BIG BOX
COMMERCIAL BIG BOX
A PRESENTATION TO MARKET BASED VALUATION
small box Good Morning
Welcome The following presentation is similar to the IAAO Annual Conference in Minneapolis presentation. I am Ken Voss, MAI, SRA, AI-GRS, CAE; I have valued (appraiser) and rendered decisions (Georgia Hearing Officer) on Big Box facilities. The following are opinions and have followed the same practices as an appraiser and as a Hearing Officer. We will address some definitions, methodologies, opinions, and best practices But, a brief recap on where we are today In The Beginning
2000 Meijer v City of Midland (Michigan) 2016 Menards, Inc. v City of Escanaba (Michigan) Various appeals in Indiana, Minnesota, Wisconsin, Texas, Michigan Legislative changes in state laws to assist assessors Dark Store Theory (Vacant store) Fee simple (unencumbered) Highest and best use analysis (current use) Restrictive covenant's Approaches to value (what is appropriate) Definition: Fee Simple
The definition of a fee simple estate is at the foundation of what assessors are often asked to examine, and it has become clear, particularly in property tax appeals that it is necessary to clear up this concept for assessors, appraisers, courts, and others in the appraisal community. Fee Simple: absolute ownership unencumbered by any other interest or estate, subject only to the limitations imposed by the governmental powers of taxation, eminent domain, police power, and escheat. Fee simple is an ownership concept, not a value concept. Definition: Fee Simple
The word UNENCUMBERED is where the appraisal definition digresses from the legal definition. The Dictionary of Real Estate definition emphasizes absolute ownership, but the word unencumbered implies unspecified encumbrances by interests or estates in something other than fee simple.
The implication, is that in one appraisal, fee simple means a valuation of a vacant (unencumbered) property, and in another appraisal fee simple mean appraising the property assuming market rent. Definition: Fee Simple
One of the main debates that has emerged as a result of the word unencumbered has been the interpretation that a property encumbered by a lease is not fee simple, and that appraising a property in fee simple means one must assume the property in unencumbered by a lease, or vacant.
Carrying this further, multitenant office buildings and apartment buildings must be appraised as vacant properties even if they are fully occupied, which suggests something contrary to what exists, or know as a “hypothetical condition.” Definition: Fee Simple
THEREFORE:
Fee Simple is a term of ownership Fee Simple is not a term of occupancy Fee Simple is not a term of value Fee Simple is a property right concept Fee Simple ownership may be subject to market or contract rent Definition: Lease
A lease is a possessory right that does not diminish fee simple ownership A lease and the rent it provides to the fee simple owner is a benefit to the owner and the prime reason for the investment The lessee has the benefit of possession of space in which to operate their business. A lease may impact value, but is has nothing to do with Fee Simple Definition: Leased Fee
The ownership interest held by the lessor, which includes the right to receive the contract rent specified in a lease, plus the reversionary right when the lease expires. The term is used by appraisers as a basis to estimate the lessor’s value subject to a lease. It is based on the capitalization of net operating income (NOI), or the sum of the present value of the forecast NOI over a projection period and the present value of the reversion. What the appraisal profession refers to as leased fee is really fee simple subject to a lease. Definition: Bundle of Rights (Pins)
Consider fee simple as a pin cushion that may convey leases, easements, deed restrictions, and other encumbrances. The property is still owned in fee simple, it is just subject to one of the encumbrances, or pins. The encumbrances may have an impact on property value, but they do not change fee simple ownership.
Also: The Bundle includes the right to possess; use; manage; income; capital; security; prohibition of harmful use; liability to execution; power of transmissibility; absence of term. Definition: Sale-Leaseback
Retailers control the design and construction of new buildings, purchase land, retained contractors to ensure branding is accurately incorporated and costs are controlled. Companies are able to recover their development costs by selling new facilities to investors in a sale-leaseback arrangement. A sale-leaseback is a financing arrangement rather than a sale of real property. Definition: Build-to-Suit
Over time, national tenants with strong credit ratings realized they could achieve better results by using preferred developers, rather than directly managing and funding the construction. The arrangement, Build-to-Suit, typically sees the developer secure funding on good terms because the corporate retailer guarantees the loan. The rent for the new retail facility is based on construction cost plus a return, and the sale is affected by the company’s credit rating and its corporate guarantee of the loan obligation. Definition: Big Box
A BIG BOX is just that when viewed overhead Generally, it is open, with high ceilings, steel pipe columns for support, minimal interior finish, sealed concrete floors, fluorescent lighting, HVAC, Sprinklers, loading docks, storage areas, small interior retail space, may have Garden Center or Automotive facility. Typically a single user, 100,000/SF to 200,000/SF or more Numerous current and recently closed improvements fit this criteria: Home Depot, Lowe’s, Costco, At Home, Brands Mart, Dicks, Best Buy. Located in Shopping Centers (Regional, Community, Neighborhood), Power Centers, or Free-Standing Definition: Deed Restriction
Deed Restrictions limit the ability of prospective buyers to use the comparable properties for the subject property’s highest and best use necessarily limit, if not eliminate, the willingness of those buyers to purchase the restricted property. Those who would be interested in buying the property with restrictions would need to make modifications to convert the property into something else. Given the need to make modifications, the buyers would necessarily pay a lower price. Definition: Highest and Best Use
A theoretical concept that underlies valuation analysis. An appraiser, must first perform general market analysis in order to analyze the characteristics of the market that cause the subject to have value.
The highest and best use of a property, is the use that generates the highest net return to the property over a reasonable time period. Definition: Highest and Best Use
A Principle of appraisal and assessment that requires each property be appraised as though it were being put to its most profitable use, given probable physical, legal, and financing constraints. The principal entails first identifying the most appropriate use, and second the most profitable use with that market. The correct determination of its highest and best use is one of, if not the most important steps in the appraisal process. Definition: Highest and Best Use
Highest and best use should not be assumed to be the current use When you transition from Mass Appraisal to Single Property Appraisal for purposes of defending an appeal, the determination of the highest and best use is required as part of the process. This analysis must be done on the subject property and the potential comparable properties used to develop a value estimate. The following slides, provides a brief review of each Highest and Best Use test Highest and Best Use: Physically Possible
Identify the physically possible uses of the site Check topography, configuration, size, vegetation, etc. Most any use relative to size is physically possible. Highest and Best Use: Legally Permissible
Check zoning classification for setbacks, lot coverage, building height, etc. Which of the physically possible uses are legally permissible? The zoning classification determines what can be legally constructed; the appraiser determines what can be physically be constructed. Highest and Best Use: Financially Feasible
The appraiser analyzes a group of potential uses that are physically possible and legally permissible. The appraiser determines which of the group being analyzed are financially feasible Note: The greatest influence on possible development of the subject site assuming it is unimproved is zoning Location is critical within a commercial corridor and the neighboring uses The Principle of Conformity suggests that a conforming use will produce the maximum return for an owner Highest and Best Use: Maximum Productivity
The test of Maximum Productivity is applied to those uses that have passed the first three tests (Physically possible, Legally Permissible, and Financially Feasible) Of the Financially Feasible uses, the highest and best use is that use which produces the highest residual land value consistent with the market acceptance of risk and with the rate of return warranted by the market. Methodology: Sales Comparison Approach
The Sales Comparison Approach is a process whereby prices and rents actually paid for properties similar to the subject are used to develop an indication of value for the subject property. This approach is based on its foundation in the Principle of Substitution which states that a prudent investor will pay no more to buy or rent a property than it will cost him to buy or rent a comparable property somewhere else in the market The Sales Comparison Approach can be an effective approach to value, assuming the data gathered is properly analyzed and verified. Methodology: Income Capitalization Approach
The Income Capitalization Approach is a technique in which the anticipated net operating income (NOI) to be generated by the subject property during the projected period of ownership is capitalized into a value estimate. The accuracy of the Income Capitalization Approach is related to the estimation of income, vacancy, expenses, and characteristics of the net operating income stream, the economic life span, the capitalization rate (OAR, Ro), and the methodology used in converting the net income into value. Income Approach-Ro’s
Capitalization Rates Type Low High Average Market Extraction 5.90% 7.70% 6.71% Trepp.com 5.25% 6.66% 6.19% Real Capital Analytics 5.90% 7.20% 6.30% RERC 5.00% 8.00% 6.40% RealtyRates 7.40% Band of Investment 7.24% DCR Analysis 6.64% Implied: Real Estate Taxes are embedded in the Capitalization Rate. Methodology: Cost Approach to Value
Used by all assessing jurisdictions Generally Replacement Cost New is used The Cost Approach reflects market thinking because market participants relate value to cost. Buyers of real property tend to judge the value of an existing structure not only by considering the prices and rents of similar buildings, but also comparing the cost to create a new building with optimum physical condition and functional utility. Moreover, buyers adjust the prices they are willing to pay by estimating the cost to bring an existing structure up to the physical condition and functional utility they need. Methodology: Cost Approach to Value
Illustration: Marshall Valuation Service (MVS) (price per square foot) Class C, Type Average, Section 13, Various Pages: Supermarket $83.33 RETAIL STORE $80.34 DEPARTMENT STORE $105.52 DISCOUNT STORE $64.40 MALL ANCHOR $85.29 Accurate description of property being appraised Methodology: Cost Approach to Value
Depreciation Physical Deterioration: wear and tear from regular use, the impact of the elements, or damage, and may be curable or incurable Functional Obsolescence: a flaw in the structure, materials, or design that diminishes the functional utility and value of the improvement, and may be curable or incurable External Obsolescence: a temporary or permanent impairment of the utility or salability of an improvement or property due to negative influences outside the property, and is incurable Methodology: Cost Approach to Value
Useful life: the period of time over which a structure or a component of a property may reasonably be expected to perform the function for which is was designed. Actual age: the number of years that have elapsed since construction of an improvement (historical or chronological age) Effective age: the age of property that is based on the amount of observed deterioration and obsolescence it has sustained, which may be different from its chronological age. Remaining economic life: the estimated period over which existing improvements are expected to contribute economically to a property; an estimate of the number of years remaining in the economic life of a structure as of the effective date of value Remaining useful life: the estimated period during which improvements will continue to provide utility. Transactions: Second Generation Leased Fee Sales
These sales represent large retail space leased to second generation tenants prior to the date of sale. The majority of these properties were originally constructed for other major retailers. After the tenant vacated the premises, the property sold to an investor. Similar to Build-to-Suit sales, this category will be driven by the negotiated lease rate and the credit worthiness of the tenants. These type of spaces will vary depending upon which party pays for tenants improvements/retrofit. If a costly retrofit/renovation is financed by the landlord and amortized over the lease term, sale prices may approach prices reflected by build-to-suit sales. Prior to Retrofit After Retrofit Transactions: Fee Simple Sales
Sales that represent transactions involving properties that were vacant at the time of the sale. These sales provide a reliable indication of value for a vacant building. The purchaser of such a property may be another retailer (typically lower quality) that plans to occupy the space “as is” or with limited modifications. Many of these properties are purchased by ‘entrepreneurs’ that may have a use/tenant for the property and plans to lease the balance to other tenants. Speculators purchase these properties in the hope of turning into second generation sales. Market Segmentation
Class A Investment First generation space Very good location Long term leases National or regional tenants Attracts national investors, such as REITS, retirement funds, etc. These are the best properties that demand high rents, and when sold will command the highest prices and lowest capitalization rates (Ro’s) Market Segmentation
Class B Investment First generation space Slightly older, good locations Remaining lease terms exceed 10-years Attracts national and regional tenants May be desirable for national investors These may still be first generation properties in less desirable locations Market Segmentation
Class C investment Nearing the end of their economic life for first generation space May be classed as second generation space Less desirable retail locations Remaining lease terms less than 10-years Properties sell at the low end; capitalization rates are at the high end The continued use as a Big Box is an interim use Market Segmentation
Class D Investment Classified as second generation space Sell at low prices Often vacant or soon to be vacant Original market demand for these properties has moved to more desirable retail locations or needs different size building footprint CREDIT WORTHINESS
Moody’s Credit Rating Stock Price Home Depot A2 $177.29 Lowe’s Ba1 $91.80 Walmart Aa2 $98.36 Target A2 $70.61 Costco Aa $210.31
NOTE: Aaa is the highest rating VALUATION METHODOLOGY
FIRST GENERATION SECOND GENERATION CLASS A Cost, Income, CLASS A Unlikely Highest & Market Best Use CLASS B Cost, Income, CLASS B Unlikely Highest & Market Best Use CLASS C Unlikely Highest CLASS C Income & Market & Best Use
CLASS D Unlikely Highest CLASS D Income & Market & Best Use Appeal Data
1. Sales of unoccupied big box stores (106 sales) period: January 1, 2011 to June 25, 2016 range of sales: $8.72/psf to $66.84/psf median: $26.08/psf mean: $27.73/psf 2. Sales of operating stores with long-term ‘NNN’ leases in place (96 sales) period: January 1, 2011 to June 25, 2016 range of sales: $48.92/psf to $371.78/psf median: $104.58/psf mean: $127.07/psf Part of this data has led to the following results: Georgia Appeals: Big Box Retail Results
Results To Date Number of Jurisdictions 15 Properties Reduced 36 Beginning Value(s) $433,043,428 Ending Value (s) $323,512,915 Difference $109,530,513 Percentage 33.86% Estimated Property Taxes Lost $547,653 Note: This is not all of the appeals; many have been resolved. Many have been withdrawn. Therefore, consider the following Best Practices Best Practice: Highest and Best Use
The analysis of highest and best use is at the heart of an appraisal when developing market value of real property. Property rights are not relevant to the highest and best use analysis. The study of highest and best use revolves around whether the property’s current use or an alternative use is the highest and best use. Four steps are involved in the highest and best use analysis. These steps are efficient at getting to a reasonable, market supported conclusion. The four steps again are: Physically Possible; Legally Permissible; Financial Feasible; and, Maximum Productivity Best Practice: Comparable Sales
The best comparable sales are those that mirror the subject’s highest and best use, including a similar conclusion regarding first generation space. Keep in mind, that both first and second generation space relate to the utility of the space, not the first or subsequent occupant. Trade are demographics Levels of competition Building age, size, and condition If leased: terms of the lease and renewal options; remaining term of lease; relationship of contract rent to market rent BEST PRACTICES: ECONOMIC, DEMOGRAPHIC AND REAL ESTATE DATA
Analyze economic and demographic data From the subject property trade area or county Related to the most specific property type possible If outside the local area, select reasonable comparable geographic areas based on demographic and economic characteristics Analyze real estate market data (rents, sales, etc.) from the trade area Best Practice: Adjustments to data
All real estate development is built-to-suit for specific users or types of users and like many other market data, should be qualified as being at market levels. If so, they can be considered for use in any approach to value. Custom features can be useful that can be adjusted. If market supported, so comparable cost, rents, or sales can be used Basing adjustments on actual real estate market behavior and subject’s trade area tends QUESTIONS