Below is a part of the paper presented.
New York State Judicial Institute
April 7, 2015
By Michael Rikon
VALUATION OF PROPERTY
Real property value is very dependent on the factual circumstances presented. It is also dependent on the reason for the need to value the property.
The same property may be valued differently as of the same date depending on whether the subject property was taken in an eminent domain proceeding, or, it’s assessed value is questioned in a tax certiorari proceeding. The value of real property may also be the basis for a lease renewal, a divorce, a dissolution of a business partnership or in many other litigations.
Since most issues in valuation arise in the context of a condemnation case, we shall address that subject, first. The general rules that follow are applicable to most other valuation cases, except tax reduction cases.
In a condemnation case, real estate is valued as if it is free and clear of all leases, mortgages or encumbrances. It is a fair market valuation. Matter of City of New York (Bronx River Expressway), 278 App. Div. 813 (1d Dept, 1951).
If not a condemnation case, one would value subject to leases and encumbrances.
Appraisers estimate property value by utilizing three approaches to analyze real estate data. The three classic methods of valuing real property are: the market data or comparable sales approach; the income capitalization approach; and, the cost approach. Let’s examine each method separately.
Market Data Approach
This approach, also known as the comparable sales approach, is used when the subject property is similar to other properties that have been sold, or perhaps are currently under contract for sale in the subject property neighborhood. This method works well for residential properties and is always used for vacant land. The appraiser will analyze the sales by making a grid to show the appraiser’s adjustment for location, size, time, zoning, marketing factors, view, and other factors that a buyer would consider, all with the idea that the comparable sales, as adjusted, will indicate a value of the subject.
It is a rare appraisal that does not include the sale comparison approach to value property. The appraiser will research the market for information on properties that are similar to the subject property and have recently sold. The objective is to find sales that have similar characteristics such as topography, condition, size, location, zoning, date of transaction, etc. Appraisers then must “adjust” the comparable sales for the various factors, usually in a grid comparing the comparables to the subject property. All of the comparables as adjusted are then studied by the appraiser, often with several adjusted sales being given more weight than others to indicate a value of the subject.
Several points must be made regarding adjustments to the “comps.” Generally, the comparable sales used should be verified. The sales should have taken place as close to the valuation date as possible or they may be deemed remote as to time. The sales should be adjusted for market conditions to reflect a rising or falling market. The comparable sales must have the same highest and best use. In reviewing an appraiser’s adjustment factors, one must be alert for any large adjustment since the greater the adjustment, the less reliable the sale.
The determination of the suitability of comparable sales is a matter resting within the Court’s sound discretion. Matter of M.T.A. (Collegiate Church), 86 AD3d 314 (1st Dept 2011).
The Capitalization of Income Approach
This approach analyzes a property’s income-producing capability and then capitalizes the future income to indicate present value. Case law has indicated that if the property is indeed income-producing, the capitalization approach must be used. 41 Kew Gardens Road Associates v Tyburski, 70 NY2d 325 (1987).
If there are leases on the property, they are not binding upon condemnation. In condemnation, the property is valued as if it is free and clear of all liens, encumbrances, and leases. Matter of City of New York (Allen Street), 256 NY 236, 242 (1931). The appraiser makes an extensive market study and estimates the economic rent of the property. Actual rents provide a good indicator of fair market rental, especially if there is no indication that the actual rent is too high or too low and they were recently negotiated.
Just as was the case when adjustments were made to comparable sales by using a grid, each of the comparable rentals will also be adjusted by a grid to consider such factors as market conditions, location, or physical characteristics of the comparable lease. In any event, there must be a grid or other detailed explanation to show how the gross rental of the subject property was determined.
The appraiser then estimates the expenses of the property. The net income is then applied a capitalization rate which, itself, is determined by a study of various economic factors including the returns on other investments, taking into account mortgage, equity components, and risk. The rate of capitalization should be a reflection of the market, i.e., what an investor would require from an investment in a property of similar age, kind, and condition.
The capitalization rate is the most critical part of the equation. The lower the “cap” rate, the higher the value of the property. Conversely, the higher the “cap” rate, the lower the value. A capitalization rate must be determined based on an objective study of various factors including a band of investment which allocates between mortgage and equity. The resulting mortgage and equity rates are weighted and blended to produce an overall capitalization rate.
The resulting “cap” rate is then divided into the net income to indicate a value for the property. Care must be taken not to capitalize a speculative or hypothetical income stream from a non-existent structure. Arlen of Nanuet v State of New York, 26 NY2d 346 (1970). But a property with an existing lease and in development may certainly be considered as enhanced by the lease, for that is exactly what a buyer would do when purchasing the property. Matter of Village of Port Chester (Bologna), 95 AD3d 895 (2d Dept, 2012).
In the cost approach, an appraiser values the property premised on the value of the land and then adds what it would cost to build a new structure. The value is based on reproduction costs less observed depreciation. All increment costs are also considered and added to the value. The cost approach is rarely used for real estate. Real property must constitute a “specialty” for the cost approach to be employed. A “specialty” has been defined as a building designed for a unique purpose. For a building to be a “specialty,” it must be truly unique so that only the owner would have use for it and the sole way to replace it would be by its reproduction.
Thus, an appraiser will rarely use the cost approach in the appraisal report. When it is used it is only to value a special purpose property that is not frequently sold in the market. It may be used in valuing new or proposed construction when there is reliable construction cost data available. Indeed most real estate appraisers are not qualified to provide evidence of cost. It is much more prudent to adopt instead the value found by an architect, cost estimator, or builder. An appraiser who attempts to present a cost value by simply using a reference book is looking for trouble. A rare example of specialty valuation is Matter of County of Suffolk (C.J. Van Bourgondien, Inc.), 47 NY2d 507 (1979).
The appraiser will then reconcile the values found by the market data approach with the value determined by the capitalization of income approach. Most appraisers will rely more on the income approach if the property is income-producing.
The Appraisal Foundation publishes the Uniform Standards of Professional Appraisal Practice (USPAP) on a yearly basis. The Standards are developed by the Appraisal Standards Board. The Foundation has been authorized by Congress as the source of appraisal standards and appraiser qualifications. There are many standards that must be considered by an appraiser.
A few of the most important are the requirement that the appraiser consider the effect and use of existing land use regulations and the reasonable probability of re-zoning (Rule 1-3); the consideration of an anticipated public or private improvement located on or off the site to the extent they are reflected in market actions (Rule 1-4(F)); and the requirement that an appraiser analyze all agreements of sale, options, and listings of the subject property current as of the effective date of the appraisal (Rule 1-5(a)). There are more rules and they should be reviewed as should the mandatory ethics rules.
Michael Rikon is a shareholder in Goldstein, Rikon, Rikon & Houghton, P.C. which concentrates its practice in eminent domain cases. From 1973 to 1980, Mr. Rikon served as a Law Clerk to the Honorable Albert A. Blinder of the New York State Court of Claims. He began his law career as an Assistant Corporation Counsel for the City of New York, a position he held from 1969 to 1973, where he was a senior trial attorney in the Condemnation Division. He was a consultant to the New York State Commission on Eminent Domain in 1974 and 1975. He earned his B.S. at the New York Institute of Technology; his J.D. from Brooklyn Law School, and a Masters of Law from New York University School of Law.