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Specializing in Real Estate Appraisal and Property Tax Consulting |
| WINTER 2009 |
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In This Issue: |
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The Valuation of Air Rights Air rights are defined as "the right to undisturbed use and control of designated air space above a specific land area within stated elevations. Such rights may be acquired to construct a building above the land or building of another or to protect the light and air of an existing or proposed structure on an adjoining lot" (The Appraisal of Real Estate, 13th Edition).The practical relevance of air rights as separable assets is found in highly urbanized areas in which land is both quite scarce and expensive. Such rights may be purchased in fee or leased. As noted in the above definition, the boundaries of air rights, particularly the lower boundary, are specified as a part of the legal description. For example, air rights might be described as that portion of the property above 50 feet from the surface. It is rare that an upper boundary is specified. Such upper boundaries are typically subject only to governmental regulations (e.g., building and zoning codes, and U.S. Federal Aviation Administration height restrictions). In some jurisdictions, air rights may be transferable to the owner of another property. Transferrable development rights were envisioned many years ago by urban planners seeking alternative tools for controlling land uses and densities. In order for air rights as separate assets to have measurable market value, there must, of course, be demonstrable demand. Since all sites in highly urbanized areas (including New York City) are not developed to maximum permitted density, there are obviously unused air rights. However, without apparent market demand for the transfer of such rights, their market value is likely manifest solely in the value of the underlying property. Similarly, the right to construct a 100-story building is of little importance if demand exists only for a 40-story structure. As with all aspects of real estate, market demand drives market value. The most straightforward-method of valuing air rights is by direct comparison, using sales of similar air rights. The most appropriate unit of comparison is likely to be sale price per planned developmental density (expressed in square feet) rather than sale price per permitted density, for reasons previously cited. While direct comparison is preferable, sales of air rights occur infrequently. This in itself raises obvious questions regarding market demand for such rights. It is, thus, incumbent upon the valuation professional to analyze both the existence and depth of demand. Assuming that adequate demand does exist, the appraiser may rely on residual analysis to form an opinion of the value of the air rights. This involves the use of income capitalization to estimate the value of the proposed development within the air rights. The total costs of construction (hard and soft) are then deducted. The residual is an indication of the value of the air rights. This technique, being highly sensitive, requires an extraordinary degree of accuracy, particularly in terms of costs, in order for the results to be accurate. |
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Office Building Area Calculations Since office buildings are leased and sold on the basis of size (square footage), the means of determining size is clearly important. There are various terms used in describing size, including, among others, gross building area, net leasable area and usable area.If standards exist, most would agree that they are those of the Building Owners and Managers Association (BOMA). However, the BOMA standard is not universal. Local standards often trump those of BOMA. It is, therefore, important to owners, tenants, brokers, assessors and appraisers to understand the applicable measurement standards in any particular situation. Table 1 contrasts BOMA area definitions with those that appear in the Dictionary of Real Estate Appraisal, Fourth Edition. There is obviously no single uniformly accepted measurement standard. Rather, one should do the necessary research to determine the standard used in a particular locale. Further, in comparing properties, one must use consistent area measurements in order to get meaningful analytical results. If one examines the rent rolls of a particular multitenant office building over the span of several years, it will often be the case that the total reported square footage of the building changes over time. This is due to shifting tenancies and suite alterations. Although the size of the building may not change, these differences arise through inaccurate measurement. Inaccurate measurement of square footage has obvious implications in terms of rent and expenses paid, assessments for capital item replacement and, indeed, sale price/value.
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Qualitative Adjustments Comparable data are essential elements of the valuation process, specifically in the application of the sales comparison and income capitalization approaches. The means by which these data are analyzed are equally essential in supporting accurate opinions of value.Most readers of appraisal reports are accustomed to seeing quantitative adjustments of comparable sales and rental rates. Such adjustments are typically expressed as percentages {e.g., +5% or xl.05 if the comparable is inferior by 5%). Difficulties arise when there are insufficient data to support such precise adjustments. In recent years, the use of qualitative analysis has emerged in recognition of the frequent unavailability of market support for precise percentage adjustments and the reality that the market for real estate is imperfect. Qualitative techniques may include statistical and graphic analyses. Examples include linear regression and scatter plots. Other techniques include trend analysis, relative comparison analysis and ranking analysis. Trend analysis is particularly useful when one has relatively large data sets. Table 2 illustrates a trend analysis reflecting the relationship between sale price and site size.
The relative comparison analysis technique is frequently used by appraisers. It involves the rating of significant elements of the comparables (e.g., location, site size, age, condition) as each compares with the property being valued. Such ratings are often expressed as "similar," "inferior" or "superior" (Table 3).
Ranking analysis is a technique in which comparable data are arrayed by relative rank, either by individual characteristic or by overall comparability. Such rankings are useful in both identifying the importance (or lack of same) of individual elements and in bracketing the supportable range of value of the subject. Table 4 shows an example of a ranking analysis.
Ranking analysis is also useful in demonstrating overall relationships between value-influencing variables and price/value. For example, there is clearly such a relationship between net operating income and price/value for income-producing real estate. Simply stated, price/value varies directly (in the same direction) with net operating income, all other factors being equal. Ranking analysis permits the simple but compelling demonstration of such relationships. The use of qualitative analysis is growing in the valuation profession. Such analyses, if properly performed and presented, can add significant support, clarity and credibility to the conclusions reached. Qualitative analysis should not be viewed as less rigorous than quantitative analysis. Rather, if properly applied, it requires the same degree of rigor and provides equally reliable results. |
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Effective Gross Income Multipliers An effective gross income multiplier (EGIM) is a factor that expresses the relationship between sale price or value, and effective gross income. Effective gross income includes all collected income. Sources of income vary by property type and lease structure but may include expense reimbursements, application fees, termination fees, percentage rent and administration fees. Effective gross income is net of both physical and economic vacancy. The latter is often termed "lag vacancy."
The calculation for EGIM is sale price/value divided by effective gross income. It is, thus, characterized as a factor (multiplier) as contrasted with a rate (e.g., an overall capitalization rate or "cap rate"). The EGIM can be converted to a rate by taking its reciprocal. The resulting rate may be considered an "effective gross cap rate," although this is not a term of art in the valuation body of knowledge.The EGIM is an effective valuation tool for use in the income capitalization approach, particularly when expenses and net operating income are unavailable. It also provides an additional value indication by direct capitalization and discounted cash flow analysis. The strength of the EGIM is that it accounts for varying levels of vacancy among the comparables and subject. This is in contrast with the gross income multiplier, which is based on potential rather than effective gross income. The primary weakness of the EGIM is that it is very sensitive. Relatively small differences in EGIMs have an inordinately large effect on the resulting value. Furthermore, the EGIM does not reflect varying expense ratios among comparables and the subject. The expense ratio is the relationship between expenses and either gross or effective gross income. The expense ratio is typically expressed as a percentage. All other factors being equal, higher expense ratios result in lower values since there is less net operating income. Higher expense ratios also increase risk since relatively small increases in expenses or decreases in effective income will have an inordinately large effect on net operating income. One must therefore be quite careful in the analysis and selection of EGIMs. |
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