High Tech Rabbits
Challenges in Appraising a Unique Property
Welcome!
• Challenges and lessons learned in appraising a
“high tech” rabbitry.
• This seminar is designed to explore the challenges
regarding appraising unique properties.
• We will cover:
• Assessing the Scope of Work
• Value Definitions
• Valuation Process
A Little History
•
•
•
•
First approached 14 years ago to appraise a rabbitry.
The business has been operating for 3 years
Located in very rural area
Owner constructed building without detailed plans,
blueprints, or itemized costs.
• Very specialized building
• Climate controlled
• High tech labs and offices
• Sprayed fiberglass growing area
• Other specialized amenities
Subject Property
Challenge #1 - Acquiring Market Data
• No Market Sales Data
• No Market Cost Data
• No Market Income Data
• Limited Owner Income Information
• Now what?
Solution?
• We could not support value from the market or
from income statements provided by the owner.
• Met with client and suggested that the owner
needed a feasibility study and an investor – not
an appraisal and a loan.
• End of story?
12 years later . . .
• In the fall of 2010, I received call from local bank,
who stated they had an unusual agricultural
property they wanted us to consider appraising.
• Their client has an existing high tech “rabbitry”
and had plans to construct a new facility.
Challenge #2 – Assessing the SOW
• What value does the client really want?
• The engagement letter stated “Fee Simple”
• Sometimes the client is unsure, and the
appraiser may need to help the client determine
which value meets their appraisal needs.
• The client was unable to figure out which value
they wanted.
Solution?
• After considerable discussion with the local lender we
received verbal instructions to proceed with a “ValueIn-Use” appraisal.
• Upon completion and submission of the report the
reviewer stated that they called for a market value of
fee simple but what they received was going concern
(he was actually incorrect).
• He said they needed a value of real estate and
improvements (sticks and bricks) to make real estate
loans.
• He suggested completing a cost and a sales approach.
Lessons
• Sometimes, you have to stop the train to make sure you
are on the right track.
• That may require bringing additional participants to
the discussion (what the local lender and reviewer
wanted were 2 different things) to clarify the scope
of work with the people who will make the decisions.
• Our policy now regarding the scope of work , in dealing
with unusual appraisals, is to communicate directly
with the personnel who will be reviewing the report or
making final decisions.
• Our advice is to air on the side of over-communication.
Challenge #3 – Value Definition
• The engagement letter stated “Fee Simple”
• Our statement to our client: Typically with animal
production facilities, if it is not operating, there is a
measureable discount from the market and “fee
simple” becomes reminiscent of a
liquidation/distressed value.
• Fair Market Value in Continued Use?
• “Sticks and Bricks”?
• Liquidation Value?
Fair Market Value In Continued Use
“The estimated amount, expressed in terms of money,
that may reasonably be expected for a property in an
exchange between a willing buyer and a willing seller,
with equity to both, neither under any compulsion to
buy or sell and both fully aware of all relevant facts,
including installation, as of a specific date and
assuming the business earnings support the value
reported. This amount includes all normal direct and
indirect costs, such as installation and other
assemblage costs to make the property fully
operational.”
Source: Valuing Machinery and Equipment: Fundamentals of Appraising
Machinery and Technical Assets, Second Edition, American Society of
Appraisers, page 567.
Going Concern
“the market value of all the tangible and intangible
assets of an established and operating business with
an indefinite life, as if sold in aggregate”. Going
concern value includes the incremental value
associated with the business concern, which is distinct
from the value of the real property. The value of the
going concern includes an intangible enhancement of
the value of the operating business enterprise, which
is produced by the assemblage of the land, buildings,
labor equipment and the marketing operation. This
assemblage creates an economically viable business
that is expected to continue.”
Source: The Appraisal of Real Estate, Twelfth Edition, page 27.
“Value In Use” vs. Going Concern
• Fair market value in continued use is generally applied to
industry specific equipment that are installed in a facility
of some sort to perform a specific function such as dairy
or poultry prod facility.
• Going concern value includes all assets in an operating
business, both tangible and intangible assets. Tangible
assets include land, buildings, bins, warehouses,
processing equipment, etc. Intangible assets are
described by terms such as good will, blue sky, etc. and
may include customer lists, contracts, patents,
proprietary processes and other things that are intangible
in nature.
Solution
• After considerable discussion with the local lender
we received verbal instructions to proceed with a
“Value-In-Use” appraisal.
• However, as previously stated, upon completion and
submission of the report the reviewer stated that
they called for a market value of fee simple but what
they received was going concern (he was actually
incorrect).
Lesson
• Communicate, communicate, communicate
• The different types of value
• With the appropriate personnel
Challenge #1 (revisted)
• Acquiring Market Data
• No Market Sales Data
• No Market Cost Data (although we had requested
it several times from various sources)
• No Market Income Data
• Now what?
Solution
• We had basically 4 ¾ years of solid “owner
operated” income stream with a steadily rising
net income each year with 2010 showing the
greatest net income.
• Developed a market supported opinion of value
from 5 years of profit and loss statements,
provided by the owner.
• Got net income by stripping several layers of
non-real estate income that need to be peeled
away to get to NOI.
• It was messy, and at times felt like we were on
thin ice.
Lesson
• We decided to focus on what we had and not on
what we didn’t have.
Now . . . Where do we get a cap rate?
Rates
• In an ideal market, information would be available
relating to each sale of similar properties and rates
could be directly observed in the market place.
• As our neighborhood does not approach the ideal or
perfect scenario it is difficult to extract a direct
capitalization rate from the market.
• In order to qualify the capitalization rate that would
be applicable to the subject property’s Market Value
as a Rabbit Breeding/Raising facility, we will look at a
variety of market cap rates.
NNN Lease Properties
• On the low end of the spectrum, where owner
participation/management are minimal and corporate
guarantees back long term income streams with minimal
risk of loss due to unexpected expenses/events are NNN
leased properties.
• Within this investment group cap rates range from 6.5%
(for prime, absolute net, and lengthy ground lease) to
10.0% (for B-grade, double net, building leases (think
Dollar Stores) that have less than 5 years remaining on
their initial lease term, or are older buildings where
tenant loss is a higher risk).
• The subject operation is considered not likely to break
below the 10.0% cap rate range due to the participation
level required by the owner.
Poultry
• The poultry industry has also been considered as a
source of cap rate data that will help qualify the
subject’s cap rate potential.
• Analysis of 13 poultry raising facilities (pullets, broilers,
breeders and the rest being egg-production facilities)
revealed a range in capitalization rates between
11.23% and 15.22% with an average of 13.97%.
• Further analysis reveals that there is a direct
relationship between the age of the facility and the cap
rate, with the lower end of the range being newer,
modern facilities and the upper end of the range being
older facilities.
Dairy
• The dairy industry can also be looked to for cap rate
indications because what is typically being traded is the
Market Value of an operation comprised of specialized
building improvements that are not easily converted to
alternate uses.
• A survey of dairy sales from 2007 to 2010 revealed a range
in cap rates between 7.28% and 14.21% with an average of
9.65%.
• As with poultry operations, there is a direct relationship
between age of the facility and cap rate. The lower cap
rates are modern facilities where there is a balance
between buildings, dairy equipment, herd size, and land
(for dispersion of manure). In other words there is a
balance among the integrated systems.
Band of Investment Method
• “Because most properties are purchased with debt and equity
capital, the overall capitalization rate must satisfy the market
return requirements of both investment positions. Lenders must
anticipate receiving a competitive interest rate commensurate with
the perceived risk of the investment or they will not make funds
available.”
• “The mortgage capitalization rate (Rm) is the ratio of the annual
debt service to the principal amount of the mortgage loan. The
rate established at the inception of a mortgage is commonly called
the mortgage constant. It should be noted that the mortgage
capitalization rate (Rm) differs from the mortgage interest rate (Ym).
The mortgage capitalization rate is a function of the interest rate
(Ym), the frequency of amortization (monthly, bi-monthly, semiannual, or annual payments), and the amortization term (# of
years) of the loan.”
• “The equity investor also seeks a systematic cash return. The rate
used to capitalize equity income is called the equity capitalization
rate (Re). It is the ratio of annual equity dividend to the amount of
equity investment.”1
1
Excerpted from The Dictionary of Real Estate Appraisal, 13th Ed. Appraisal Institute, Page 505-506
Rate Selection
• In selecting the appropriate capitalization rate to apply to the
contract rent, the preceding data is considered for its
applicability to the subject operation. The subject is not
considered likely to break below the 10% cap rates level
common to B-grade Net Leased properties;
• Poultry production facilities indicated an average cap rate of
approximately 14%;
• Dairy production facilities indicated an average cap rate of
9.65%.
• Realty Rates Investor Survey (4th Quarter) for Special Purpose
properties revealed an overall cap rate range from 6.18% to
16.14% with an average of 11.01%.
Value Conclusion
• The Realty Rates data is considered the most widely
based, and has been weighed heaviest in concluding the
subject’s cap rate potential to be 11% with support from
the Poultry, Dairy and Net Leased property sectors.
• Therefore:
(EBIT/NOI) $???,???
(Cap Rate)
0.11
=
$?,???,???
At this point we also received RCN cost data on proposed
facility which supported our opinion of value from the
income approach. We reconciled the two values and
submitted the report for final approval.
Final Challenge
“Is there any functional and/or external obsolescence” due
to location of property?
• Reviewer, who belongs to an another professional
appraisal organization, stated “in his opinion there
should be”.
• I observed other animal production facilities being
purchased by investors due to positive cash flow, as
investments and then hire an on site manager. My
opinion, was that if this property generated sufficient net
income to a typical investor, it would not exhibit a
discount due to location.
• We had several extended conversations regarding the
issue, and my final response was . . .
Solution
I can’t split the ‘hare’ that fine!