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 “Value-In-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, semi-annual, 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!