Ten Important Legal Issues in a Commercial Lease

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Our colleagues at Lapp, Libra, Thomson, Stoener, & Pusch, Chartered recently published “Ten Important Legal Issues in a Commercial Lease” (Winter 2012)

Shenehon Company’s next newsletter, Valuation Viewpoint (Spring 2012), describes another aspect of commercial leases: the renewal lease. Bob Strachota answers client questions and describes the process of negotiating renewal leases. In times of economic unrest, determining “fair market rent” is difficult. A link to Bob’s article, “Defining Market Rent for the Renewal Lease”, will be available following publication.

Ten Important Legal Issues in a Commercial Lease

2012 Release: The Family Law Financial Deskbook out this Spring!

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William C. Herber and Robert J. Strachota recently updated their chapter “Real Estate and Partial Interest Valuations“, a general review of real estate appraisal in divorce for the 2012 Edition. The Deskbook is published by the Minnesota State Bar Association.

Shenehon Company advised the Minnehaha Creek Watershed District

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Shenehon Company advised the Minnehaha Creek Watershed District (MCWD) in implementing its plan to purchase the former Cold Storage building site for restoration of shoreline along Minnehaha Creek. Details of the transaction are as follows:

Subject Property:
Cold Storage Facility Site – 16.9 acres
325 Blake Road
Hopkins, MN 55343

Owner:
Stewart Lawrence Group

Acquisition Price:
$14.95 Million

Immediate Goal:
Restore over 1,000 feet of shoreline on Minnehaha Creek and sell the excess land for private redevelopment

Long Term Goal:
Storm water management of the Cottageville Park neighborhood to protect and preserve Minnehaha Creek for future generations

The city of Hopkins and the MCWD previously collaborated on the Cottageville Park redevelopment project. Storm water management for that area, a cooperative effort with the Metropolitan Council, was significantly improved as a result of the acquisition.

Look for full details in the upcoming issue of Valuation Viewpoint, produced and published by Shenehon Company.

Related Articles:
Minnehaha Creek Watershed District Wants Cold Storage Site, Hopkins Patch
Watershed District to Buy Hopkins, Biz Journal
Minnehaha Creek will be getting big improvements, StarTribune

Using Demographics to Answer Valuation Questions

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Shenehon Company recently completed a study to determine whether a city’s decision to allow municipal vs private liquor affects the type of retail establishments willing to locate in a given city. In this unique analysis, the appraisal team correlated national retailer’s site location parameters with the presence/absence of municipal liquor. Shenehon Company’s analysis, lead by Scot Torkelson, CBA, presented an in-depth study of the site-location parameters used by retail giants typically found in metropolitan areas similar to Lakeville, MN.

Links to articles describing the study follow:
Pioneer Press – Lakeville study: Lose municipal liquor sales, pay more in property taxes
Thisweek Newspapers – Update: Study results suggest Lakeville keep its municipal liquor
iStockAnalyst – Lakeville study shows municipal liquor is a winner
Lazy Lighting – Lakeville Liquor Study: Close Stores, Raise Taxes

The Economy is so Bad That…

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I got a pre-declined credit card in the mail.
CEOs are now playing miniature golf.
Exxon-Mobil laid off 25 Congressmen.
I bought a toaster oven, and my free gift was a bank.
Angelina Jolie adopted a child from America.
Motel Six won’t leave the light on anymore.
A picture is now only worth 200 words.
They renamed Wall Street, “Wal-Mart Street”.
Then Bill and Hillary travel together, they now have to to share a room.

And finally,

I was so depressed last night thinking about the economy, wars, jobs, my savings, Social Security, retirement funds. etc…, I called the suicide hotline. I got a call center in Pakistan, and when I told them I was suicidal, they got all excited and asked if I could drive a truck.

Off-Site Parking & The Tax Court

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In urban areas, office buildings, apartments, retail, and other such uses often lack sufficient on-site parking. In many situations, owners are permitted to fulfill their parking requirements with a nearby parking solution. The off-site parking lot and the subject property may have the same ownership, or the subject property may be permitted to use an off-site parking option through a lease, easement, reciprocal easement agreement, or other right of use. When parking for the subject property is provided by another property, the tax court has been clear that an appraiser should not discount the subject property for lack of parking. However, the Tax Court is not always clear as to how the parking should be valued or how any income resulting from the parking should be treated.

Recently, the Tax Court provided some guidance in 444 Lafayette, LLC and Meritex Enterprises, Inc., v. County of Ramsey, (April 7, 2011). In this case, although there are no parking spaces on the subject property, the subject property is benefitted by a reciprocal easement agreement that was entered into in August of 2004. This reciprocal easement agreement provides 966 employee parking spaces and 13 visitor/delivery parking spaces. In addressing how to handle these parking spaces the Court said, “it is appropriate to include parking income from adjacent parcels since there is an easement which benefits the Subject Property with not only the parking, but also the income from that parking.” This ruling certainly does not address how to value all parking arrangements. However, in situations where there is an easement, the Tax Court makes it clear that the easement adds value to the subject property; it not only satisfies the parking requirements, it also generates income, to which the property owner is entitled. These benefits are transferred to the subject property and the value of the benefits must be taken into account. In a tax appeal, the issue of how to handle parking arrangements not directly tied to the subject property is very complex. In such cases, the fee simple valuation of the subject property must include the consideration of easement and leasehold rights, as well as the larger parcel, and how it should be handled.

Fair Market Value versus Distressed Value

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By Clay Shultz, ASA Senior Valuation Analyst

Are you looking for a real life example of the difference between fair market value and distressed value? Look no further than the History Channel’s Pawn Stars. If you’ve never seen an episode, here’s a brief description: The setting is a Las Vegas pawn shop, which specializes in antiques, memorabilia, and other historical collectibles. Episodes feature everyday people trying to sell (or pawn) their interesting items – ranging from old currency to antique firearms – to the shop’s proprietors. Generally, the shop’s staff members know a little about the items in question. But, more often than not, they rely on an expert to offer an opinion as to what the item is worth. Once the expert has given an estimate of value, negotiations begin. A typical scenario goes like this:

  • The expert estimates that the item could sell for $4,000 to $5,000 at auction.
  • The seller hears $5,000 and makes that the asking price.
  • The pawn shop employee counters with a very low number, citing that the shop can only hope to resell the item for the estimated value of $4,000 to $5,000 given by the expert. Meanwhile, the store has overhead costs in addition to the carrying cost of its inventory.
  • After some back-and-forth, the seller realizes that in order to achieve the auction value of $4,000 to $5,000, he or she will likely incur an auction fee, which could substantially lower the proceeds from sale.
  • Finally, the seller comprehends that the offer from the shop is for cash in hand today, as compared to having to wait for the opportunity to sell the item at auction. In the final analysis, the seller usually sells the item to the shop for a price substantially lower than anticipated.

So what’s going on here? Regardless of the particular fair market value definition used, it is generally understood that the buyer and the seller are free from any compulsion to act and the asset is offered in the open market for a reasonable period of time. On Pawn Stars, it is true that neither party is compelled to act. Nonetheless, the seller goes to the shop with the intention of receiving cash today, which makes it a compulsive sale. Additionally, we have only one buyer and one seller and no market exposure. Likewise, it is important to keep in mind that fair market value describes the price at which property would change hands, not the net proceeds to the seller. In real world situations, like Pawn Stars, sellers frequently appear much more concerned with getting cash in hand than maximizing their net proceeds. As a result, the item is generally sold well below the expert’s estimated fair market value.

Recent Decline in Transaction Multiples

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By Charles A. Miller, CBA

Sales price valuation multiples for small- to middle-market privately held companies have historically been fairly steady over time in many industries. However, the public capital markets experienced significant declines in 2008 and 2009 at the forefront of the recent recession; and the recession negatively impacted sales price multiples for privately held companies as well. The decline is illustrated in the following graphs reproduced from “Historic Trends in Private Company Multiples” (BVR, Business Valuation Resources, LLC, May 2010). These charts illustrate that sales price multiples declined roughly 20% or more by 2009 from the central tendencies shown 2001 to 2007.

The first chart was created using data from Pratt’s Stats® and the second was created using data from BIZCOMPS®. Both databases (available at BVMarketData.com) contain details of sold private businesses, including selling price, industry, financial information, valuation multiples and more. The Pratt’s Stats® database has financial details available for more than 16,470 private companies including both larger M&A transactions and main street businesses while the BIZCOMPS® database typically contains transactional information on smaller “Main Street” businesses (service station, restaurant, convenience store, print shop, travel agent, florist, coin laundry, beauty salon, auto repair shop, video rental, day care center, etc.).

Note: in the above chart, MVIC is an abbreviation for Market Value of Invested Capital. MVIC includes both the market value of equity and the interest bearing debt.

Note: in the above chart, SDE is an abbreviation for Seller’s Discretionary Earnings. Seller’s discretionary earnings is defined as the company’s net profit before taxes and any compensation to the owner (normally one working owner) plus amortization, depreciation, interest, other non-cash expense and non-business related expenses.

Recently, there have been positive signs that the mergers and acquisition market is improving, which may eventually translate into improved multiples. According to a recent article in the StarTribune (Neal St. Anthony et al, “Flurry of Deals Signals Recovery.” StarTribune, January 31, 2011), Minnesota investment firms closed 298 mergers and acquisitions in 2010 compared to 152 the previous year. Much of the improvement was attributed to an increase in activity in December 2010. Nationally, there were 9,833 deals in 2010 compared to 7,350 in 2009, and 8,734 in 2008.

It remains to be seen if, or how much, transaction multiples will improve in 2011 with the recent stabilization of the economy. However, business valuations performed with effective dates in late 2008 to 2010 should address the existing recessionary economic environment, especially when transactions from previous years are used for comparison purposes.

Federal Rules of Evidence Change

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Expert Witness Discovery Rules Changed on December 1, 2010

Forensic accountants and valuation experts will now enjoy greater work-product protections as a result of key changes in the Federal Rules of Civil Procedure. Draft reports and most communications between an expert and the retaining attorney are considered privileged. Over the years, opposing sides employed a variety of time-consuming, expensive strategies in the attempt to maintain confidentiality. Draft reports and attorney-expert interactions are crucial elements in developing defensible opinions of value that are consistent with case law and comprehensible to the average person. These revisions, effective December 1, 2010, do not change the responsibility of the court under Daubert. Although attorney-expert communications are no longer automatically discoverable, the court still determines what evidence will be admitted in any given case.

We recommend that appraisers retain all source documents in the job file to verify facts and data used to prepare the report; limit the number of drafts shared with the retaining attorney; and not rely on assumptions provided by the attorney unless those assumptions are disclosed in the report.

Click here for more information on these changes.

The Recession is Over: Should Someone Inform the Real Estate Industry?

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By: Robert J. Strachota
It’s official!

The National Bureau of Economic Research recently announced that the recession ended in June of 2009. However, most real estate professionals, including the majority of our clients, report that economic conditions for the real estate industry have worsened.

On a positive note, of 170 major metropolitan areas in the United States, the Twin Cities ranks 66th on the affordability index for residential housing. The affordability index is a ratio which compares housing costs for median-priced existing homes to income levels. It gives us a good indication of which markets are over-priced and, therefore, subject to additional decline. Currently, mortgage costs and household income in the Twin Cities are relatively well-balanced. The residential market is unlikely to experience further decline. However, the commercial markets are much less stable and, depending upon the submarket in question, declines are expected to continue for the near term.