Working With The Appraiser
|Copyright 2014 by Virgo Publishing.|
|By: Ray Wilson|
|Posted on: 11/01/2003|
The intent of this article is to offer some suggestions to the owner who is preparing to have his facility appraised to ensure a proper valuation. The appraisal process is relatively simple. Many years ago, an appraiser could simply state the value conclusion, and it wasn’t questioned. Today, every statement and conclusion in the report must be supported with hard evidence for the appraisal to be acceptable to a lender. Every appraisal is reviewed, and the appraiser is often required to provide further clarification or additional documentation and support.
Owners can assist in the process by making sure the appraiser knows and understands relevant data and the trends that impact value. By helping in this matter, the likelihood of a proper valuation increases.
Appraisal’s Critical Role
The appraisal plays a critical role in the financing process. Borrowers who obtain appraisals with inflated values and unsupported conclusions often experience delays in obtaining their financing. A properly prepared appraisal report can save the borrower more money in time savings than a fractionally lower interest rate. A properly prepared appraisal can also make the difference between having an acceptable vs. unacceptable after-debt-service cash-on-cash return.
Having an appraisal report that properly estimates future expenses, for example, can make the difference between obtaining the loan or being denied. Some elements of the appraisal are more important than the value conclusion. Value, for instance, is not always the critical factor in the amount of loan dollars attainable. Often, it is the debt-service coverage ratio (DCR). The DCR also has a bearing on the interest rate the lender is willing to offer.
General and Specific Data
To estimate the value of a property, the appraiser must follow a specific valuation process. The process starts with the gathering of relevant data about the income-generating capability of the property being appraised and market trends impacting its value. More than anyone else, the owner is typically the best person to provide this information. By communicating with the appraiser and providing these insights, the owner assists in the process and can expedite a successful result.
To properly analyze the property, the appraiser must consider regional, city and neighborhood trends. The owner can point out aspects of the city or neighborhood that are important to the subject. These could include traffic patterns, the direction of population growth, the location of nearby high density housing, or perhaps just the high traffic volume generated by the commuter park-and-ride lot around the corner.
Barriers to entry (a fancy phrase to express the difficulty of doing a development) are critical considerations in the valuation process. If your city doesn’t look favorably upon self-storage and land available for development is limited, the risk of new competition and oversupply is reduced. Some cities have passed moratoriums on selfstorage development. These factors create scarcity, which enhances value. Make sure the appraiser is aware of them.
Provide the appraiser information specific to your facility, such as information about the site and building improvements that may not be so obvious. For instance, your facility may have a higher percentage of ground-level access units than the competition, ceiling heights that are much higher, access driveways that allow a wider truck and trailer turning radius, or a sign that is visible from both directions on an elevated freeway. Every little advantage your facility has over the competition should be pointed out to the appraiser, because it can impact the value and the appraiser could miss it.
Perhaps the most important element in the whole process is for the appraiser to understand the facility’s income-generating capability. After all, it is said that, “The value of any property is the sum of the present worth of the future cash flows.” Provide the appraiser the most recent income and expense data, as well as the historical data that shows trends demonstrating the facility’s past performance. Valuation is about measuring risk, and for an existing facility, it is important to show consistency in the income-generating capabilities of the subject over time. If the facility is proposed, the appraiser needs additional support for projections of revenue and expenses, as well as space (unit) absorption.
Operating Income. Real estate income includes all income directly and indirectly related to the rental of space, (i.e., real estate). Whether you are renting an apartment, warehouse or self-storage unit, you are renting “space.” This also means income generated “indirectly” from the rental of units is considered real estate income and can be included in the valuation of the real estate.
If, on the other hand, you have a large “show room” where you sell a considerable amount of retail product, you are in the retail business. Lenders will consider it as being real estate income when valuing your facility. Thus, income in self-storage facilities comes from the rental of space and ancillary income derived from the following sources:
Most lenders allow ancillary income so long as it does not exceed 6 percent to 8 percent of rental revenue; otherwise, it is considered business income. Income derived from the leasing of trucks is considered business income because it is derived from personal property, i.e., the truck and the contract, which is not tied to the real estate.
Operating Expenses. Operating expenses include all expenses to maintain the facility and continue production of income. If you are expensing certain items for IRS purposes, be sure to point it out to the appraiser. An automobile is not a legitimate self-storage operating expense. Neither are trips to Europe to attend self-storage conferences—too bad.
If you were recently successful in a real estate tax appeal, make sure the appraiser knows about it. Using simple trend analysis is no substitute for a detailed, item-by-item analysis of each operating expense. If your actual expenses are out of line with industry norms, talk to the appraiser and determine why. Perhaps there are good reasons your expenses should be lower. You may be paying yourself a management fee that is twice or three times what an independent property manager would charge. Make sure the appraiser is using the right amount. Don’t let him just accept your expenses for what they are; you might not be managing the facility as efficiently as you could.
Net Income. The definition of net income differs between appraisers and accountants or property managers. Thus, it is important to note for the appraiser what should be included in the income and what should be excluded from the expenses. Net operating income used by appraisers typically represents net income before capital-improvement expenses, which are generally capitalized and not expensed; the same is true of reserves for replacements.
Reserves for replacement should not be included as a line-item expense, because the capitalization rate used to capitalize the net income is typically derived from sales, which do not reflect reserves. Thus, including reserves as an expense would overstate the expenses and understate the value of the property. Since the amount of the reserves for replacement falls directly to the bottom line, the diminutions in value can be calculated by capitalizing the reserves amount by the capitalization rate.
For example, if 20 cents per square foot is set aside as reserves, and the facility has 50,000 square feet, the subject’s expenses would be overstated by $10,000. Using a 9 percent capitalization rate results in a value loss of more than $100,000 ($10,000 divided by .09 equals $111,111).
It’s your property; it’s your money. It is critical that you, the owner, get involved in the appraisal process. Due to federal banking regulations, the owner pays for the appraisal, but the lender hires the appraiser. It behooves you to recommend to the lender a qualified appraiser with a lot of self-storage valuation experience. Self-storage is considered a “niche” market, and most lenders prefer using appraisal firms that have considerable experience in self-storage. One major reason is such an appraiser already has an existing database and access to other data, which will be required to support the valuation conclusions.
You can maximize the potential of receiving an appraisal that will be acceptable to the lender. Provide the appraiser with requested information in a timely manner, and offer your knowledge about the property and the surrounding market. Please note, however, that while the appraiser can discuss elements of the appraisal process, he is prohibited from revealing any conclusions without first obtaining the permission of the client, “the lender.”
When the appraisal has been delivered to the lender, ask for a copy of the report; it should be interesting to see how another set of eyes views your investment.
Ray Wilson is a valuation specialist and president of Pasadena, Calif.-based Charles R. Wilson & Associates Inc., which specializes in the appraisal of self-storage facilities nationwide. He has appraised more than $5 billion in appraisals in the past five years. For more information, e-mail firstname.lastname@example.org; visit www.crwilson.com.