property, as defined by Section 1235.155 of the Code of Civil Procedure, for which there is no relevant, comparable market, shall base his or her opinion on the value of reproducing the improvements without taking into consideration any depreciation of obsolescence of the improvements. Walter D. Carney, MAI Federal and State Statutes Rules of Evidence or Evidence Code • California Evidence Code 824 (c) This section does not apply to actions or proceedings commenced by a public entity or public utility to acquire real property or any interest in real property for the use of water, sewer, electricity, telephone, natural gas, or flood control facilities or rights-of-way where those acquisitions neither require removal or destruction of existing improvements, nor render the property unfit for the owner’s present or proposed use. Walter D. Carney, MAI Rules of Civil Procedure or Code of Civil Procedure • Governs civil procedures – common laws, and pleadings and motions – in federal courts and 50 state systems, and territorial courts. Walter D. Carney, MAI Rules of Civil Procedure or Code of Civil Procedure • California Code of Civil Procedure, 1263.320 (a) The fair market value of the property taken is the highest price on the date of valuation that would be agreed to by a seller, being willing to sell but under no particular urgent necessity for so doing, nor obliged to sell, and a buyer, being ready, willing, and able to buy but under no particular necessity for so doing, each dealing with the other with full knowledge of all uses and purposes for which the property is reasonably adaptable and available. Walter D. Carney, MAI Rules of Civil Procedure or Code of Civil Procedure • California Code of Civil Procedure 1263.320 (b) The fair market value of property taken for which there is no relevant, comparable market is its value on the date of valuation as determined by any method of valuation that is just and equitable. Walter D. Carney, MAI Case Law and Special Statutes • Case Law – Appellate Court Systems and Supreme Courts • Special Statutes – may set out additional rules and procedures to appraise unique properties Walter D. Carney, MAI Special Statutes • California Public Resources Code, Section 5405 “The amount of compensation or land, or both, required…for the taking of the parkland and facilities shall be equal to one of the following: (a) The cost of acquiring substitute parkland of comparable characteristics and of substantially equal size...and the cost of acquiring substitute facilities of the same type and number, plus the cost of development of such substitute parkland, including the placing of such substitute facilities thereon. Walter D. Carney, MAI Other Reference Sources • Nichols®, The Law of Eminent Domain Volume 4, Part 4 §12C.01 Special Use Property Defined 1. The unique value to the particular owner involved and not to others; 2. The special attributes inherent in the property itself and the improvements that, while unusual, are not unique; 3. The special attributes inherent in the property itself; or 4. The conversion to a peculiar use. Walter D. Carney, MAI “Just Compensation” • “Such compensation means the full and perfect equivalent in money of the property take.” • “The owner is to be put in as good position pecuniarily as he would have occupied if his property had not been taken.” (so-called “Indemnity Principle”) United States v Miller, 317 U.S. 369, 373-374 (1943) Walter D. Carney, MAI “Indemnity Principle” • Indemnity principle ruling added context to “Just Compensation” clause, and to the 5th Amendment • “Focuses exclusively on the owner’s loss,” “not on the gain to the condemnor” • “Thus we have held that fair market value does not include the special value of the property to the owner arising from its adaptability in his particular use” United States v Miller, 317 U.S. 369, 373-374 (1943) United States v General Motors, 323 U.S. 373, 378 (1945) United States v 564.54 Acres of Land, 441 U.S., 506 (1979) Walter D. Carney, MAI “Indemnity Principle” • “If the land owner has adopted a peculiar mode of using the land…and he is to be deprived of that use, justice requires that he be compensated for the loss to himself.” Eisenring v Kansas Turnpike Authority, 183 Kan. 774, 779, 332 P.2nd 539, 543 (1958) Walter D. Carney, MAI Fair Market Value • Willing buyer and willing seller • Neither is compelled to transact • Each fully knowledgeable of all of the uses and purposes of the property is reasonably adaptable • Assumes the existence of a market of comparable sales Walter D. Carney, MAI Commonly Treated By Courts as Special Use Properties • • • • • • • • • Worship Facilities Cemeteries Schools Historic Properties Industrial Properties Sand and Gravel Facilities Railroad Terminals Utility Facilities (e.g. water companies) Non-Profit Special Use Walter D. Carney, MAI Special Purpose/Use Case Studies Social, Fitness and/or Recreational Facilities (Profit and Non Profit) • Denied: Fitness/Recreation Facility (YWCA) Illinois: People ex rel. Director of Finance v Young Women’s Christian Association of Springfield (State Supreme Court 1981) • Denied: Recreation Facility (Private Beach and Cabana Club) New York: Matter of the County of Nassau (Town of Hempstead), (State Supreme Court 1971) Walter D. Carney, MAI Special Purpose/Use Case Studies Social, Fitness and/or Recreational Facilities (Profit and Non Profit) • Held: Social Club New York: St. Angello Abate of Amsterdam, New York., Inc. v State, (NY App. Div. 1979) • Held: Social Club Massachusetts: Benevolent and Protective Order of the Elk, Lodge No. 65 v Lawrence Redevelopment Authority, (State Supreme Court 1992) Walter D. Carney, MAI Special Purpose/Use Case Studies Worship Facilities • Denied: Church Oregon: State v First Methodist Church of Ashland, (State Court of Appeals, 1983) • Held: Church California: Redevelopment Agency of Long Beach v First Christian Church, (State Court of Appeals, 1983) Walter D. Carney, MAI Special Purpose/Use Case Studies Historic Properties • Denied: Historic Commercial US (Arkansas, Hot Springs National Park): Fordyce v United States, (United States Court of Claims, 1981) • Held: Historic Commercial Arkansas: Scott v State, (Arkansas State Supreme Court, 1959) • Held: Historic Residential New Hampshire: Portsmouth Housing Authority v Fusegni, (State Supreme Court, 1974) Walter D. Carney, MAI Special Purpose/Use Case Studies Industrial Properties • Held: Adhesive Manufacturing Facility California: City of Commerce v National Starch and Chemical Corp, (State Court of Appeals, 1981) Unique or Peculiar, Vacant Land • Denied: Vacant Land (Suitable Use) California: County of San Diego v Rancho Vista Del Mar, Inc., (State Court of Appeals, 1993) • Held: Vacant Land (Suitable Use) Illinois: Central Illinois Light Co. v Porter (State Court of Appeals, 1968) Walter D. Carney, MAI Valuation Methods • By Market Data (Comparable Sales) Analysis of comparables, of sales in particular: “…has an external validity which makes it a fair measure of public obligation to compensate the loss incurred by an owner.” United States v Toronto, Hamilton & Buffalo Navigation Co., 338 U.S. 396, 402 (1949) Walter D. Carney, MAI Valuation Methods • By Other Approaches/Methods However, “When market value has been too difficult to find, or when its application would result in manifest injustice to the owner or public, courts have fashioned and applied other standards.” United States v Commodities Trading Corp., 339 U.S. 121, 123 (1950) Walter D. Carney, MAI Valuation Doctrines/Methods Unique Doctrines to Special Purpose/Use Property: • Substitute Facilities Doctrine • Assembled Economic Unit Doctrine Walter D. Carney, MAI Valuation Doctrines/Methods Approaches in Special Purpose/Use • Cost Approach ‒ Replacement Costs New ‒ Reproduction Costs New ‒ Depreciation ‒ Developer’s Profit ‒ Land Value – Market Value • Income Capitalization Approach • Sales Comparison Approach • “Modified Market Data Approach” • Developers Approach (Land Residual) Walter D. Carney, MAI Appraiser and Attorney Roles • Simultaneously a specialized valuation assignment and a specialized legal matter/case. • Opportunity to be informed ‒ Statutes, cases, and challenges ‒ Current legal thinking and insights; and the case • Opportunity to inform ‒ What’s “Relevant” and “Not Relevant” about the subject property and the market data ‒ Current appraisal methods and insights; and the assignment • Invite and welcome challenges…and reciprocate Walter D. Carney, MAI Thank You! Walter D. Carney, MAI Senior Managing Director Valbridge Property Advisors 1 N. Market Street San Jose, CA 95113 [email protected] (408) 279-1520, x7145 How do I handle special purpose properties with complex cash flows? Presented by: Matthew Lubawy, MAI, CVA, CMEA Senior Managing Director Valbridge Property Advisors Overview of Topics to be Discussed • Appraising gaming properties • Gypsum mine on hillside overlooking Las Vegas • Vacant land with dirt piles that cost more to remove than the market value of the land Appraising Gaming Properties • Most gaming properties have a mixture of uses. The cash flow is more than just casino revenue and expenses. Examples of other uses include: – – – – – – Hotel Food/Beverage RV Park Bowling Alley Gift shops Leased Space (e.g. – shopping mall) What is Needed? • Ask for 5 years of Income Statements • Ask for gaming authority tax documents. For example Nevada Gaming Control Board has NGC-17 and NGC-31 reports. • Nevada Gaming Control Board publishes statistical data on gaming properties Example of Gaming Control Board Statistical Data How to Analyze the Data (Revenue Projection) How to Analyze the Data (Revenue & Expense Projection) How to Analyze the Data (Expense Projections) Nevada Gaming Valuation • You will first need to define the type of property you are appraising by the amenities and the income stream. The income and expenses can vary significantly. In Nevada, I analyze the property based on their location first, then by revenue. • The revenue and expenses vary significantly by area. I break down the areas in Southern Nevada by: • Las Vegas Strip, • Downtown Las Vegas, • Laughlin, • Boulder Strip, and then • Balance of Clark County. • These areas are distinct from each other. For example, the Downtown Market caters to lower-end gamblers, while properties on the Las Vegas Strip cater to high-end gamblers. Nevada Gaming (cont.) • Analyze the property based on the market and the size of the revenue. For example: • Las Vegas Strip is broken down into 3 areas: – Gaming Revenue of $1,000,000 and over, – Gaming Revenue between $1,000,000 and $72,000,000, and – Gaming Revenue over $72,000,000 • The size of revenue is usually indicative of the quality of the property and the amenities it serves. • Once you pick the property type (location and size of gaming revenue), then you will need to analyze each department such as hotel, banquet facilities, food, beverage, leased property, bowling, etc. Below is an example of how gaming is broken down. • Gaming Revenue: • Pit revenue • Coin operated devices • Poker and Pan • Race Book • Sports Pool • Depending on the property, you will need to determine how many types of table games there are in the pit and how much revenue can be generated by each gaming device (e.g., baccarat, poker, keno, roulette, etc.). You need to also determine what the drop and take is for each game. I usually analyze the averages on a daily basis. • Tax Authority keeps a record of how many gaming devices have been in service for the property. • Once all of the departmentalized revenue has been analyzed, then analyze the expenses associated with each department. For example gaming would include the following: • Gaming Expenses: – – – – – – – – – – Bad Debt Comps Commissions Gaming Taxes and Licenses Payroll –Taxes Payroll – Employee Benefits Payroll – Officers Payroll – Other employees Race Wire fees Other Departmentalized Expenses • These are just a few of the expenses associated with this department. You will also need to analyze the revenue and expenses for the other departments (i.e., hotel, food, beverage, etc.). Each department should have its own revenue and expense analysis. • Once you have calculated your revenue and expenses, then you should have a good idea of the net operating income. It is hard to find cap rates these days, but there is data available in SEC filings for properties that have sold across the U.S. Another method you can use to derive a cap rate is by way of CAPM. • Nevada’s largest casino’s suffered a combined loss of $1.35 billion in 2013, the fifth year of consecutive losses. If you come across this scenario, then you may want to use a gross revenue multiplier to value the property. • The sales comparison approach is usually analyzed based on price per room and price per square foot. There is a lot of variation between sales of properties, so your adjusted range will most likely be very wide. • Once you have completed the valuation of the property, you will need to separate out the tangible assets and the intangible assets. Break this down into real estate, FF&E, and business value (goodwill). Make sure to get an itemized list of FF&E. Keep in mind, this is a business valuation. Therefore, you need to go through the steps to determine what the real estate is worth. Gypsum mine on hillside overlooking Las Vegas • This assignment was the valuation of a gypsum mine that sat high on top of a mountainside overlooking the Las Vegas Valley. • The property had gypsum reserves that could last for several decades. • The property was at the edge of development. • The property could be rezoned to residential uses and commercial uses (master-planned community) • Utility Infrastructure was a couple of miles away. Inputs Discounted Cash Flow (Absorption Analysis) Highest and Best Use Analysis • Value of the proposed master-planned community was $112,538 per acre. • Reserve Study was conducted to determine the amount of reserves and quality of mineral rights. • An appraisal of another gypsum mine was conducted (outsourced to another appraisal firm the year before). Sales of properties with mineral rights were available. We contacted the appraiser to value the minerals rights of the subject. Value was substantially lower than the value as a master-planned community. Conclusion • After analyzing all of the data, the highest and best use conclusion was to wait a few years to develop the property. This was due to the fact that the infrastructure could be brought in closer to the subject due to another development that was proposed nearby. • Aside from one potential development close to the subject, the only land nearby was federally owned. Potential to get paid back for brining in infrastructure was very low. Residential Land with Dirt Piles • Subject property consists of 25 acres of vacant land. • The property had 15 to 20 foot high dirt piles on the property. • Estimates were prepared to determine how much dirt needed to be removed. 450,000 cubic yards, but 100,000 could be used (350,000 cubic yards to be removed) • Cost estimates were at $5.00 per cubic yard several years earlier. Residential Land with Dirt Piles • In the midst of the recession. Current cost estimates are $16 per cubic yard, or $5,600,000 • The market value of the land as though vacant was $150,000 per acre, or $3,750,000 • $3,750,000 value less cost to cure of $5,600,000 is negative $1,850,000. • Highest and best use is to develop when the market returns (projected to be 5 to 7 years). • Cost to remove dirt piles is projected to be $10.00 per cubic yard in 5 years. Appraisal Methodology • The subject was valued based on discounting the cost of removing the dirt piles 5 years in the future at $10.00 per cubic yard for 350,000 cubic yards. • Discount rate was estimated at 25% based on investors that purchased partially finished lots and their discount rates that ranged from 20% to 30%. • Present Value of removing the dirt piles is approximately $1,150,000. • Market value equals $3,750,000 less $1,150,000. Reviewer’s Comments • The appraisal was reviewed and the reviewer stated that the discount rate should be a “safe rate” of 3.5% since the cost of dirt piles is known. Sinking fund should be used. • The concept of a “safe rate” has come out of accounting practice to save money at a safe rate for a future date when cost is to be expended to pay for a future obligation. This does not reflect market practice. (Hoskold Premise used to value income stream of a wasting asset using safe rate). • An investment is based on the cost paid today and future cash flows in the future. If the cash flows are bifurcated with different yield rates, then the investors overall yield will not be met. Conclusion • In this assignment, the current market value of the land as though vacant was easily supported by market data. Rather than estimating the projected market value of the land 5 years in the future and subtracting the present value cost of the dirt piles, only the cost of the dirt piles was estimated, then subtracted from the current market value of the land as though vacant. • Apply discounts to cash flows based on market-derived data. • The use of a “safe rate” in this assignment was not be used to calculate the present value of the cash flows as this does not reflect market actions. Update (Current Value) • The subject of this case study is now in escrow. Land values doubled in the past five years (flat for two, doubled in past three years). • The appraisal we prepared projected that values would increase 20% per year on average over the next 5 to 7 years, but that the market would be flat for the first two years. Discount of 25% at 5 years was used to value the property. Contemplated 7 years (with cost increase) with 20% discount rate (similar results would have been attained).