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You can't get the value right if you get the rights wrong.

Article Excerpt
Abstract

Market value opinions of the fee interest in custom-built commercial properties present challenging problems. In these assignments, appraisers must understand the nuances between value in use and market value, and fee simple estates and leased fees. These built-to-suit properties have rents, sale prices, and overall capitalization rates that are not representative of the market for second-generation users. The cost to build and worth to the initial owner or tenant well exceeds what the property would be able to command on the market for either lease or sale. This article reviews the three traditional valuation approaches and discusses the misconceptions that lead to the wrong value for the property fee interest.

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Single-tenant, built-to-suit commercial real estate presents difficult valuation problems. One of the most challenging of these valuation problems arises when the assignment involves developing an opinion of the market value of the fee interest in the real property. This assignment condition requires the appraiser to value the property as if it sold, available to be leased at market. However, these custom-built properties are always occupied by the owner or tenant for whom the improvements were built, with any lease structured to recoup the original cost of the custom construction. If the properties were sold, they would sell as leased fees with rents well above the market rent. So, an estimate of the market value of what would actually sell would be the market value of the leased fee, which is inconsistent with the value premise. Because the value premise is inconsistent with what would sell if the property were offered for sale, appraisers frequently end up answering the wrong question: rather than the market value of the fee, they provide an opinion of the value in use of the leased fee estate based on the original lease. To properly approach such assignments, appraisers must suspend reality-as these properties never sell as if vacant and available to be leased at market-and value the properties under the assumption they are vacant and available.

These are fundamental issues in appraisal of custom-built commercial properties, and it is important to explore the root causes for the problems that appraisers may have with them. This article reviews how to approach such an assignment, considering all three traditional appraisal methods, and exposes related misconceptions that should be avoided.

Custom-Built Commercial Properties

Properties such as bank branches, fast food restaurants, freestanding pharmacies, and fitness clubs are frequently built by the owners to their specifications or built-to-suit for them. In either situation, the building is designed to conform to a particular business-model prototype. For example, Life Time Fitness health clubs are typically located in 110,000-square-foot buildings on about twelve acres, with a distinctive Federal-style architectural design. The buildings usually have two stories, three swimming pools, an expensive interior finish, and every imaginable type of fitness equipment. Walgreens' pharmacies are typically in single-story, freestanding 15,000-square-foot buildings on about two acres. These buildings also have a distinctive architectural design that features a glass entrance atrium.

For many reasons, it is often advantageous to lease the property rather than own it. This is accomplished with a build-to-suit sale/leaseback. Under these arrangements, the rental amount is based on the cost of construction. These properties are never built speculatively and then put on the market for rent or sale. Once the property is rented, the real property is often sold from investor to investor. The attractiveness of the purchase to investors, however, is more...

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