PROBLEM SET 4:MARKET AND COST APPROACHES Professor C.F. Sirmans
PROBLEM 1 • PROBLEM:A one-story industrial warehouse contains 12,000 square feet of total floor area. Office space occupies 1,200 square feet of floor area. Exterior walls are 20 feet high. The building dimensions are 80’ by 150’. Interior ceiling heights are 18 feet, clear span. There are two loading docks. The roof is flat, of built-up construction.
PROBLEM 1 • Part 1: • A) What are total direct costs of construction new? • B) What are total indirect costs? • C) What is the total Reproduction Cost New of this structure? • D) What is the indicated cost new per square foot for this warehouse?
SUGGESTED SOLUTIONS: A) Step 1: Determine the square footage. Foundation area is 80 x 150 = 12,000 square feet. Wall area is (2 x 80 x 20) = 9,200 square feet. PROBLEM 1
PROBLEM 1 • PART 2: • The warehouse in Part 1 has an effective age of 15 years. The remaining economic life of the structure is estimated at 35 years. The electrical system will have to be replaced in 15 years, and the entire structure will most probably have to be redecorated in 5 years. The plumbing fixtures have a remaining economic life of 10 years. • There is observed deferred maintenance in the roof of $500, in the office area amounting to $600, and some painting costing $300 should be done immediately. The electrical outlets are outmoded and should be replaced immediately. • A) Indicate the amount of Curable Physical Deterioration in the structure. • B) Indicate the amount of Curable Functional Obsolescence in the structure. • C) Set up a detailed table showing the amount in Incurable Physical Deterioration experienced by each major component part of the structure. • D) Indicate total Incurable Physical Deterioration observed in the structure.
PROBLEM 1 • SUGGESTED SOLUTIONS:
PROBLEM 1 • C) The 15-year effective age of basic structural components represents 30% of total estimated economic life. This is applied to indirect costs as well. The electrical system has an effective age of 50% (15/30). • Decoration has an effective age of 75% (15/20). • Curable items must be deducted from cost new before applying the percentage of effective age to estimate Incurable Physical Deterioration.
PROBLEM 1 • PART 3: • Because of problems in interior design, and the positioning and size of loading and docking facilities, it is estimated from market evidence that the subject warehouse in Part 1 and 2 rents for 10 cents per square foot per year less than do similar, competing warehouses with more acceptable design and loading facilities. Moreover, heating and ventilating expenses in this structure are 2 cents per square foot per year more than in standard buildings in the same market area. Warehouse properties of this type have been selling for approximately 5.75 times gross annual rentals. • What is the amount of observed Incurable Functional Obsolescence in this structure?
PROBLEM 1 • SUGGESTED SOLUTION:Total income loss is 12 cents per square foot per year (.10 + .02). • This is an annual income loss of $0.12 x 12,000 = $1,440. • The capitalized value of this annual income loss is: • 5.75 x $1,440 = $8,280 • Incurable Functional Obsolescence is $8,280.
PROBLEM 1 • PART 4: • A) For the warehouse building analyzed in Parts 1, 2, and 3, show a summary tabulation of total diminished utility by major category. • B) Indicate the present worth or contribution to total property value of this warehouse building, as of the valuation date.
PROBLEM 1 • B) Reproduction Cost New of Improvements $ 177,046 • Less Diminished Utility - 65,714 • Present Value (Contribution) of • Improvements $111,332
PROBLEM 1 • COMMENT:The cost approach in determining value reasons that the true measure of value of a structure is the cost of creating it. Several steps are necessary in the completion of the cost approach. First, the appraiser must determine the present cost of reproducing or replacing the building. This step requires the appraiser to have an understanding of building design and the application of a standard building cost manual. The next step is to estimate physical depreciation, functional obsolescence, and external obsolescence. This is then subtracted from the cost new. Finally, the appraiser must add site value and improvements back in to determine the final estimated property value.
PROBLEM 2 • PROBLEM:A two-family home is being appraised via the cost approach to value. The building is a rather typical two-story structure with one apartment on each floor. Local builders are no longer building “over-and-under” two-family dwellings in the area; new two-family structures are “side-by-side” duplexes. The side-by-side design, with each apartment having its own stairway and bedrooms on the second floor, is more popular, commands a higher rental, and can be constructed for about the same cost per square foot as the old over-and-under design. The problem at hand is to make a separate estimate of the incurable obsolescence ascribable to the old design deficiency. Rental and sales data for other two-family homes have been gathered and are summarized as follows:
PROBLEM 2 • SUGGESTED SOLUTION: Estimate the apparent rental loss by comparing matching pairs, and convert this rental loss into an indication of loss in value using a gross income multiplier.
PROBLEM 2 • Apparent Monthly Rental Loss • Subject property versus Rental C. • These two properties are similar with respect to age and condition, they differ only with respect to design. Property C commands $20 more per month than the subject property, which suggests a rental loss of $20 per month due to design. • Rental A versus Rental B. • These two properties are similar with respect to condition and are fairly close in age. The main difference is in design, suggesting that the rental loss attributable to the old-fashioned design is at least $20 per unit per month. Because Property A is five years older than Property B, the true rental difference due to design alone could be somewhat greater, thereby lending support to a rental difference somewhat in excess of $20 per month, say $25 per unit per month.
PROBLEM 2 • Rental A versus Rental D. • These two properties differ with respect to age, condition, and design. The rental difference is $5 per month, but it appears that the Property D can command premium rent because of its excellent condition. • Rental C versus Rental D. • These two properties are almost the same age, but they are dissimilar with respect to condition. In this case, the over-and-under design appears to command a higher rental than the side-by-side design, but the comparison is of questionable significance in light of the difference in condition and the results of the other comparison.
PROBLEM 2 • Other comparisons. • Other comparisons such as Rental A versus Rental C, Rental B versus Rental D, Rental C versus Rental A, and Rental D versus Rental B do not reveal a rental loss that could be attributed to the difference in design. • The apparent monthly rental loss due to design as indicated by Rental A versus Rental B and the subject versus Rental C is $20 to $25, say $22.50 per unit. Total monthly rent loss for the subject property is therefore: • $22.50 x 2 = $45.
PROBLEM 2 • COMMENT:This suggested solution depends on appraisal judgement in the interpretation of differences discerned from matched pairs. The problem demonstrates the use of market data and sales comparisons in the cost approach to value.
PROBLEM 3 • PROBLEM:Assume that a five-year old industrial warehouse property is being appraised. It is located in a district of similar warehouses, distribution facilities, and light assembly plants. There is no rail service, but access to major through highways is excellent. All necessary utilities are available in the required capacities and at acceptable rates. • The subject warehouse building is a 100’ x 150’ steel frame and brick structure on a 30,000 square foot site. Approximately 20% of the building area is finished as office space, with all standard required amenities. Parking, docking, and loading facilities are adequate for the type of users most likely to be attracted to the property. The building has been well maintained and is in good physical condition. It is a clear-span structure with an 18 foot ceiling. The property is currently rented on a long-term lease at $1.50 per square foot of building floor area per year.
PROBLEM 3 • Investigation of the market has identified four recent sales of similar, competitive properties that can provide comparable sales data for the valuation of the subject property. The market investigation also revealed that warehouse space with 22-foot ceilings generally rents and sells at a 10% premium over similar 18-foot ceilings space, while similar warehouse space with columns (not clear-span) typically rents and sells at a 10% discount. The secondary industrial area in the market region has less good highway access, and space in that area rents and sells at a 10% discount. Finally, the level of market prices in this market has been increasing at approximately 5% per year over the past few years. • The four comparable sales properties are highly competitive with, and closely similar to the subject property in age, construction, physical condition, and all other respects except those specifically mentioned in the following descriptions.
PROBLEM 3 • Comparable Sales Property No. 1 is an 18 foot ceiling structure with columns (no clear span) with dimensions of 80’ by 150’. It has office space comprising 20% of total floor area, and covers 55% of its site. It is located in the secondary industrial area in the market region. It sold one year ago for 80,000. At the time of sale, it was rented at $1.20 per square foot of floor area per year. • Comparable Sales Property 2 sold two years ago for $96,000. It contained 14,000 square fet of floor area, with 2,500 square feet of office space. The site was 26,500 square feet in area. The structure had an 18-foot ceiling with no columns. The annual rental at the time of sale was $17,500. It is in the same area as the subject.
PROBLEM 3 • Comparable Sales Property No. 3 was renting for $20,500 per year when it sold one month ago for $112,500. The building was a clear-span structure with an 18 foot ceiling. The 13,500 square foot building had 20% of floor area in office space, and covered 50% of the site. It is located in the same area as the subject. • Comparable sales Property No. 4 was a clear-span structure with a 22-foot ceiling. It sold one year ago for $130,000. The building measured 100’ by 150’, with 3,300 square feet of office space. At the time of sale, it was renting for $1.55 per square foot per year. It is in the same area as the subject property. The site area is 25,000 square feet.
PROBLEM 3 • The calculated GIM for each of the comparable sales properties is as follows: • Comparable Sale No. 1: $ 80,000/$14,000 = 5.56 Annual GIM • Comparable Sale No. 2: $ 96,000/$17,500 = 5.49 Annual GIM • Comparable Sale No. 3: $ 112,500/$20,500 = 5.49 Annual GIM • Comparable Sale No. 4: $ 130,000/$23,250 = 5.59 Annual GIM • The indicated annual GIM for the subject property is 5.50. • The two units of comparison used in this analysis are the GIM and the sales price per square foot of building area. The indication of value from the use of these two units of comparison are based on a GIM of 5.50, and an indicated value per square foot of $ 8.33. The results are: • GIM 5.50 x Annual Gross $22,500 = $123,750 • $8.33 per Square Foot x 15,000 Square Feet = $124,950 • These two indications of value are quite close and clearly substantiate each other. By rounding to an appropriate level, a Market Value estimate of $125,000 appears justified.
PROBLEM 3 • COMMENT:This problem requires us to first determine value using the GIM approach. The GIM approach requires three steps: 1) estimate market rent for the subject site, 2) derive GIMs from market transactions, and 3) multiply the subject’s rent by the market derived GIMs. This result can be compared to the value per square foot. This requires us to adjust the sales price for differences in the comparable sites. Using the adjusted sales price we divide by square feet to obtain a multiplier. The results of the two methods are very similar indicating that the estimated value of the subject site is appropriate.
PROBLEM 4 • Using this data, estimate the value by: • A) the gross income multiplier technique • B) price per room comparison • C) price per square foot comparison • D) overall capitalization using the market extracted overall rate
PROBLEM 4 • COMMENT:In this case, multiple techniques are used to estimate value, each yielding a somewhat different result. As the final step in appraisal, the various results must now be weighted in accordance with the appraiser’s judgement regarding the reliability of the approach, to produce one single opinion concerning value.