Secret # 6 – The Premium Adjustment
There are certain types of office condominium projects that garner a premium in the market. They have something so special going on that they have no true analog. The best example is the medical office condominium project that either adjoins a hospital or shares an elevated walk bridge with one. Yes, it’s a location adjustment, but you can bet it needs to be a strong one compared to any other projects. Even during this recession, units so seldom are available for purchase in these prized buildings that their price per square foot still sits well atop the market.
Another example is the office condo project that is located adjacent to the county courthouse. Take a look at the tenant mix and you’ll see what I mean – all attorneys and title companies. Nothing beats convenience.
Secret # 7 – The Sales Comparison is the Absolute King
There is no Parliament or Senate here… the sales comparison is king. You can’t do a cost approach on an office condominium for the following reasons, which we put in each of our appraisals:
The cost approach is not applicable to office condominium valuations due to the many common elements present in a project and common land. It is also not used or considered by market participants.
The income approach, 8 or 9 times out of 10, will produce a materially lower market value conclusion than the sales comparison approach. Here’s why:
- Almost all office condos are bought for owner occupancy. It’s an owner occupied market everywhere. When they are leased, it’s usually because the owner occupant is moving his/her business and the market is too soft to sell. Sometimes they just want to hold it for a few years as an investment because they don’t need their equity. It’s rare to find an investment group that buys a bunch of units only to lease them (most such situations are the original developer renting until they sell off or as extra cash flow after they’ve already paid off their units through the sale of the other units in the project).
- Rental rates are constrained due to a low level of demand in most cases. Why rent when your mortgage will be less? This is the major reason why people buy office condos; appreciation is a secondary motivation.
Here’s what we say in most appraisals:
The income approach does not model market actions, thinking, motivations, and behaviors. Income is a secondary consideration because market participants acquire these properties to run their businesses from them; hence, only the sales comparison approach reflects market actions.
Appraisers don’t like the doing the income approach on an office condo, myself included. Cap rates are hard to come by because there are few investors out there. It’s too easy to just use a mathematical cap rate. It’s also much more time consuming to get rental data than it is to pick from a pool of sales in a project or its immediate competitors. If it’s not required, we advise a sales comparison only appraisal.
Secret # 8 – Electric versus Gas Heat
In terms of cost, electric heat is substantially higher than all the rest. Next on the list is oil heat, although it can be at the bottom when oil prices are low. Natural gas is the cheapest.
Does this affect market value? In some cases, it does, but not all. It’s a tricky adjustment if it’s applicable at all. Most of the time you won’t be able to prove it from the market or you’ll have enough sales of units in the same project that you won’t have a need to do so. It’s just something you need to be aware of and is best applied to older, energy-inefficient buildings. Another way to handle this is to use it as support for a building/unit quality adjustment, but even then this is only one component of the total adjustment.
Coming up are more secrets. Stay tuned.
John Simpson, MAI
