Appraisers' Free Forum

**Jim Plante** · Posted: Tue Nov 27, 2007 7:08 pm Post subject: Commercial Property problem

I've got a request for proposal on a commercial property. It's giving me fits.

It's an old house that's been rezoned commercial, and encompasses about 3700 sf. It's one block off the main drag, across the street from a church, has another church across the back yard. House was built over 100 years ago. Good quality for the time. Since the death of the last resident, it has been a restaurant, which failed twice. Now it's been bought by a local insurance agent who's converted it to his insurance office, and he plans to offer two other sections to other tenants. The new owner has extensively renovated the place, and has put way more money into it than the market will pay for it around here. But it is finished really elegantly.

This job has been offered to a CG about a hundred miles from here; he promptly demanded construction contracts, materials receipts, and all other supporting data for a cost approach. The client called me right after that. I took a look at the property today (not a formal inspection, just nosing around to see what I've got.) I called two CG's in Jackson. One said he didn't have a clue how to appraise an old house converted to office space, but knew they were tough to do. He referred me to the other CG, who is experienced in these types of property. He, too, said it would more likely be a function of the cost approach and the sales comparison approach.

Now, I'm not a CG; won't be until January. But I will be dipped in kim-chee before I'll base a market value opinion on a confounded cost approach on a 100-year-old house that's been renovated and remodeled three times (that I know of). That insurance agent can figure out his own coverage needs, probably better than I can.

I can develop a credible sales comparison approach; even got some likely sales locally. But my problem is going to be developing an income approach, and how much emphasis to place on it. The property, like many others, was purchased primarily for owner occupancy. The owner plans to defray the cost of ownership by renting the unneeded space. This house has a very large lot with a nicely-developed and well-landscaped garden in the back. The whole thing is fenced with an attractive wood and vinyl fence for privacy. It has a gazebo. The owner plans to rent the back yard for wedding photos and possibly for outdoor receptions as well.

This place is as close as they come to unique. My daughter's wedding reception was held there when it was still a restaurant, and many of her wedding photos were taken in that garden. Adjustments will be my very best wild-ass guess, supported by whatever meager data exists.

I've scared off two experienced CG's with this thing. Anything you folks can do to help me figure this out will be appreciated. Am I overthinking this?
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Jim Plante

**Otis** · Posted: Tue Nov 27, 2007 7:30 pm Post subject: Re: Commercial Property problem

**Edd Gillespie** · Certified General Joined: 13 Aug 2007 Posts: 2282

JMichael · Posted: Tue Nov 27, 2007 7:32 pm Post subject:

Mr Plante,
I think if you have a good basis for the market approach your more than half way there. I personally would think you could develope a good income approach based upon comparable rentals since the owner will be leasing part of the unused space. If it ends up being low, which would be my suspicion, it is most probably due to a low floor area ratio. The rental income from the back yard for weddings I think would be business income and not attributable to the realty honestly.
Id not worry about a cost approach, Id do the income approach as I have described and then make my decision most probably on the market approach, hopefully supported by the income analysis.
Honestly I dont think its worth dipping yourself in KIM-CHEE over but a mans got certain proclivities he must satisfy from time to time.
So appraise and dip away.

Best of luck to you.
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Sink your Teeth into the A$$ of Life!!

**Jim Plante** · Posted: Tue Nov 27, 2007 7:56 pm Post subject:

Thanks for the replies, folks.
Edd, thank you in particular for pointing out the applicability of the cost approach. Now I won't look like such a s*ithead. This thing's been renovated to new condition. All the problem wood has been replaced, floor leveled, and the roof is in good shape. I'm estimating effective age at 5 years, TEL 65. Got new plumbing, wiring, appliances, fixtures, floors, HVAC, and everything else. The cost approach won't dominate the appraisal, but it'll serve as a sanity check.

Deriving cap rates from the market may be a problem, but not insurmountable. Comparable rents are available. There are even a couple of local sales, one of a similarly large house converted to commercial, but superior. The other's smaller, and in lesser condition. So I've got a bracket to work in, and there are other non-local sales to use for fill-in.
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Jim Plante

**Edd Gillespie** · Certified General Joined: 13 Aug 2007 Posts: 2282

You do sound truly impressive and I am therefore truly impressed.
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Edd “In the real estate economy, there are no guarantees that reason will prevail in a market where emotions run high and the amount of misinformation runs deep.” Jonathan Miller in The Matrix. So what’s an appraiser to do?

**M L** · Posted: Wed Nov 28, 2007 12:33 am Post subject:

The income approach in small towns is almost always the weakest approach, because most offices are owner occupied. In addition, the excess land will drive you nuts on your land/building ratios and adjustments. In some cases, it's could be argued that the income approach is irrelevant. So if it's way off base, think more on the market approach and alternative uses.
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Ya can't keep trouble from visitin, but you don't have to offer it a chair.

JMichael · Posted: Thu Nov 29, 2007 8:51 am Post subject:

ML .. the only problem I see is that the borrower intends to lease part of the building. In that instance I think the lender will want to see the income approach explored. Using market rents and a built up cap rate can be good support for the market approach, and while perhaps not a primary souce of value indication, can give both the appraiser and the lender a level of comfort with the final value conclusion.
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Sink your Teeth into the A$$ of Life!!

**Edd Gillespie** · Certified General Joined: 13 Aug 2007 Posts: 2282

**Steve Owen** · Posted: Thu Nov 29, 2007 10:33 am Post subject:

Jim, I don't really disagree with Edd, but I don't believe I would put much weight on a cost approach in the situation you described. (Might not even do one.) The facts as I understand them include that you have good comparable sales, but not good rental data. In that case, the sales comparison approach would probably get the most weight. I a similar situation in Joplin, an old remodeled victorian, I turned the job down by bidding it very high... glad I did, the property has been foreclosed once, then operated as a B&B, which I believe went under, and is now for sale, I suspect at a much lower price than the original appraisal several years ago.

You might want to get a bit innovative with the income approach if you take this on. Consider other possible uses for the property... could it be an attorney or doctors office? How about a B&B? Now, step back and look at what these (and the current) uses are renting for regardless of the building type. For example, if there are other insurance agents paying rent for office space, what are they paying? Point is, your insurance agent is in competition with them, so cannot really afford to pay much more. Base the income approach on what it could bring... doesn't necessarily have to be an exact match for building type.

The hard part will probably be coming up with a cap rate. Because there isn't much like your property that has sold while rented, you may not be able to get this directly from the market. I hate using band of investment, but that may be your only logical choice.

Fortunately, you have good comparable sales. Good luck.

Also, remember, it is what it is. Don't let what the owner paid and spent influence you too much. This may be your opportunity to make a lot of enemies in the banking world (or to be a big hero in a couple of years when they realize how much money you kept them from losing). Welcome to the world of commercial appraising.
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I haven't a particle of confidence in a man who has no redeeming petty vices.
- Mark Twain, a Biography

**George Hatch** · Posted: Thu Nov 29, 2007 10:54 am Post subject:

This looks like a kitchen sink assignment - you'll need to throw everything PLUS the kitchen sink into this one.

Comparable data is chosen on the basis of utility, not cosmetics. Surely there are other multi tenant office uses; surely there are other SFR-office conversions, even if under single tenant occupancy. Given enough time and effort you should be able to put something together that will make sone sense.

It won't be pretty compared to an appraisal problem involving a more conventional scenario, but then again that's why we're here.

**M L** · Posted: Thu Nov 29, 2007 10:56 am Post subject:

**Jim Plante** · Posted: Thu Nov 29, 2007 11:04 am Post subject:

Thanks a bunch, folks.
What's got me skittish is although I've done a number of commercial properties, I've never done one with multiple tenants. Wife has, a few years ago (in fact, for a different insurance agent.) But I believe in getting as much diverse opinion as possible. Since the effective age of this prop is so low, I'm going to do a replacement cost on it. (It'll take an FO/superadequacy hit, though). That won't get relied on.

The cap rate will HAVE to be band of investments, because that's all I've got. If I get one single good market extraction to support it with, I'll be tickled.

Since its owner-occupied, I think most weight goes to the SCA, with whatever support is available from the IA.
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Jim Plante

**M L** · Posted: Thu Nov 29, 2007 11:09 am Post subject:

There ya' go... that's all you can do in the Boondocks. No one can say you are wrong, because no one would find any better data. shrug

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Ya can't keep trouble from visitin, but you don't have to offer it a chair.

**Jim Plante** · Posted: Thu Nov 29, 2007 11:16 am Post subject:

Think I'll get permission from the client to have this peer-reviewed, and then post it in the APO section so you guys can rip it a new one.

(Remember, you never learn a damn thing when everybody agrees with you.)
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Jim Plante