Archive for category: Hot Topic

By: John T. Schmick

Investment real estate encompasses a broad range of real property types. Transactions often involve large properties bought and sold by institutional investors at the national level or in a national investment market. Participants include pension funds, investment advisers, insurance companies, and investment banks. In general, these are buyers and sellers that take direct ownership of an investment property and manage it for their own benefit. Defining or measuring the health of the investment market based on transaction activities of this type is somewhat unreliable. One is limited to data such as descriptions of capitalization rates, prices per square foot, and vacancy rates. Little information is publicly available on the periodic returns earned from these types of transactions until an individual property is resold. How, then, does one gain an understanding of the investment market on a broader scale?

The answer is found in a specialized form of real estate ownership known as a Real Estate Investment Trust, or REIT. A basic REIT is an entity that “pools investor money to purchase and manage real estate” for the benefit of its owners. REITs offer liquidity in investment real estate through ownership of shares in an entity that directly owns and manages investment real estate. Consequently, a review of the REIT industry is an effective surrogate to profiling the national investment real estate market. The ability of REIT data to reflect the overall market is related to the overall composition of REITs. In general, equity REITs include all property types, all age brackets, all geographic locations and all level of demographics

Appraisers are frequently asked where “cap rates” are heading – another way of asking whether values are going up or down. The capitalization rate (cap rate) is the ratio of net operating income to property price. It determines the return on investments. Fluctuating cap rates have a significant impact on property values. The capitalization rate is a weighted average comprised of the mortgage rate and the equity yield rate; a change in either variable impacts the overall rate. With the capital markets in disarray, buyers fortunate enough to secure financing are finding that bank lending requirements are more stringent than in the past. Higher mortgage rates and shorter amortization terms have raised the loan constant. Additionally, lenders changed the weighted average of the cap rate by requiring more equity from the borrower which is at a higher rate compared to the mortgage rate. Investors are looking for higher risk premiums compared to prior years. Below are two examples showing the impact of the change in the mortgage rate (mortgage constant), amount of equity required, and the higher yield rate:

To determine the appropriate cap rate, appraisers rely on sales of similar properties for support, however the number of sales in today’s environment is low for several reasons. First there is a gap in pricing between what the seller perceives the property is worth and what the buyer is willing to pay – buyers and sellers have radically different perceptions of values in the current market. Appraisers also depend on Information provided by investment brokers in local markets as to the direction of capitalization rates. In their listings of Class A and B quality properties, investment brokers have found that prospective buyers have increased their cap rates 150 to 250 basis points higher than those of one year ago. The increase in the capitalization rate was most pronounced after the September/October 2008 credit meltdown when financing suddenly became more difficult to secure.
Investment brokers cited examples of listings in which the asking prices were lower due to the higher cap rates. One office building, originally listed with a capitalization rate of 7.6% in early 2008, posted a cap rate in the low 8% range by the summer of 2008; it is currently listing a cap rate in the low 9% range. Two grocery-anchored centers are listed with cap rates of 9.5%. An industrial building in the suburbs was purchased in 2006 with a long term lease in place at a 7.25% capitalization rate is now being offered, with the same lease, at a cap rate of 9.0-9.5%. Class B office buildings currently being offered in the Twin Cities are in the 9% to 10% cap rate range depending on the length of the leases. Class A property capitalization rates are in the upper half of the 8%s. The chart below offers a historical look at capitalization rates and the anticipated outlook on a national basis.

The concept of “value” is paramount for the business and real estate communities. Vast sums of capital are committed based on opinions of value. Value is also a key component in litigation and taxation matters.

When valuing real estate and businesses, the most commonly used standard of value is that of “market value”. There are many definitions of “market value” such as the following from the Appraisal Institute . Market value is:

“The most probable price, as of a specified date, in cash, or in terms equivalent to cash, or in other precisely revealed terms, for which the specified property rights should sell after reasonable exposure in a competitive market under all conditions requisite to a fair sale, with the buyer and seller each acting prudently, knowledgeably, and for self-interest, and assuming that neither is under undue duress.”

Most definitions of market value (or fair market value in the case of business valuation) represent the value of property in exchange. In other words, the value opinion describes the estimated amount at which a property should exchange between a hypothetical willing buyer and willing seller in the open market in an arm’s length transaction.

However, there are many situations in business and real estate valuation assignments where using the “value in exchange” principle is not the most appropriate standard to use. The valuation professional will rely on additional standards of value, such as “use value” in order to complete these assignments. The Appraisal Institute describes “use value” as: the value a specific property has for a specific use, as opposed to the value in an exchange. This standard of value is often selected when the real estate is being valued as a component of a larger business enterprise.

The Appraisal Institute has been very careful to segregate the purpose and definitions of “market value” and “use value” in its publications to minimize confusion. However, to the non-appraiser, the statement that “use value is not market value” can be misleading. In fact, there is a subset of market participants who expect to use a property “as is” – in its current state. For them, use value is the same as market value. However, for other market participants, this is not the case. Perhaps the American Society of Appraisers stated it more clearly in a 1989 article:

“Value-in-use is the market value of a going concern that reflects a value to a particular user, recognizing the extent to which the property contributes to the enterprise and/or profitability of the enterprise. Included in this value are installation costs, engineering design and layout fees, and miscellaneous cost savings resulting from an assembled operation.”

Regardless of the definition, when estimating “use value” for real estate, the valuation analyst focuses on identifying the value that the real estate contributes to the enterprise, without regard for the hypothetical monetary amount that might be realized from a sale on the open market (in exchange). Consider the typical, older manufacturing plant occupied by a long-term tenant. There may be considerable “use value” to the tenant as a result of improvements made specifically to accommodate that tenant. However, the same manufacturing plant may have only a nominal value in the open market for another use. Conversely, if the current tenant were to move to another facility, significant investments above and beyond the original cost of the new property would likely be needed to satisfy the business requirements of the tenant. In this situation, it is in the tenant’s best interest to remain in the existing facility.

Although there are many assignments where the application of “use value” is appropriate, we will use a relatively common scenario for demonstration purposes. In the valuation of businesses, the business enterprise and the real estate used by the business enterprise are frequently owned by different, but related, ownership groups. As an example, the business enterprise may have several shareholders whereas the real estate occupied by the business may be owned separately by one of the shareholders. In this type of situation, the valuation analyst must determine rents that are reasonable and fair to both parties. Fair rent as determined under “use value” may differ greatly from that concluded using “market value”.

To illustrate the potential difference in rents between “use value” and “market value”, let’s assume that we have a situation in which an investor owns an existing manufacturing building with a current value on the open market of approximately $4 million. The subject industrial building has been occupied for several years by a manufacturing company that requires the use of specific heavy duty equipment. As such, additional improvements with a depreciated value estimated at $1 million have been made to the property over the years to accommodate the manufacturing tenant. These include, but are not limited to: additional electricity lines to power the equipment, additional plumbing which serves the equipment, hardened flooring, additional lighting, and heavy-duty overhead cranes. The lease in place is near expiration. The valuation professional must determine the fair rent.

For this situation, we assume that an appropriate annual rate of return to the real estate owner/investor is 10% based on a fifteen year lease. The property is expected to appreciate approximately 2% annually given that the tenant is required to maintain the property adequately. Further, at the end of the 15 year lease holding period, it is anticipated that the property will be placed on the open market for sale and the improvements made specifically for the current tenant will have minimal economic value. In reality, some improvements may have a ready market for long periods of time while other improvements, such as technology, grow obsolete rather quickly.

Based on the preceding assumptions (simplified for the purposes of this example), the following table illustrates that a fair rent based on the “use value” assumption is $444,000 annually, while the rent based on a typical “market value” (in exchange) assumption is $324,000 annually. Thus, the manufacturing company tenant would pay an additional $120,000 (37% annually) in rent to accommodate the improvements needed to serve ongoing business operations.

In an actual lease negotiation, the current tenant would likely argue that the existing improvements have already been paid for in the prior lease and that the new lease shouldn’t include the value of the improvements. On the other hand, the landlord might point out that if the tenant were to move to a different facility, the cost of providing the necessary improvements to the new site would be greater than the value of the existing improvements. Additionally, the tenant would incur both moving costs and a loss of profits from downtime during the move. All of which make the existing facility more attractive. As one might expect, the results of a lease negotiation are highly dependent upon the situation-specific details.

Value conclusions can differ significantly depending upon the standard selected. Although the principle of “use value” is not as widely understood or practiced in the appraisal community as “market value”, it is of equal importance. The competent valuation expert understands the differences and similarities between “use value” and “market value” and must articulate these assumptions to the client. In cases where a market may exist for the special use property (such as an automobile dealership) or the business is dependent upon the real estate for its earnings (such as a golf course) the real estate may take on the value of the tenant specific improvements. In these types of valuations, “use value” may be synonymous with “market value”, whereas in other situations, the value conclusions differ. Regardless, it is the responsibility of the business and real estate valuation experts to properly identify the type of value assumed in each analysis.

As one of the few firms in the country specializing in the valuation business enterprises as well as commercial real estate, Shenehon Company is uniquely positioned to solve valuation problems that involve both business and real estate components such those discussed in this article.

Introduction

On September 9, 2008, a Court-appointed Commission recognized an important threshold of damages in the area of condemnation law. The decision (State of Minnesota v. Parcel 212 Kindercare) came thirteen months after the Interstate 35W bridge collapse which precipitated the condemnation and taking of the subject real estate. The taking closed and, ultimately, destroyed a thriving day care business. This ruling is significant because it is in stark contrast to past interpretations of Minnesota Statute 117.186 (Compensation for Loss of Going Concern).

Briefly, the power of eminent domain states that: Any property may be condemned and taken by the U. S. Government for public purpose. However, the owner of that property must be paid fair market value under the Takings Clause of the Fifth Amendment to the United States Constitution. Article 1, Section 13 of the Minnesota Constitution describes an even broader scope of government responsibility by guaranteeing that, “private property shall not be taken, destroyed, or damaged for public use without just compensation.” In this case, determining the fair market value of the property (for purposes of just compensation) was complicated by the fact that the taking destroyed the business itself. In the State of Minnesota, fair market value historically includes only the real estate because it is assumed that the business itself could easily move to another location. Thus, it was quite rare that the facts of a case warranted an award for loss of going concern.

Summary of Facts

In light of recent changes, what happens when a business cannot relocate?

In 2006, the State Legislature revised Minnesota Statute 117.186 and expanded the traditional interpretation of loss of going concern, stating as follows within Subdivision 2:

“If a business or trade is destroyed by a taking, the owner shall be compensated for loss of going concern, unless the condemning authority establishes any of the following by a preponderance of the evidence:

• the loss is not caused by the taking of the property or the injury to the remainder;
• the loss can be reasonably prevented by relocating the business or trade in the same or a similar and reasonably suitable location as the property that was taken, or by taking steps and adopting procedures that a reasonably prudent person of a similar age and under similar conditions as the owner, would take and adopt in preserving the going concern of the business or trade;
• compensation for the loss of going concern will be duplicated in the compensation otherwise awarded to the owner.”

The bridge collapse of August 1, 2007 created the circumstances for the test case of compensation for loss of going concern when the subject business is, in fact, destroyed. Numerous properties in the area of the bridge collapse required immediate condemnation action; one of those properties was a day care located on the north side of the Mississippi River, near 10th Avenue.

As a result of the taking of the real estate rented by Kindercare Day Care Center, the operating day care business was destroyed. Minnesota Statute 117.186 became the basis for recovering damages for the loss of going concern, with the plaintiff arguing that all of the above criteria for just compensation were met.

Opposing Viewpoints

In its brief, the State took a narrow view of the use of the word ‘destroyed’ in the Statute, claiming that to destroy meant, “to ruin completely,” “tear down or break up, demolish,” “to do away with or put an end to,” etc. Under this strict interpretation the State argued that the criteria of the Statute were NOT met.

The State further noted that 26% of the affected clients were transferred to other facilities operated by Kindercare and provided evidence that the facility could reasonably be relocated in its market area.

On behalf of Kindercare, Shenehon Company argued that the nature and immediacy of the closing; the difficulty of placing the children in other facilities; the fact that the building was demolished within a very short time frame of the taking; and the significant obstacles to relocating a day care (including the zoning restrictions, planning time to get a day care approved, the need for sufficient play area for outside activities, finding a facility that met all licensing requirements, etc.), placed Kindercare in an impossible situation. In fact, the business could not reasonably relocate and was completely destroyed.

Commission’s Findings

The Commission determined that the transfer of some students to other facilities did not preclude recovery of damages for the taking of a very desirable location. Additionally, it found that the incidental increase in revenue at other locations did not relieve the State from its obligation to compensate the owner for the loss of its location under the statute’s business damage compensation provisions.

After hearing evidence from both sides, the Commission ruled that the Kindercare Day Care business was, in fact, destroyed by the taking and awarded the defendants full damages. Therefore, under the revised provisions of Minnesota Statute 117.186, the State is liable for the loss of going concern and must pay the owner just compensation.

As it relates to loss of going concern, the Commission determined that Minnesota Statute 117.186 requires that a taking must demonstrate: (1) that the going concern value will in fact be destroyed as a direct result of the condemnation; and (2) the business either cannot be relocated as a practical matter or that relocation would result in irreparable harm. In this case, the Commission awarded a considerable compensation package to Kindercare.

Summary

According to the findings of the Commission, for businesses that rely heavily on carefully selected locations (such as day care facilities) or are subject to significant regulatory or licensing hurdles in the development of the business, demonstrating a reasonable inability to relocate is sufficient to justify payment for damages due to loss of going concern.

The case is currently being appealed by the State of Minnesota.

Robert Strachota and Christopher J. Stockness (Shenehon Company) teamed up with Tom Gump (Neighborhood Development Partners) to produce this article for the Minnesota Real Estate Journal. The authors address the difficulty of valuing and marketing a development project in an economic downturn. Economic forecasters are guardedly optimistic as we enter the 4th Quarter 2008, but most housing studies indicate that we will see only a modest increase in demand for the next few years. Launching a successful development project in this environment calls for the use of strategic planning techniques. It is more important than ever that the planning team include an experienced appraiser to analyze and value the proposal to increase the chances of arriving at a unique, viable development project.
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One only has to read the newspaper or watch the news to see how a troubled housing market and the general economic downturn have affected development projects.

Evidence of the weak economy is everywhere. Mortgage interest rates are rising foreclosures are up and the jobless rate is climbing. The housing market is grim and likely to get worse before it gets better.

During these uncertain times, it’s difficult to remain optimistic. There is a large inventory of available housing and new housing starts are at historic lows; investors, developers and lenders are reluctant to break ground on new projects. Those whose projects are already in the pipeline must decide whether to move forward as planned, put everything on hold or attempt to revise their plans. It’s safe to say that we are in the midst of an economic downturn — largely initiated by the troubled housing market — and no one knows when it will end.

For investors interested in launching a large development project, it is easy to buy into the doom and gloom of the current market and assume the worst. Money is tight, carrying costs are high and there are no guarantees that roads and utilities will be in place on schedule. Although not every development plan is feasible, strategic intervention at the onset of a project may increase its chance of success. Hiring an experienced appraiser to analyze a proposed development and offer valuation guidance makes good business sense.

This article focuses on how strategic planning techniques can affect not only a development project’s value, but its success in today’s uncertain market.

Part I – Analyzing a Development Project

Introduction

Typically, as a part of a potential investor’s due diligence, an appraiser is hired to analyze the proposed development and the land associated with the project. Often considered the simplest of appraisal assignments, appraising land for development purposes is actually quite complex. When large parcels of raw land are involved, the highest and best use (HBU) of the land may be in transition from rural or agricultural use to a more urban use. Anytime there is a change in the HBU, value is affected.

In addition to relying on the traditional valuation methods to arrive at a value (cost, market and income approaches), the experienced appraiser relies on a subdivision analysis of the development to further confirm the value. A subdivision analysis forecasts the overall performance of the proposed project based on market evidence. The appraiser may suggest valuing several scenarios in order to clearly define the relationship between current costs and future benefits. When appropriately and correctly executed, the subdivision analysis provides one of the most accurate looks at the behavior of typical market participants.

Before hiring an appraiser, inquire about the firm’s experience in the area of subdivision appraisal. A qualified appraiser not only has the knowledge and experience to complete the assignment, he or she has a wealth of relevant information from previous assignments. The appraiser is familiar with the many stages of a project, recognizes typical subdivision infrastructure costs and has monitored the success or failure of previous developments.

The Appraiser’s Role

The appraiser’s role in development analysis can vary – from that of consultant to that of appraiser. As a consultant, the appraiser may be asked to analyze market data, make recommendations, suggest strategies for moving the project forward and/or offer an opinion of value. Determining housing absorption rates, quantifying market supply and demand, performing highest and best use analyses, and providing a feasibility analysis for the proposed development are all examples of appraisal consulting.

If the investor decides to move forward, the appraiser may be asked to render a formal opinion of value. In this capacity, the appraiser does not advocate for or against the project, but remains independent in his or her analysis, valuing the project as of a certain date, based on current market information and appropriate assumptions. When the market is less optimistic, the success or failure of the project may depend upon the depth of analysis leading to the appraisal report. Both the land development proposal itself and the appraisal supporting its value are subject to greater scrutiny in a weak economy. Whereas a verbal opinion or a summary report may have been sufficient in the past, a more detailed, inclusive self-contained report may be necessary to adequately address investor concerns at this point in time.

It is often a good idea to tackle development assignments in phases. This is particularly true during times of economic uncertainty. A Phase I appraisal analysis ranges in scope from consultation on the feasibility of a development to providing a verbal opinion of a likely value range. Let’s say that as a result of the feasibility study, the appraiser determines that the infrastructure costs are much higher than those of similar development projects. He or she may suggest that the developer pay less for the raw land to offset these anticipated costs.

During a Phase I analysis, the appraiser has the opportunity to provide feedback on the subject’s value and make recommendations without writing a complete appraisal. The client and the appraiser will discuss the Phase I findings and determine if or when to proceed with a Phase II analysis. Phase II typically involves the completion of a full summary or self-contained report which meets the criteria (scope and methodology) outlined in the client’s engagement letter.

When appraising a proposed development, the appraiser usually starts by meeting with the developer to hear, firsthand, the details of a project. The more sophisticated the developer the more analysis will have been completed and the further along in the planning stages a project will be by the time an appraiser is engaged. After meeting with the developer and armed with an understanding of the vision, marketing plans and scope of the project, the appraiser begins an independent study of the market and the proposed development. It is important for the appraiser to keep the client in the loop throughout the process. When the appraiser and the stakeholders work together, the client is more likely to make an informed decision. The following discussion focuses on the more complex issues of a subdivision appraisal and describes several strategies common to successful development plans.

Telling the Story – Extraordinary Assumptions

To determine the highest and best use of raw agricultural land, the appraiser may rely on the use of extraordinary assumptions to accurately depict the value of land. In-depth research allows him or her to identify the appropriate use(s) of the land and come up with a time-table of development – ultimately affecting the appraised value of the land.

Consider, for example, agricultural land which may be considered for a mixed-use development in the near future. Its appraised value will be greater than what it is as agricultural land, but less than its value if it were already fully entitled for development. Because the land is raw and the developer’s vision not yet a reality, value is based on defining the relationship between current costs for the developer and future benefits. The appraiser often includes extraordinary assumptions in the report to show how various anticipated conditions change overall value.

According to the Uniform Standards of Professional Appraisal Practice (USPAP), an extraordinary assumption is an assumption, directly related to a specific assignment, which could alter the appraiser’s opinions or conclusions if it were untrue. Development projects, by their nature, are dependent on events which may or may not happen in a timely fashion. For example, if a project is delayed six to 12 months due to construction problems or the inability to obtain city approvals, the value conclusion may no longer be valid. When the most likely scenario is based on extraordinary assumptions, those assumptions must be prominently mentioned in the transmittal letter and supported by the research and analysis in the report.

From evidence presented in the appraisal, the reader should be able to judge the validity of the extraordinary assumptions. Some types of assumptions involve more risk than others. If a development plan has received preliminary plat approval and is expected to receive final plat approval within six months, it is considered valid to assume that final approval will be forthcoming. Typically, facts of this nature can be verified by contacting the appropriate city officials. In comparison, if value is dependent upon municipal utilities, originally scheduled to be extended to a site by 2009, but now not likely to be in place until 2015, the appraiser is dealing with a different level of risk. The delay may create a less feasible scenario and that should be reflected in the conclusion of value. Extraordinary assumptions serve a purpose, but in order for the appraisal to be credible, they must be clearly stated and supported by strong, reliable evidence.

Part II – Development Strategies

Flexibility

When the market is weak, it’s essential that the investors consider not only the type of real estate currently in demand, but also the mix of uses most likely to enhance feasibility and accommodate the ever-changing market. Having a complementary zoning designation, such as a Planned Unit Development (PUD) or Mixed-Use zoning designation, gives the project flexibility by allowing a variety of land uses.

In contrast, a development project zoned primarily for single-family units may saturate the market with a specific type of housing. It does not attract a diverse pool of potential buyers which results in a longer absorption period than for comparable mixed use developments. By offering a variety of housing types and a commercial component, the developer appeals to a broader sub-market than is possible with a project exclusively marketing single-family homes. Additionally, when the developer has the flexibility to adjust the ratio of residential units to multi-family rental units and/or commercial uses based on demand, the community benefits as well.

Think Smaller

The housing boom of the earlier part of the decade is not likely to recur in the near future. Recent housing studies indicate only a modest increase in housing demand over the next few years. In an effort to avoid costly vacancies due to overbuilding, developers may reduce the overall size of the project, accommodate a range of uses and schedule construction in manageable phases.

Well-designed projects attract a good mix of residential and commercial buyers, promote economic stability and reduce the chances of obsolescence during future market swings. Five or 10 years ago, it was more common than it is now for investors and developers to focus exclusively on projects exceeding 100 acres in size. They anticipated sustainable growth in the single family market over several years. As the market trended downward, the economics of development projects have changed. As the absorption rate of housing units drops off, purchasing large tracts of land in the early stages of development becomes less economically feasible. In a strong market, developers purchased available land outright, building as needed. Now, large upfront investment costs can hinder the success of a development and increase the capital recovery time.

One way for developers to minimize the initial costs of a project is to pay less for the land. By purchasing smaller tracts of land and using first rights of refusal or purchase option agreements to lock in adjacent land parcels for the future, additional land is available if needed. This strategy creates an advantage not only for the developer, but also for the property owner. The owner receives some money upfront for the right of refusal or option while waiting for a turnaround in the market to create additional demand for the land. The potential seller might not be able to sell the property in today’s market for what he/she could have sold it for in 2005, but banking on the success of the adjacent development and a market turnaround, he/she hopes to sell it at a comparable price in the near future.

Going Green

Global warming, rising energy costs, and environmental consciousness have created a huge market throughout the United States for environmentally conscious products. The opportunity to create energy-efficient green housing is not only a responsible approach to development it is also a great way to tap into a new market of potential buyers. In commercial real estate, green building — especially Leadership in Energy and Environmental Design (LEED) certified development — has seen strong growth from coast to coast throughout the United States. Developers, building owners and occupants enjoy the energy savings while creating a good public image. Although green residential development has not been as widely visible as it is in commercial developments, it represents an area of demand in the housing market. As such, it has the potential to set a new development apart from existing housing and development projects.

Part III – Stone’s Throw Development

Shenehon Company was hired to appraise the future Stone’s Throw development in spring 2006. The development consists of 600-plus acres of land where the developer intends to develop approximately 200 acres of commercial land and 400 acres of mixed residential land. The property, located in the southeast corner of Hassan Township, is considered to be one of the few prime development parcels remaining along the northwest metro’s Interstate 94 corridor — a fast-growing portion of the metropolitan area.

This assignment was complicated from the beginning – the property was still in a very raw agricultural state — it was zoned agricultural — and there was no finite plan in place for the extension of sewer and water to the site. Additionally, city planners and developers in neighboring municipalities (as well as nationally) knew there was potential interest in an interchange at Brockton Lane North and Interstate 94. If the interchange became a reality, it would further increase the commercial viability of the site.

Initially, the appraiser, developer and investors met to share information and determine the appropriate scope and methodology of the assignment. Considering the site’s raw nature and the multiple variables involved with potential development options it was determined that two valuations were needed. The first was a “Best Case Scenario,” assuming a mixed-use development with a strong commercial component. The second was a “Moderate Case Scenario,” which would conservatively analyze the development under a highest and best use of single-family development. We also engaged the services of a local law firm with land-planning experience to help make the appropriate assumptions regarding the regulatory, statutory and other legal constraints associated with the proposed development.

One of the most challenging aspects of this appraisal was that during the research and analysis phase, it became apparent that the residential boom of the past 10 years was about to end. Most of the evidence was based on hearsay: reports of builders and developers backing out of purchase agreements and options for land purchases. There were definite signs that the economy was trending down, but no one knew for sure how it would affect the market. We used two value scenarios in our analysis so that the investors could see the impact of choosing one over another. The lower end of our concluded value range for a mixed use development (Best Case Scenario) actually fell above the purchase agreements for the land, providing a strong indication that the project had a very good chance of being successful. We were, therefore, quite comfortable with our valuation of the development. In situations like this, where the development’s location, legal and infrastructure issues might result in a development vastly different from the one laid in our Best Case Scenario, the investors were wise to stipulate two valuations.

Each valuation scenario required extraordinary assumptions to arrive at a reasonable value range for the proposed development. The extraordinary assumptions were set forth based on extensive market research as well as regular meetings attended by the appraisers, the developer, investors, legal counsel, land planners and local municipal officials. In this appraisal assignment, the use of extraordinary assumptions allowed the land and proposed development to be appraised under a scenario that all parties involved were comfortable relying upon.

Despite its large size, the site and potential development have several unique characteristics: a development plan with significant green space, a strong potential for a diverse mix of housing and commercial uses and a great location. On the southeast corner of Hassan Township, the property is adjacent to the municipalities of Rogers, Dayton, Maple Grove and Corcoran. Rogers was deemed the most suitable development partner, but the surrounding cities expressed interest in being involved as well. Demand was also supported by several letters of intent from national development firms expressing strong interest in developing large tracts of land. The ideal location was further complemented by the types of uses being considered and the development flexibility the site offered.

Appraising development projects when the market is trending downward creates a new set of challengers for appraisers, developers, lenders and other real estate professionals. Creativity and the flexibility to adapt to a changing market are crucial to the success of a development. There is still a market for land development, even when the economy is weak, especially if the plan has unique features that set it apart from run-of-the-mill existing and potential projects.

In the case of Stone’s Throw, the purchase of land and start of development took place as the market weakened. Although the developer may make a few changes, having a unique and flexible development will keep the project on track toward the original expectations.

Appraising development land is complex during the best of times. To arrive at a credible value conclusion in a weak economic environment, it is more important than ever for the appraiser to complete the necessary due diligence and maintain open communication with all members of the development team.
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Questions or Comments? Please email Chris Stockness at CStockness@Shenehon.com

Christopher J. Stockness, senior real estate appraiser, joined the real estate division of Minneapolis-based Shenehon Company six years ago. His experience in appraising special purpose property ranges from resorts, marinas and airplane hangars, to restaurants and development projects.

Robert J. Strachota is president of Shenehon Company. For more than 30 years, he has prepared real estate and business enterprise valuations. He regularly serves as an expert witness in Federal, State and District courts and spends some time each year teaching at the local universities.

Tom Gump is principal and managing broker of Neighborhood Development Partners, LLC. He invites comments and questions about this column. He can be reached at:

Neighborhood Development Partners, LLC
750 2nd St NE Ste 100
Hopkins, MN 55343
952.224.9140
TomG@NDP-MN.com