DISCLAIMER: This publication is intended for EDUCATIONAL purposes only. The information contained herein is subject to change with no notice, and while a great deal of care has been taken to provide accurate and current information, UBC, their affiliates, authors, editors and staff (collectively, the "UBC Group") makes no claims, representations, or warranties as to accuracy, completeness, usefulness or adequacy of any of the information contained herein. Under no circumstances shall the UBC Group be liable for any losses or damages whatsoever, whether in contract, tort or otherwise, from the use of, or reliance on, the information contained herein. Further, the general principles and conclusions presented in this text are subject to local, provincial, and federal laws and regulations, court cases, and any revisions of the same. This publication is sold for educational purposes only and is not intended to provide, and does not constitute, legal, accounting, or other professional advice. Professional advice should be consulted regarding every specific circumstance before acting on the information presented in these materials.

© Copyright: 2013 by the UBC Real Estate Division, Sauder School of Business, The University of British Columbia. Printed in Canada. ALL RIGHTS RESERVED. No part of this work covered by the copyright hereon may be reproduced, transcribed, modified, distributed, republished, or used in any form or by any means – graphic, electronic, or mechanical, including photocopying, recording, taping, web distribution, or used in any information storage and retrieval system – without the prior written permission of the publisher.

LESSON 7 The Cost Approach Part I – Site Valuation

Assigned Reading 1.

Appraisal Institute of Canada & Appraisal Institute (US). 2010. The Appraisal of Real Estate, Third Canadian Edition. Chapter 16: Land and Site Valuation

Note: Selected readings can be found under "Online Readings" on your Course Resources website. Recommended readings are provided only for your information, should you wish to learn more about these topics. Recommended readings are NOT tested on the final examination.

Recommended Reading 1.

"Application of the Residual Approach to Land Value", Appraisal Institute of Canada Claim Prevention Bulletin CP-07, also known as Professional Excellence Bulletin (PP-07-E), August 1993.

2.

Boykin, J.H. 1996. AImpropriety of Using Dissimilar-Size Comparable Land Sales@. Appraisal Journal. 1996. 64(3). pp. 310-318. This article illustrates the importance of selecting comparable sales both similar in size to, and with the same highest and best use as, the land being valued. For each use, there is an optimum site size. - Boykin, James H. 1997. "Correction to 'Impropriety of Using Dissimilar-Size Comparable Land Sales'". Appraisal Journal. 65(1). pp. 108. Correction to calculation error in original article.

3.

Data Verification, Appraisal Institute of Canada Claim Prevention Bulletin CP-14, also known as Professional Excellence Bulletin (PP-14-E), February 1995.

4.

Rabianski, J.S. 2005. Site Size Adjustments: A Technique to Estimate the Adjustment Magnitude. Appraisal Journal. 73(4). pp. 397-407. This article presents a practical illustration of the graphing technique to estimate a site size adjustment.

5.

Sevelka, T. 2005. "A Review of the Subdivision Development Method (Part I)". Canadian Appraiser. 49(3). pp. 38-41.

6.

Sevelka, T. 2005. "A Review of the Subdivision Development Method (Part II)" Canadian Appraiser. 49(4). pp. 37-39.

7.

Emerson, D.M. 2008. Subdivision Valuation. Chicago: Appraisal Institute. This book covers all basic elements of subdivision valuation by offering a comprehensive overview of single-unit residential subdivision valuation methodology, focused primarily on the valuation of proposed subdivisions. Specific topics include market, neighbourhood, site and improvement analysis; profit, timeline, yield and discounting concepts; highest and best use; and the three approaches to value. A variety of case studies is presented throughout the text to illustrate the application of subdivision valuation methodology.

7.1

Lesson 7

8.

Tse, Yiuman; Zietz, Emily Norman, Greer, Gaylon. 1998. "Anticipating Change in Development Activity Levels". Journal of Real Estate Research. pp. 159-168. This study demonstrates how co-integration analysis of privately-owned housing within different areas can aid developers in anticipating changes in the level of market activity. The basic tenet is that there is a relationship between market areas such that activity in one market area can be used as a predictor for future activity in another market area.

9.

Wolverton, M.L. 1993. "Case Study: An Alternative Technique to the Land Residual Method". Appraisal Journal. 61(2). pp. 239-244. Although dated, the theory presented in this article is still valid. This article is based on an actual appraisal assignment in which the land residual method was considered and then discarded in favour of an alternative technique. It presents an example of how a simple analysis of the correlation between market rent and land prices at dissimilar locations can result in a more reliable value estimate. The case study involves an apartment building site.

Learning Objectives After completing this lesson, the student should be able to: 1.

explain the economic and appraisal principles important to land valuation;

2.

apply the direct comparison approach to estimate the value of a site;

3.

explain and apply the extraction and allocation methods for land valuation;

4.

discuss various surveying and mapping systems used to identify land;

5.

explain methods for measuring and comparing different parcels of land;

6.

explain which is the most appropriate method of valuing land for any given situation;

7.

adjust comparable sales to account for differences in depth, size, irregularities, corner lots, and locations; and

8.

explain and apply in a simple situation, the income-based methods used to value land where there are insufficient sales.

Instructor's Comments This lesson will focus on a discussion of Chapter 16 which outlines different methods to estimate land or site value. In most instances, land value will be based on the market demand given a site's present zoning. However, appraisers should be aware that both of these factors can change in future, affecting value. The site or land value is the first step of the Cost Approach to the valuation of improved properties. Therefore, this lesson is titled as Cost Approach, Part I. However, the subject of many appraisals is undeveloped land, and, in such circumstances, the land value analysis can form the entire appraisal. Given sufficient sales of vacant, or unimproved land, the direct comparison approach is the best approach to estimate the market value of the site. If there are insufficient land sales, then other methods can be utilized to generate market derived data appropriate to the valuation of the site. Two of the more typical methods are the extraction and abstraction methods. These will be reviewed in some detail in this lesson. Also, there are three income-based techniques that can be considered – land residual, ground rent capitalization and development (or subdivision) methods. These relate to some valuation elements that will be presented in more detail in Lesson 7.2

The Cost Approach Part I – Site Valuation

10 on the Income Approach, but will be introduced in this lesson to provide the student with a basic understanding of the mechanics of how they are applied in the context of valuing vacant land.

Reading Notes Chapter 16 – Land and Site Valuation Accurate land values promote well-informed land use decisions by both the public and private sectors. Urban economists and planners have long recognized that outdated land values contribute to inefficient land use and undesirable growth patterns. The valuation of land requires three steps: 1. the identification of land through mapping or land registry systems (see Lesson 3); 2. analysis of the physical and economic factors that influence land value (see Lessons 3 and 4); and 3. application of one of the six methods of valuing land. This lesson begins with a review of the economic principles important in land valuation, followed by a discussion of the mapping systems used in Canada. The remainder of the lesson covers units of comparison for valuing land, methods of valuation, adjustments, and the valuation of land with insufficient sales. Land Valuation Theory

Land holds a unique and pivotal position in social, political, and economic theory. Land supports all life and stands at the centre of human cultures and institutions. Wars have been waged over land, and rights to the ownership of land, which are embedded in the laws of all free nations and defended by their courts. Land's uniqueness stems from its fixed supply and immobility. Land cannot be manufactured or reproduced. Also, land is a factor of production required directly or indirectly in the production of all other goods. Our most basic resource, land, is the source of all other wealth. Appraisal Principles Important in Land Valuation

Principles that are important in land valuation are supply and demand, highest and best use, surplus productivity, and change and anticipation. Supply and Demand

Supply and demand comprise the cornerstone of valuation theory. The forces of supply and demand interact to determine the market value of property, which is reflected in sale prices. Supply and demand have special significance in land valuation because the supply of land is essentially fixed. This means that the price of land in a particular area will be determined by demand factors such as: population density and rate of growth; local employment and income levels; the capacity of local transportation systems; and mortgage interest rates. Figure 7.1 illustrates the interaction of supply and demand to determine the price of land. Note that the supply curve, s, is vertical, meaning that the quantity of land is fixed: regardless of price, additional land cannot be produced. Hence, its price will vary with local demand. When the demand curve rises from d to d', the price rises from P to P'.

7.3

Lesson 7

Figure 7.1: Land Supply and Demand Curve Short Term

Although the total supply of land is fixed, the supply for a particular use may increase or decrease. For example, forest or farm land on the periphery of a city may be developed for residential use. The increased supply slows price increases. However, the practical limits to such development and continued growth in demand lead inevitably to higher prices and more intensive use, for example, smaller lots and the substitution of multi-family for single-family houses (see Figure 7.2). Figure 7.2: Land Supply and Demand Curve for a Particular Market

Local transportation networks strongly influence the pattern of development and prices. Before the automobile, urban land markets were concentrated near central business districts, resulting in sharp price differences between centrally located and peripheral land. Improved roads and transportation increased demand for peripheral land and increased the effective supply of urban land. For example, when the most frequent mode of transportation was by rail and water, residential properties located in downtown centres near the rail terminal and dock. Since that time the automobiles and mass rapid systems have to a large extent, replaced rail and water transportation so that residents were able to move to the peripheral areas (with better highway access and less congestion). Price differences between central and peripheral land have, in effect, been reduced by better transportation systems.

7.4

The Cost Approach Part I – Site Valuation

Zoning and other land use controls have an opposite effect because they limit the available supply of land for a given use. This usually results in higher overall prices but lower prices for land where use is restricted. The principles of supply and demand explain the large differences in land values between urban and rural areas, between different urban areas, and even between different neighbourhoods in the same urban area. No other commodity exhibits such large variations in price-certainly not consumer nondurables, such as food and clothing; nor consumer durables, such as appliances and automobiles; nor buildings. In general, the more immovable an item, the more its price will vary by area. Land, which is totally immovable, varies more in value than other economic goods, although transportation and accessibility can reduce locational differences. Highest and Best Use

The principle of highest and best use means that the market value of property depends on potential use rather than on current use alone. The principle is most obvious in the case of vacant land, which commands value based on potential use. The more profitable the potential use, the higher the demand and market value. Vacant land in an urban area commands greater value than vacant land in a rural area. The principle of highest and best use applies to improved land as well. Take, for example, a commercial/industrial property in an expanding urban area now rezoned for residential use. The value of the land for residential use may exceed its value for commercial use, and may even exceed the combined value of the land and building for commercial/industrial use. The property may then be purchased for residential redevelopment use, the commercial buildings demolished, and a residential single-or multiple-family structure built in its place. When appraising residential land an appraiser may not be able to find vacant sites in the area and may have to rely on sales of residential properties with old homes that have a very short remaining economic life. Often, developers/builders purchase old homes and rent them out until they are ready to demolish them for the construction of a new home. The cost of demolition is then added to the purchase price of the property to arrive at a value for the vacant land. Besides demolition costs, one must consider any site preparation costs after demolition and any costs to improve the services to the site, i.e., new water or sewer lines, any off-site costs associated with redevelopment. Holding costs include any legal fees and financing. Another consideration in the valuation of some parcels of land is that they may achieve their highest and best use as a part of an assemblage. This relates to the concept of plottage discussed in Chapter 10 of the textbook. Individual parcels may not have the same use potential on their own as compared to being part of an assemblage. Estimating the assemblage value of a parcel of land would entail the analysis of the costs and timing of achieving the assemblage, the economic demand for the assembled property, and the subject's parcel contributory value. The possibility, feasibility and reasonable probability of assemblage must be reflected in the appraisal analysis. In some cases an appraiser may be required to distinguish between market value and use value. Market value is the most probable sale price of a property in an open-market, arm's length transfer. Use value is the value of a property for a particular use. For most properties, market value equals use value. However, for properties not in their highest and best use, the current use of property does not result in the highest economic return to the property; for example, the market value of a farm on the periphery of an expanding city may greatly exceed its use value. In many jurisdictions, for property taxation purposes, nonagricultural lands are appraised at market value while agricultural lands are appraised at use value. This lesson discusses the valuation of land on a market value basis. Surplus Productivity

Economists divide factors of production into four groups: land, labour, capital (buildings, machinery, equipment, and supplies), and management. The principle of surplus productivity states that returns attributable to land are what remain after returns to labour, management, and capital are satisfied. Hence, gross income less income paid for labour, management, and capital equals income residual to land.

7.5

Lesson 7

The principle of surplus productivity underscores the unique position of land in production and helps explain why land values can vary dramatically. If two parcels are used for identical purposes and are similar in their labour, management, and capital requirements, but one, because of its location, produces greater gross income than the other, the difference in net income will be reflected (capitalized) entirely into differences in land values. Consider two similar and adjacent businesses, one with a corner location and the other on an interior lot of the same size (Figure 7.3). The two businesses have the same labour, management, and capital requirements, but the first, because of its corner location, generates ten percent more in gross income than the second. After returns attributable to the other three agents of production are subtracted, the net income attributable to land on the corner parcel is twice that of the adjacent parcel, resulting in a land value that is also twice as high. In other words, a purchaser would be willing to pay twice as much for the corner location to obtain the greater gross income. This analysis assumes, of course, purchasers are able to accurately predict the difference in gross incomes that results from the different locations. Figure 7.3: Illustration of Surplus Productivity

Gross income Income paid to labour Income paid to management Income paid to capital Net income attributable to land Capitalization rate* Land value

Corner Location

Interior Location

$1,100,000 -300,000 - 100,000 - 500,000 $200,000

$1,000,000 - 300,000 - 100,000 - 500,000 $100,000

÷ 0.16

÷ 0.16

$1,250,000

$625,000

* The capitalization rate is the rate of return that one would achieve on an investment in real property. One can convert net income (after expenses) to an indication of capital value by using the formula Value = Net Income / Capitalization Rate. This will be illustrated again later in the lesson, and as part of the discussion of the Income Approach, in Lesson 10.

Change and Anticipation

Change and anticipation are closely related principles. The principle of change states that market value is determined by dynamic economic, political, and demographic factors such as zoning, rent controls, interest rates, transportation, and local economic conditions. Because the supply of land is fixed, its value is particularly affected by changes in these market forces. The principle of anticipation, which underlies the income approach to value, states that market value equals the present value of future benefits. In the case of vacant commercial land, this principle means that land values will reflect the capitalized value of anticipated net incomes from commercial development of the land. Similarly, the value of vacant residential lands will reflect the capitalized value of rents (either actual or imputed) attributable to the land. The principles of anticipation and change underscore the need to estimate market value for valuation purposes as of a given date.

7.6

The Cost Approach Part I – Site Valuation

Factors Affecting Land Values Factors or forces affecting land values can be divided into four broad categories:    

Physical, environmental and locational Economic Government, legal and political Social

Physical, Environmental, and Locational Factors

These factors largely explain patterns of land values within a city or market area. In analyzing such factors, it is useful to distinguish the concepts of site and situation. Site attributes are the size, topography, and other physical features of a given parcel. Situation attributes, or linkage, focus on the location of the parcel relative to other places, such as the central business district, freeway access, shopping, schools, the ocean, or a dump. Site attributes affect land values because owners are able to use the land's inherent resources; situation attributes affect value because of nearness or accessibility to other resources. Successful land valuation must consider both site and situation variables. Modelling Land Value

Like the value of any other economic good, the market value of land reflects the present worth of future benefits. Vacant land has value because of its potential to produce rental income in the future. For residential land, net income can be viewed as the annual value of residential use (imputed rent) less annual maintenance expenses. For commercial land, future benefits relate to expected rents less development, maintenance, and holding costs. The general model takes the form: LV 

PGI  C R

where LV is land value, PGI is projected potential gross income (real or imputed), C is expected costs, and R is a capitalization rate. (Note that this is the same formula as introduced earlier in this Lesson, Value = Net Income spacing/ Capitalization Rate.) The projected income reflects the economic forces influencing supply and demand, – population density and growth, income levels, the supply of competitive sites, accessibility, public services, and so on. Expected costs include operating expenses, maintenance, and costs of development. The capitalization rate is a function of interest rates, risk, loss of liquidity, and anticipated gains or losses over the holding period. The interaction of all of these factors determines current market prices. An improvement in local economic conditions, for example, will increase projected revenues and result in higher prices. An increase in interest rates will curtail demand, lower the present worth of the projected income stream, and result in lower prices. As this formulation makes clear, the demand for land is a derived demand. Land earns income only in conjunction with capital and labour, the costs of which must be satisfied first. For example, if residences in an area sell for $300,000, and the costs of site preparation, construction and profit are $160,000, builders and developers will bid the price of land to $140,000. If an increase in demand raises housing prices to $350,000 while costs increase to only $180,000, the market price of the land rises to $170,000. If housing prices remain constant at $300,000 while construction costs increase to $180,000, land prices will fall to $120,000.

7.7

Lesson 7

Historical trends in land prices underscore the residual nature of land values. Land prices rose sharply during the economic expansion of the 1920s and then plummeted during the Great Depression. Since World War II, land values have increased at an average annual rate of 5 – 7 percent, usually gaining momentum during business expansions and slowing during recessions. The overall rate of increase has been somewhat higher than the rate of inflation, but consistent with returns on other investments. In general, land values in the suburbs have increased faster than in the central business districts. In terms of the land model, improvements in transportation and accessibility, along with associated population shifts, have increased potential returns to suburban land relative to central business district land. Regional employment and shopping centres have followed, further stimulating demand. Returns to land in the central business districts have also increased in recent years. The net results include:  

increased intensity in the use of land, both in the central business districts and suburbs; and smaller price differences between suburban and central business district lands than occurred historically.

Government can affect the value of land in a number of ways. Fiscal policy, road construction, public services, and land use controls influence potential gross incomes. Taxes, fiscal policy, and building codes affect construction costs. Capitalization rates are, first and foremost, a function of interest rates, which reflect government monetary policies. Economic Factors

Economic factors relate to the general state of the international, national, regional, and local economies. Demand variables that affect land values include employment levels, wage rates, income levels and purchasing power, the availability of financing, interest rates, and transaction costs. Supply variables include the quantity of available land; development, construction, and financing costs; and taxes and other holding costs. These factors, particularly those that relate to the supply of land, can vary substantially from one area to another. Legal, Governmental, and Political Factors

Legal, governmental, and political policies can increase or decrease the demand for land. Favourable policies promote efficient land use and development. At the national level, economic, fiscal, and monetary policies can either spur or retard economic growth and the demand for land. Provincial and local governments often provide specific incentives or disincentives for land development through such mechanisms as taxation, zoning, land use controls, and rent controls. The quality of local governmental services, such as roads, schools, public transportation, and police and fire protection, also affects demand. Developers may work with local governments to amend zoning bylaws to allow certain developments or to change what is allowed in certain areas. As the cities grow and their needs change, so does the demand for certain types of developments. Local governments have to be aware of these changes and adapt their community plans accordingly. As the community's needs change, then governments must plan for the expansion of roads, sewers, water, and other services in an orderly fashion. Development usually expands from the centre of a city to its outskirts and thus new developments can often be hooked up to the existing utilities. It is often not practical to allow the development of isolated parcels of land because the cost of servicing them is high. If developers are prepared to pay for much of these services, then maybe the development will proceed. But nothing is certain and developers' plans are often prolonged while negotiations take place to resolve certain issues. Governments change, public attitudes change, and so do economic conditions. One year plans can often extend to 2 – 5 years or longer. So beware of appraising developments planned for the future!

7.8

The Cost Approach Part I – Site Valuation

Social Factors

Social factors help explain patterns of land use as well as demand and price. Sociologists hold that people have basic desires for territory and companionship. These desires are manifested in the "clustering" of people near urban centres and in variations in the use of land. Prestige also plays a major role in land use, as individuals and groups seek particular locations for social and economic reasons. These motives lead to "invasion" and a "succession" of land uses. Invasion occurs as one population, for example, affluent retirees seeking waterfront homes, seeks to expand its territory and improve its position. Succession occurs as the new population displaces the old, for example, young families moving into an area of homes occupied by "empty nesters". These changes take place until a new equilibrium is achieved with an obviously different pattern of land use and values. Age distributions, education, crime rates, and pride of ownership are other social factors that affect land use patterns and values. Because land is limited in supply developers and investors are constantly on the lookout for land that can inventoried for future use. They will be examining community plans to see where future development is planned so they can investigate the area to see what sites are available for redevelopment. Like any business they need an inventory to sell and their inventory is land that can be developed for future residential, commercial or industrial uses. In some cases, developers may even create a demand based on a social or perceived social need and then apply for a rezoning for a certain type of development. For instance, in one community a developer has taken some farm land on the outskirts of a city and constructed an entertainment complex. The location is about one mile from the closest residential subdivision and consists of a new municipal swimming pool, 8 hockey rinks, a practice facility for a national basketball team, a 12 screen movie facility, an I-Max theatre, restaurants, and a pub. A few years later they constructed several multi-storey residential condominiums on the river. It has proved very successful and was feasible because there was adequate farm land available. The original price was low enough such that the development was financially feasible. As well, there is a major four lane highway located about 2 km away, so access to the development is very good. Appraisers should always be looking at their neighbourhoods to see if there is any similar pattern emerging or the possibility of it emerging. Once redevelopment begins, then adjacent lands become attractive because they may have the potential to be developed to complement the initial development. In the example above, there is also some waterfront property bordering it to the south that is presently used as a storage area for cars imported from Japan. It has the possibility of becoming a residential area of homes and townhomes to complement the entertainment area. Therefore, value can be created by (1) the public through its demand for certain facilities, and (2) by developers seeking out investment opportunities. Astute developers travel and research other national and international markets to see what is happening and then refine these trends for the local market. Examples include:   

auto malls where all the car dealers are grouped in one giant car mall; big box stores located away from the existing retail areas; or large entertainment complexes built on the fringes of existing cities where large tracts of land are available at reasonable prices.

Units of Comparison

Land should be analyzed and valued according to common units of comparison so that sale prices can be expressed as a price per unit. The units chosen should conform to the basis upon which land is analyzed and sold in that local market. Four basic units of comparison are used to value sites: frontage, area, parcel or lot, and units buildable.

7.9

Lesson 7

Frontage

Use of the front metre or front foot1 as a unit of comparison is based upon the premise that frontage significantly contributes to value. Frontage refers to the width of the property boundary which abuts the street upon which the lot fronts. Frontage can be a good measure of land value for commercial property because larger frontage provides prominence and accessibility from the street. Industrial property that borders a railway line or waterfront may also be valued on the basis of its frontage. The amount of frontage a residential property has on a lake, river, or ocean may determine its value. Residential properties are most often based on their frontages assuming a fairly standard depth common in that neighbourhood. Area (Land) Site Valuation – Units of Comparison Lot Measurement or Area Basis:  price per front metre/front foot of lot  price per square metre/foot /hectare/acre of land  price per lot Density of Development Basis:  price per unit or buildable unit  price per buildable square metre/foot

Lot area can be measured in square feet or square metres, hectares, or acres. Area measures are especially useful for irregularly shaped parcels where frontage is not an important factor. Appraisers are frequently unable to find comparable land sales of identical sizes. An average sale price per square metre (or hectare) allows the appraiser to use sales of comparable land to value the subject property. Sales can also be broken down to establish prices for minimum land requirements and excess land requirements – excess land refers to land over and above the size of lot needed for the building(s). Area measures are frequently used to value commercial and industrial sites. In some cases, they can also be used for residential sites.

Lot or Bulk Basis

The lot unit of comparison is used when the market does not indicate a significant difference in land prices even when the sizes are slightly different. For example, residential lots in a new subdivision or industrial properties in an industrial park may sell for a price per lot or parcel even though there are slight differences in total areas or shapes. Units or Units Buildable

A site may be sold on the basis of how many units are, or can be, built on it. For an undeveloped parcel of land, the number of units that can be built on a site is defined in the land use controls. For example, a multiple family site may be sold on the basis of the number of apartments or strata units that can be built on the site. A parking lot could be sold based on the number of cars that can be parked (selling price per car). In these cases, the appraiser would have to consider zoning, market demand, setback limitations, topography, and height limitations. Agricultural land may be sold based on the yield per hectare for particular crops. Buildable Area

For certain types of properties, particularly for high-rise commercial (office) properties, the site may be valued based upon the buildable area for the structure, either actual or as permitted by the land use controls. For example, a typical zoning restriction may permit development of an office building site to an "FSR" of 8.0. "FSR" refers to floor space ratio. An FSR of 8.0 means that the site can be developed with an office building to a maximum area of 8.0 times the site area. So, a 10,000 square foot site with an FSR of 8.0 is capable of being developed with an 80,000 square foot building. The land could be valued using the buildable square foot area as the unit of comparison. This is particularly useful, for example, when valuing an office building site where the FSR for the comparables varies from that of the subject. 1

The use of either metric or Imperial measures can be acceptable. An appraisal analysis should be consistent with the particular market in question, applying metric or Imperial measures as is standard in that market.

7.10

The Cost Approach Part I – Site Valuation

Land Data Analysis Classification

Classification is the sorting of sales and other market data into homogeneous groups. In land valuation, classes should reflect geographic areas subject to different market influences, variations in zoning and other land use controls, and probable use. Classifying land by area and then by zoning or probable use produces useful groupings. These sorting criteria ensure that land values will reflect market data for parcels with similar or competitive uses in the same area. Figure 7.4 contains a hypothetical example of land classification. Land is divided into four market areas and then, within market area, into zoned use. There are fifteen classes in all; zoning does not permit every use in every market area. If there are too few parcels for meaningful analysis in the resulting class, it may be possible to combine certain uses across geographic areas, for example, to combine all industrial zoned land into a single class. Figure 7.4: Hypothetical Land Classification System Area

Zoning

Market area 01

Residential: Single-family Residential: Two- to four-family Commercial Industrial

Market area 02

Residential: Single-family Residential: Apartment Commercial

Market area 03

Residential: Single-family Residential: Two- to four-family Residential: Apartment Commercial Industrial

Market area 04

Residential: Two- to four-family Residential: Apartment Commercial Mobile home

Once land sales have been classified and prices expressed per common unit of comparison, the appraiser can determine patterns and trends in land values. Plotting market data on land value maps, calculating descriptive statistics, and graphing land value data are three ways to discover and display trends. Plotting Land Value Data

Maps on which land sales and other market data are plotted provide an excellent picture of land value patterns. Land value maps can show market data such as sale price, sale price per unit, and sale date. Time-adjusted sales can be plotted in place of nominal sale prices. At a more sophisticated level, computerized mapping and land information systems can produce land maps displaying selected information in a desired scale and format.

7.11

Lesson 7

Descriptive Statistics

The descriptive statistics which are useful for analyzing patterns and trends in land values include the number of vacant land parcels, number of sales, measures of central tendency (median and mean), and measures of dispersion (range713 and standard deviation). The measures of central tendency and dispersion should be calculated for sale prices (or other available measures of market value) expressed in common units of comparison. In this way, the measures of central tendency will indicate the typical or average sale price per unit. Similarly, the measures of dispersion will indicate the degree of variation in terms of standard units. Table 7.1 shows several of these statistics for hypothetical data. Table 7.1: Descriptive Statistics for Hypothetical Data Number of parcels

Number of sales

Percent sold

Median

Average 2 deviation

Market area 01 Residential: Single-family Residential: Two-to four-family Light commercial Heavy commercial

1,210 294 109 234

104 36 14 3

8.6 12.2 15.6 12.5

2.85 4.34 5.67 7.35

0.84 2.50 3.98 3.17

Market area 02 Residential: Single-family Residential: Multi-family Light commercial

2,203 88 154

314 10 18

14.3 11.4 11.7

1.36 6.35 4.88

0.42 1.65 1.40

Market area 03 Residential: Single-family Residential: Two-to four-family Residential: Multi-family Light commercial heavy commercial

1,810 76 40 318 49

145 12 4 29 6

8.0 15.8 10.0 9.8 12.2

1.98 3.78 6.14 7.55 7.64

0.55 2.42 1.12 3.33 2.67

Market area 04 Residential: Two-to four-family Residential: Multi- family Light commercial Mobile home

214 48 180 888

38 6 13 76

17.8 12.5 7.2 8.6

5.01 6.09 5.83 1.67

2.89 1.22 3.14 0.26

5,223 584 176 761 92

563 86 20 74 9

10.8 14.7 11.4 9.7 9.8

1.87 4.69 6.22 6.69 7.55

0.75 2.51 1.30 3.89 2.99

Totals Residential: Single-family Residential: Two-to four-family Residential: Multi-family Light commercial Heavy commercial

The statistics are helpful in several respects. First, the number of sales in each category tells the appraiser which categories contain enough sales. In the example in Table 7.1, the residential multi-family and heavy commercial categories do not have enough sales in individual market areas to give statistically significant results and can be combined in further analyses. Second, the measures of central tendency (median) and dispersion (average deviation) give the appraiser a good indication not only of the typical sale price per unit, but also of the consistency of the data and, thus, of the confidence that can be placed in the computed measure of central tendency. Clearly, the median sale price per 4

Average Deviation (also known as Average Absolute Deviation) measures the average spread, or difference, between each observation and the median observation. The term absolute indicates absolute value; that is, the direction of spread – whether above or below a measure of control tendency – is unimportant.

7.12

The Cost Approach Part I – Site Valuation

unit will provide a more reliable and consistent indicator of market value for mobile home lots than light industrial property. Appraisers know they will have little trouble valuing mobile home lots, but will have to conduct a detailed analysis of the light industrial land. Graphic Analysis

Graphic analysis can help the appraiser discern systematic relationships in land values, which can then be incorporated in valuation schedules and adjustment factors. In general, sale price per unit is the dependent variable and is depicted on the vertical (y) axis of the graph. Any other variable for which data are available can be selected as the independent variable and represented on the horizontal (x) axis. One variable of particular interest is the number of units, that is, number of square metres, frontage, or buildable units. Often there is a systematic negative relationship between the number of units and sale price per unit: the greater the number of units, the lower the sale price per unit, at least up to a point. When graphed, this relationship results in a downward sloping curve, the standard market demand curve, as illustrated in Figure 7.5. A graph of this sort helps one to visualize the relationship and make appropriate adjustments in land valuation schedules. Figure 7.5: Graph of Sale Price per Front Foot

Other data, such as distance to the central business district, lot depth, neighbourhood desirability, or other value influence can be analyzed in the same way. Software for personal computers simplifies the graphing of land data. Most spreadsheet software provides easy-to-use graphic capabilities. Methods of Valuation

There are six methods of site valuation. The most common technique is by applying the direct comparison approach. If there are insufficient market comparables, then other techniques such as extraction or allocation can be used. There are also three income capitalization approaches – land residual, ground rent capitalization and subdivision development (or discounted cash flow). Table 16.1 in Chapter 16 provides an excellent summary of the procedure, applicability and limitations of these six land valuation techniques.

7.13

Lesson 7

Site Valuation – Techniques 

direct comparison extraction allocation income capitalization  land residual  ground rent capitalization  subdivision development

  

The primary method of land valuation is the direct comparison approach, which is always preferred when enough sales are available. Because lot sizes are often dissimilar, direct comparison may be difficult, necessitating the use of comparative unit methods. Direct Comparison Approach – Comparative Unit Method

In the comparative unit method, the appraiser determines the average or typical per unit value for each type of land. The average value can be found by calculating the median or mean sale price per unit. A typical value can be found by carefully considering the available data, analyzing them with the techniques just described, and making an informed judgment. Medians are generally preferable to means, as they are not influenced by extreme observations; e.g., in appraising single-family lots, the presence of one or two extremely large or valuable properties may significantly skew the mean, while the median would be unaffected. The appraiser can use computed medians as the comparative unit values. This would work well in those classes with enough sales data, which certainly includes each class of single-family residential land, as well as a number of the other classes. Where sales are insufficient, the appraiser can compare computed medians among the classes for reasonableness and consistency. If the medians appear reasonable, they can be used to establish comparative unit values; if not, the appraiser can use other information or judgment to override medians. When there are too few sales within a class, but sale prices per unit are similar between classes, the appraiser can combine classes in order to develop values. Direct comparison is the most commonly used and preferred method of valuing land.

The primary advantage for the comparative unit value method is its relative ease and simplicity. Suppose there are ten to twenty vacant land sales in a residential neighbourhood, that each has been adjusted to the same date, expressed in terms of a common unit (say, dollars per square metre), and plotted on a map of the neighbourhood. The appraiser's knowledge about the neighbourhood could probably derive a reliable value per front metre for the neighbourhood with little difficulty. Of course, this is only a starting point; the comparative unit value must then be refined by block and site adjustments applied when necessary. The comparative unit value method is suited to classes in which parcels may vary in size but are relatively homogeneous in other respects. In such cases, the appraiser might want to take advantage of the efficiency of the method. Site Adjustments

After establishing comparative unit values, the appraiser can determine individual parcel values by applying necessary site adjustments. Site adjustments recognize the characteristics of individual parcels, such as size, shape, and topography. Site adjustments can be developed and applied in one of three ways:   

by adding and subtracting dollar amounts; by adding and subtracting percentages; by multiplying factors.

To illustrate the difference between the last two techniques, assume that two adjustments (based on market data and research) are required from a subject parcel: a premium of ten percent (+.10) for size and a decrement of fifteen percent (-.15) for restricted access. The base lot value is $100,000.

7.14

The Cost Approach Part I – Site Valuation

If these percentages are summed, the net adjustment to the subject parcel is -.05. The net percentage adjustment of -.05 is applied to the subject property by multiplying the base lot value ($100,000) by a factor of 0.95 (1 – .05). Hence the computed value is: $100,000 × 0.95 = $95,000 When factors are multiplied, the size adjustment of ten percent would be stated as the factor 1.10 (1 + .10) and the access adjustment of fifteen percent as 0.85 (1 – .15). The net adjustment is then: 1.10 × 0.85 = 0.935 The computed value of the subject parcel is then: $100,000 × 0.935 = $93,500 In general, the two methods of applying percentage adjustments yield similar, but not identical, results. There is a specific order of adjustments which must be followed, and this dictates which percentage adjustment can be summed and which cannot. The type and order of adjustments was explained in Lesson 5. Property adjustments required in land valuation can be grouped into the following categories: 1. 2. 3. 4. 5.

Depth adjustments; Other size adjustment; Irregular shape; Corner influence; and Location and other.

Depth Adjustments

Size is perhaps the most important site characteristics requiring adjustment, because larger parcels often sell for less per unit than smaller parcels. For example, depth adjustments are important when land is appraised on a front-metre basis. Assume, for example, that the comparative unit value of a lot in a residential area has been established at $7,692 per front metre and that the standard depth of parcels in the area is 33 metres. The value of a 13 metre by 33 metre lot is: 13 × $7,692 = $99,996, say $100,000 The value of a lot twice as deep (13 metres wide and 66 metres deep) is probably more than $100,000, but less than two times $100,000. Depth tables provide a means of adjusting front-metre values for parcels of nonstandard depth. The tables result in front-metre values that increase with depth, but at a slower rate. Depth tables apply the principle of contribution, which states that the value of a characteristic is measured by its contribution to the value of the whole. Depth tables generally have two columns, depth and depth factor. The depth factor is the factor which, when multiplied by the standard front-metre value ($7,692 in the example above), gives the front-metre value of a property with indicated depth. The standard depth of 33 metre lot has a corresponding depth factor of 100 percent. As depth increases beyond 33 metres, depth factors increase, but at a slower rate than depth. The depth factors for 50 and 66 metres may be 114 percent and 121 percent, respectively. As depth decreases below 33 metres, depth factors decrease from 100 percent, although more slowly than decreases in depth.

7.15

Lesson 7

Caution in Using Rules of Thumb A rule of thumb is not a fact. It is a conclusion, perhaps the result of analysis, but where the source study is often unknown. If using a rule of thumb approach in an appraisal analysis, the appraiser becomes responsible to justify, from market evidence, that the rule of thumb is applicable in the subject situation.

Depth factors should be based on market analysis. They can be developed by plotting sale price per front metre against depth and then drawing a smooth line or curve to fit the data. The relationship is not likely to be linear, so the use of statistical techniques that assume a straight-line relationship should be avoided (i.e., you cannot use a straightforward price per metre of depth, at least not for all price ranges). In this case, manually fitting a smooth curve to the data is probably preferred. Sales used in the analysis should either have similar site characteristics or be adjusted for differences in characteristics. A rule of thumb sometimes used to help construct depth tables is the "4-3-2-1 rule." As illustrated in Table 7.2, this rule states that the first 25 percent of depth represents 40 percent of the value; the second 25 percent, 30 percent of the value; the third 25 percent, 20 percent of the value; and the final 25 percent, 10 percent of the value. Although this rule of thumb can be helpful, actual depth tables should be supported by available market data. Table 7.2: Valuation of Irregular Lots Percent of Depth

Percent of Value

First 25% Second 25% Third 25% Fourth 25%

40% 30% 20% 10%

Depth factors for various zoning classifications and areas often differ greatly. In some cases, land values increase or decrease in proportion to direct depth. This is often the case with industrial or farm property and some commercial properties, particularly shopping centres. At the other extreme, the front-metre, or strip, value of commercial property may increase only slightly as depth increases beyond norms. Residential property usually falls somewhere between these two extremes. Other Size Adjustments

When land is appraised on a basis other than the front metre, size adjustments can be derived and applied in a manner analogous to that described for depth adjustments. For example, if the square metre is the unit of comparison, sale price per square metre should be plotted against square metre and an appropriate curve fit to the data. When the parcel or lot is used as the unit of comparison or when the base lot method is used (i.e., a standard lot size represents the base), adjustments may be required for "excess" land or for undersized lots. As with depth tables, consistency in making such adjustments requires that the size (or range in size) of the standard parcel or lot be specifically defined beforehand. Irregular Shape

All appraisers should have a guideline for appraising triangular or other irregular lots. In general, a triangular lot is worth less than a rectangular lot with the same area and frontage because of the lost utility for construction and general use. Appraisers, on an ongoing basis, should examine the sales of irregular shaped lots to see how their prices relate to typical shaped lots, i.e. more rectangular in shape.

7.16

The Cost Approach Part I – Site Valuation

Corner Influence

Corner location can also influence residential land values, although the degree of influence is much smaller and less consistent. On the one hand, property values may be raised by easier access and better landscaping opportunities. On the other hand, corner lots generally entail increased maintenance responsibilities, exposure to traffic, and added liability to special assessments for street maintenance and improvements. If a regional or local pattern is not evident, a reasonable policy is to ignore corner influence altogether in appraising residential properties. Nevertheless, it is relatively straightforward to test the effect (if any) of the corner influence on residential property values through statistical analysis or other applications of the direct comparison approach to value. Location and Other Adjustments

Land values will often vary significantly within an area due to proximity to schools, shopping centres, public transportation, nuisances, and so on. Appropriate adjustments should be developed based on paired sales and other market analyses. Plotting sales and other market data on land maps can make such analyses easier. Other site characteristics often requiring adjustment include view, topography, traffic flow, limited access, flooding susceptibility, noises and other nuisances, golf course or water frontage, and soil conditions and drainage. Such adjustments, however, are required only when some of the parcels in the neighbourhood are affected. If none or all of the parcels are affected, no adjustments are required, because standard or common features are reflected in comparative unit and base lot values. Lessons 5 and 6 discussed the direct sales comparison approach, and the quantitative and qualitative approaches to analyzing and adjusting comparable property data. Lesson 6 described the hybrid approach, which blended these two types of analysis together. Case Study 1, later in this lesson, provides an example of how the hybrid direct comparison adjustment technique may be applied in the valuation of a vacant parcel of land. Land Valuation with Insufficient Sales

When vacant land sales are insufficient for the direct comparison approach, the appraiser must resort to one or more less preferred methods. Successful application of these techniques requires careful research and good judgment. When using these other techniques, when selecting market comparables, developed or undeveloped, it is important that the properties are similar to, and have the same highest and best use as, the subject property. Essentially, the appraiser is going to create vacant land comparables from market information on improved property sales. Then, these manufactured vacant land sales are going to be analyzed in the normal manner, by applying the direct comparison approach. The following sections will explain various techniques on how this is done. Extraction Method

In the extraction method, also known as the abstraction method, depreciated building values obtained from the cost model (to be discussed in detail in Lessons 8 and 9) are subtracted from sales prices of improved parcels to yield an estimate of the contributory value of the land. In other words, land value (LV) equals sale price (S) minus depreciated building value (B). LV = S – B These calculated values are then used as a supplement or alternative to vacant land sales in application of the direct comparison approach. The method is particularly useful in highly developed areas where there are few, if any, vacant land sales. Its reliability depends on the accuracy of the sales data and building values used in the analysis. In general, the method is more accurate for parcels with relatively new structures, for which

7.17

Lesson 7

The Extraction Method essentially creates land sale comparables by subtracting the depreciated value of improvements from improved property sales. This results in an indication of the land value component of the improved property sale, which can then be analyzed as if it were a vacant land sale.

replacement cost and depreciation are more easily estimated. For mid-age properties, it is more difficult to estimate the amount of depreciation. Depreciation will be discussed in detail in Lesson 9. For very old properties, most of the value is in the land with a nominal dollar amount for the improvements. When older properties are sold it is good practice to try and find who purchased them. Was it purchased by someone for redevelopment or someone who is going to live in the home? A review of the neighbourhood will indicate what is happening and if the homes are being demolished or rehabilitated.

If sales of improved parcels are scarce, appraised values may be used in lieu of sales prices to obtain estimates of total property values. Calculated extractions are completely divorced from direct sales data, and become more hypothetical and more difficult to defend, if challenged. In such cases, the extractions will only be as accurate as both the total and improvement value estimates from which they are derived. Accordingly, appraisers should use the method only as a last resort when sales data for both vacant and improved parcels are inadequate and then only when the total and building value estimates have been carefully validated. This method may offer support for values found by the other methods previously discussed. Consider the following example. After analyzing the local market, the appraiser determines the following on a recent, improved sale. Sale Price Subtract Depreciated value of Buildings Indicated Land Value

$350,000.00 - $260,000.00 $ 90,000.00

The extracted land value of $90,000.00 becomes a comparable that is used in a direct comparison approach analysis to indicate the value of the subject land. Allocation Method The allocation method is also known as the land ratio method, and is based on the principle of balance. In theory, for a given type of property and area there tends to be a consistent overall relationship between land and improvement values. Hence, when there are insufficient vacant land sales in a given area, the appraiser can seek comparable areas outside the immediate subject property area, with sufficient land and improved sales, determine the typical ratio of land value to total value, and apply the ratio to sales of improved parcels or other benchmark parcels in the subject area. Since an appraiser may work in a certain area or areas, then over a period of time they will be able to see patterns emerging regarding the land-to-building ratios. In many jurisdictions, assessment organizations may show the breakdown between land and improvements and the appraiser may be able to calculate the land-to- improvement ratio from their records. This is not totally reliable, but it may assist the appraiser when trying to establish a range of percentages The Allocation Method, also known or ratios. as the land ratio method, essentially creates land sale comparables by calculating the ratio of the contributory value of land from improved property sales, based on the ratio of land value to improved property value from sales in other, similar areas.

7.18

Assume, for example, that an older residential neighbourhood has too few vacant land sales or sales of newly built houses for the appraiser to apply either the direct comparison approach or the abstraction method. However, three other neighbourhoods in the jurisdiction have approximately equal desirability and residences are of the same vintage as those in the subject neighbourhood. Recent sales of residential property in the three neighbourhoods

The Cost Approach Part I – Site Valuation

resulted in the values shown in Table 7.3. From these results, it appears reasonable to apply a land ratio of about 0.28, or 28 percent, to the subject neighbourhood. Allocation    

uses land-to-building or land-to-property-value ratios in improved areas to support a land value in the subject area, when no land sales are available; subject and comparable properties must be improved to their highest and best use or this technique is less applicable; the ratio from one area and price range is not necessarily transferable to another area or price range; and The allocation between the land and improvements will generally be quite consistent in new developments or subdivisions (assuming similar housing for the neighbourhood).

Table 7.3: Illustration of the Allocation Method Neighbourhood

Average land value

Average total value

Land ratio

1 2 3

$78,545 $81,020 $75,163

$283,619 $290,888 $273,950

0.277 0.279 0.274 Say 0.28

As with the abstraction method, the allocation method should not be used to establish land values directly. Once obtained, the typical land ratio is applied to sales prices to obtain a set of estimated benchmark values. The ratio may be applied to appraised values for selected parcels, but this is less desirable. If a typical property in the subject neighbourhood of the example recently sold for $287,900, its land value would be estimated as: $287,900 × 0.28 = $80,612 Benchmark values computed in this way are used as a guide for the neighbourhood. The allocated vacant land values are then used as comparables in the direct comparison approach to estimate the value of the subject site. An advantage of the allocation method over the abstraction method is that estimated improvement values are not explicitly required in the analysis. This makes the allocation method particularly useful in older neighbourhoods where there are few sales of vacant or newly improved parcels. The method can be reasonably accurate if applied with care and validated to ensure that calculated land and building value estimates are consistent with available sale price data. Income Capitalization Procedures

The income approach will be discussed in some detail in Lesson 10. However, it is important to know that there are three techniques, based on the application of elements of the income approach that can be used to assist the appraiser in estimating vacant land value. These techniques are: land residual, ground rent capitalization and cost of development (or subdivision) methods. While it is not the intent of this course to provide detailed instruction on the elements of these three techniques, a general understanding of the basics of these methods completes the toolkit available to appraisers to be able to simulate the market's behaviour to estimate vacant land value where insufficient vacant land sales exist.

7.19

Lesson 7

Land Residual

Earlier, the formula value (V) equals annual net income (I) divided by capitalization rate (R). The land residual technique is based on the fact that the net income can be divided between the improvements and the land; and that different capitalization rates can be attributed to the property as a whole, to the improvements only and to the land only. The methodologies to do this are taught in subsequent courses. Through manipulations of the formula V = I/R, one can estimate the net income appropriate to the property (land and improvements) and to the improvements. By subtraction, one can calculate the remaining or residual income that is then attributed to the land – hence, the land residual method. Land Residual  



uses the income capitalization approach to isolate income to the land by segregating income attributable to the building from the overall income. requires capitalization rates for both the land and the building, which are different from the rate associated with the overall property, and which are difficult to get with similar risk and income patterns. is somewhat of a theoretical technique because buyers and sellers do not buy land and buildings, rather, they buy rights in real estate.

For example, Income Attributed to the Property Income Attributed to the Building Residual Income Attributed to the Land

$180,000.00 - $100,000.00 $ 80,000.00

Deriving, from the market, a rate of return appropriate to vacant land, one can then convert the residual income attributed to the land using this same V=I/R formula. In our example, let's say that the capitalization rate appropriate to vacant land is 8%. Then, the residual value of the land can be calculated as: Value = Income / = $80,000 / = $1,000,000

Land Capitalization Rate 8%

This residual land value may now be analyzed as a comparable in the direct comparison approach. Alternatively, if the subject's income attributable to the undeveloped site can be estimated by analyzing market comparables, by applying the market-derived land capitalization rate, one can estimate the value of the subject property. This is illustrated in the next section, under the discussion of ground rent capitalization. Ground Rent Capitalization

Ground rent is defined as the rent paid for the right to use and occupy land according to the terms of a ground lease; the portion of the total rent allocated to the underlying land.3 Simply stated, a ground lease is a lease of unimproved land. Normally, ground leases are used when the owner is a long-term investment corporation who does not want to give up future rights to the land, but wants to permit its development by another party.

3

The Dictionary of Real Estate Appraisal, 4th Edition. Appraisal Institute.

7.20

The Cost Approach Part I – Site Valuation

Ground Rent Capitalization    

establishes a ratio of income to value (the capitalization rate) in the comparable properties and then uses that ratio for the subject property can be an excellent method if the market thinks and acts in this manner requires very similar expenses and upside potential to be accurate can be incorrect if the risk is not the same in comparable properties and the subject property.

For significantly improved properties, ground rents are typically for very long terms that correspond to, or exceed the expected life of the building. Terms such as 60 or 99 years (or more) are not uncommon. This approach may be applicable if there are significant ground rent comparables in the subject's market. Normally, ground rents are associated with long-term investment properties or specialized government properties, such as waterfront or harbour properties. In Québec, a ground lease is called an emphyteutic lease, and it normally requires the lessee to construct a building. To apply this approach, the appraiser analyzes vacant land ground lease (rental) comparables. Market derived capitalization rates are used to convert the ground rent into market value. Again, the formula V=I/R is used. Example: Ground Rent (annual) Land Capitalization Rate Indication of value

= =

$28,000.00 7.00% $28,000.00 / 7.0% $400,000.00

This can now be used as a comparable and be analyzed using the direct comparison approach. Alternatively, one can estimate the ground rent appropriate to the subject property, typically by using a direct comparison analysis of comparable ground rent comparables. Dividing the subject's estimated ground rent by the land capitalization rate will give an indication of the subject's capital value. For example, if the subject=' market-derived ground rent is estimated at $21,000; and if market comparables indicate a land capitalization rate of 7%, then the subject's value can be estimated as follows: Value = Ground Rent (Net Income) / = $21,000 / = $300,000

Land Capitalization Rate 7%

Cost of Development Method

The cost of development method can be appropriate for newly subdivided land or land ripe for subdivision. The appraiser projects improvements to the land, estimates the total revenues and development costs, and calculates the value residual to the land after subtraction of all costs, expenses, and developer's profit. The method is based on the principle of surplus productivity. Land value is calculated as a residual after the requirements of labour, capital, and management are satisfied. Cost of Development Method   

is not used in some markets at all, but is quite applicable in others. assumes land value is based on development potential, not on alternative properties. does not consider other listings, but only that it is feasible to develop the project.

7.21

Lesson 7

For example, assume that the subject property is a 40-acre parcel zoned for residential use with four home sites allowed per acre. Developers are currently selling 1/4-acre lots in the area, with street improvements and utilities, for $17,500 to $22,000 ($20,000 is typical). Site preparation, street improvements, and utilities will cost approximately $1,400,000; planning, administrative, sales, and other overhead costs average 25 percent of gross sales in such projects; and a reasonable allowance for interest expenses, other holding costs, and profit is 40 percent of net income. The estimated value is found as shown in Figure 7.6. Figure 7.6: Cost of Development Method Projected sale price of lots (160 x $20,000) Site development costs Total overhead costs (25% of $3,200,000) Net income before holding costs and profit Holding costs and profit (40% of $1,000,000) * Indicated value of undeveloped land

$3,200,000 -1,400,000 -800,000 $1,000,000 -400,000 $600,000

* To be precise, this value should be discounted at a market rate to reflect the fact the development will not occur immediately and may take 6 months to a year or more to complete the subdivision. If this amount were discounted to the present, say at 10% for one year, this would indicate a value of $545,000 today for the undeveloped land.

This method involves considerable speculation and should be used cautiously. The projected improvements must represent the most probable use of the land. Estimated costs should include the direct costs of site preparation, utility hookups, all indirect costs, and a reasonable allowance for profit. As long as the land is not subdivided, anticipated revenues and expenses should be discounted for time. Once subdivided, however, each parcel becomes an individual entity, and its value should reflect its most probable sale price if exposed to the current market. This is a very complicated method and will usually require the assistance of experts familiar with subdivision development. Summary: Land Valuation

Separate land values are required for application of the cost method of appraisal. In addition, separate land values may be required by assessment legislation. Land prices exhibit more variability than prices of other assets due to land's immobility and fixed supply. To achieve accurate results, appraisers must stay informed with respect to the demand factors affecting land values. The immobility of land also leads to positive and negative price impacts of externalities and location. Adjustments must also be made to comparable sale prices for the different physical aspects of various land parcels. When land sales are infrequent, there are alternatives for estimating value. However, these alternatives require more appraisal judgment and are less preferable to evidence obtained from actual market sales.

7.22

The Cost Approach Part I – Site Valuation

Case Study 1 – Hybrid Direct Comparison Adjustment Technique The purpose of this case study is to provide an example of how the hybrid direct comparison adjustment technique may be applied in the valuation of a vacant parcel of land. The following case study demonstrates how the hybrid procedure might be applied in actual practice. The valuation problem is to estimate market value of the subject property with an effective date of February 1, 2008. Given the complexity of the problem, you conclude that a form report is inappropriate and that a narrative report is required. The subject property is a 66.52-acre vacant parcel located in High Ridge District. The site is irregular, elongated, slightly sloping, and has legal vehicular access to the public road system. It includes several good building sites with water views. Vegetation comprises stands of mature trees interspersed with undergrowth (ferns, bushes, grasses). Drainage is good. Well and septic field are required because this is a rural area. Negative influences include a nearby military base and penitentiary that both create noise and safety issues. The subject's Rural 1 zoning does not permit subdivision. You conclude that the subject property's highest and best use is development with a single-family residence. Refer to the Land Sales table below. All of the indices were inspected, sale details verified with at least one party to the transaction, and their development characteristics verified. The indices are first summarized and quantitatively adjusted in a table, and then following this are the detailed descriptions of the indices and support for the quantitative adjustments. Land Sales

Land Sales INDEX

SALE DATE

1 2 3

May-07 May-05 Apr-06

SALE PRICE 485,000 440,000 495,000

MKT COND ADJ

AC

551,006 687,366 740,669

27.98 46.25 54.93

PRICE PER ACRE 19,693 14,862 13,484

LOC ADJ

SIZE ADJ

-23% -10% -23% 0% 18% 0%

Median Standard deviation Subject

Feb-08

ADJ PER ACRE 13,194 11,444 15,911 13,194 17%

66.52

Keep in mind that order of adjustments calls for market conditions to be adjusted first, followed by location and size adjustments – meaning these are applied to the sale price that has already been adjusted for market conditions. In the table above, for example, the index 1 sale price is first adjusted for market conditions to $551,006 and then converted to a price per acre of $19,693. Next, the location adjustment of -23% and size adjustment of -10% are summed and applied to the $19,693 amount as follows: $19,693 × (1 – 0.33) = $13,194 per acre. Quantitative Analysis

Index 1 – 4725 Hedges Road, High Ridge District. Hedges Road is a narrow paved road. Index 1 sold in May 2007 for $485,000. This rectangular, moderately rolling, heavily treed upland site with fir trees and pond is not a view lot. Although there is an older, ±800 ft2 (74.32 m2) cabin and an old wooden shed on the property, it was the purchaser's intention to build a new dwelling on the lot. The purchasers specifically stated that they had no intention of subdividing at the time of sale. Because the purchaser's intention at time of purchase was not to subdivide, this index represents single building lot value.

7.23

Lesson 7

Index 2 – 942 Belmont Road, High Ridge District. Belmont Road is a paved road. Index 2 sold in May 2005 for $440,000. This 'L'-shaped, moderately rolling, heavily forested upland site with fir and arbutus trees has some ponds and some level portions. A good quality single-family detached dwelling has since been constructed. Although there are some possible ocean and mountain views, the purchasers have built the dwelling such that only views to the north and west are provided. The purchaser stated that at the time of purchase she and her husband were "just looking for some land," and had no plans to subdivide. The regional district confirmed that no subdivision application has been submitted for the site. Index 3 – 5235 Rocky Road, Sweetwater District. Rocky Road is a neighbourhood paved road. Index 3 sold in April 2006 for $495,000. This highly irregularly-shaped, elongated, mixed gently sloping and moderately rolling, heavily forested upland site, provides superb southerly views of the Mulachat reservoir and the Gatineau Hills. The purchaser stated that he had no plans for Index 3 other than to keep it for his own private park. The regional district confirmed that no subdivision application has been submitted for Index 3. The subject property is compared with the three indices. The three major elements of comparison that require adjustment are specified on the following table: Element of Comparison

Index To Be Adjusted

Market conditions (time)

All indices need to be adjusted.

Location

All indices need to be adjusted.

Size

Index 1 requires a size adjustment.

The Land Sales table shows adjustments for market conditions (time), location, and size. Support for the adjustments is provided below. Market value is estimated by qualitatively analyzing and reconciling the quantitatively adjusted sale prices. Market Conditions Adjustment (time)

Prior to application of any other adjustments, variation of sale prices over time must be resolved. Based on the market conditions analysis completed in the market study, the monthly market conditions adjustments shown in the "use" column of the following table are applied to the indices. Because there have been only a few sales and resales of vacant rural land, sales and resales of improved rural residential properties were also analyzed. A relationship between sales of vacant and improved residential properties was applied in order to estimate the market conditions rates for vacant rural acreages shown in the use column on the table. Period

Improved

Vacant

Use

2004-2008

1.15%

2005-2008

1.35%

1.99%

1.70%

2006-2008

1.91%

2.64%

2.25%

2007-2008

1.44%

1.15%

1.50%

The "use" column reflects a weighting of market conditions changes indicated by both improved and vacant properties for the appropriate period. For example, the market conditions adjustment for Index 1 for 2007-08 is shown as 1.50%. By applying 1.50% per month, non-compounded, to the May 2007 $485,000 sale price of index 1, its market conditions adjusted sale price is calculated as $551,006. (Note that your analysis may differ slightly from $551,006, depending on your assumptions – for example, the land sales table above adjusts for the fact that not all months have the same number of days).

7.24

The Cost Approach Part I – Site Valuation

Location Adjustment

The location adjustment for each index is estimated by comparing assessed land values for ±10 acre (4.047 ha) lots in the locations of the indices to the estimated $200,000 assessed value of an upland 10 acre lot in the subject location (based on analysis of assessed 10 acre properties in the subject location). The assessed land values appear to be less than market values of 10-acre lots. However, assuming the assessment authority has valued them consistently, the assessed value relationships between the different areas are reasonable for providing locational adjustments. Refer to the following table: Location Adjustment Location Adjustment Indices 1 & 2 Loc Ac Land Value Median Adjustment Clapham Dr 6.08 207,000 Rocky Point Rd 7.88 238,000 Rocky Point Rd 10.00 281,000 Rocky Point Rd 10.00 281,000 259,500 -23% Index 3 Mount Matheson Rd 10.00 155,000 Mount Matheson Rd 10.00 169,000 Mount Matheson Rd 10.00 169,000 Mount Matheson Rd 10.00 160,000 Mount Matheson Rd 10.00 169,000 Mount Matheson Rd 10.33 180,000 Mount Matheson Rd 11.27 175,000 169,000 18% Subject 10.00 200,000

Based on the foregoing, Indices 1 and 2 are adjusted downwards by 23% to reflect the inferior value of the subject location relative to that of Indices 1 and 2; Index 3 is adjusted upward by 18% to reflect the superior value of the subject location relative to that of Index 3. In general, it is preferable to use arm's length sales rather than assessed values to estimate a locational adjustment. However, you may find that there are often too few sales to estimate a reasonable locational adjustment, particularly for rural properties such as this 10-acre site. In such cases, assessed values may be the only available tools and therefore may be relied upon, remaining cautiously aware of their reduced accuracy in comparison to market sales. Where locational adjustment have been estimated using only a few available market sales, you might also consider using assessed values as a cross-check on that adjustment estimate. Size Adjustment

The appropriate adjustments for land size are found by adjusting 12 vacant land sales in both the subject and neighbouring areas for market conditions (to February 1, 2008) and then plotting them in ascending order by land size. This is illustrated by the following chart that shows the relationship between price per acre and lot size in the subject High Ridge area. The graph shows the trendline with an R-Square statistic of 0.7019. This chart indicates that a 66 acre lot achieves a typical market value that is ±$2,000 per acre less than that of a 28 acre lot, a decrease of ±10% ($2,000  $20,000 per acre). However, it does not indicate a significant value difference between 46 acres and 66 acres. Considering the foregoing, Index 1 is adjusted downward by 10% for size but Indices 2 and 3 are not adjusted for size.4 4

When using a per unit value measure (e.g., value per square foot of land area), care must be taken to avoid "double-adjusting" – adjusting a comparable for size, when this variation is already accounted for in the unit measure. There is no double adjustment if the properties are substantially different in size, to the point that increasing/decreasing returns to scale become a factor. For example, a 3-acre property and a 30-acre property with excess land will have a substantially different per acre value. To compare these two properties, this difference in scale must be accounted for with an adjustment.

7.25

Lesson 7

High Ridge-Price Trend with Size 60,000

40,000 30,000

Acre

Price Per Acre

50,000

20,000

2

R = 0.7019

10,000

0 0.00

50.00

100.00

150.00

200.00

250.00

300.00

350.00

Size in Acres

Interim Market Value

Refer to the Land Sales table. Once adjusted quantitatively for the three primary variables, the range of market values is $11,444 to $15,911 per acre. The 17% standard deviation indicates that the probable value dispersion around the $13,194 per acre median value is fairly narrow, i.e., the reliability of the median adjusted value is fair to good. As would be expected, Index 3, with its excellent views, indicates the top of the adjusted sale price range. At this point, qualitative analysis is applied to estimate the point in the range of $11,444 to $15,911 per acre that is appropriate for the subject parcel. Qualitative Analysis

Once the three primary variables have been quantitatively adjusted, the remaining secondary qualitative differences should be categorized. This assists in gaining an overall perspective of the indices in comparison with the subject property. These secondary variables for the three indices are: view, topography, tree cover, and shape. The adjusted sale prices are shown on the following table after adjusting for the three primary variables of market conditions, location, and size. Each index's qualitative characteristics relative to the subject are then rated. Element

Index 1

Index 2

Index 3

$369,168

$529,285

$873,991

27.98

46.25

54.93

$13,194

$11,444

$15,911

View

--

-

++

Topography

-

-

-

Tree Cover

0

0

0

Shape

+

0

0

Overall comparability

-

-

+

Adjusted Sale Price Acres Adjusted Sale Price Per Acre

7.26

The Cost Approach Part I – Site Valuation

The secondary variables for each index are analyzed as follows: Index 1 – is inferior in topography and is very inferior in view, similar in tree cover, and superior in shape. Because views are important to purchasers of residential properties, view is given significant weight. Index 1 is rated inferior to the subject property. Index 2 – is inferior in topography and view, but is similar in tree cover and shape. Overall, again with significant weight given to view, Index 2 is rated inferior to the subject property. Index 3 – is inferior in topography, similar in tree cover and shape, and very superior in views provided. Overall, particularly because of the superb views provided, Index 3 is rated superior to the subject property. Armed with the above, the subject property can now be ranked as shown on the following table: Index

Overall Comparability

Adjusted Sale Price Per Acre

3

Superior

$15,911

1

Inferior

$13,194

2

Inferior

$11,444

Subject

The qualitative analysis indicates that the market value of the subject property likely lies between $13,194 and $15,911 per acre. Considering that the ability of a site to provide views is a desirable feature for residential lots, and that the views provided by Index 3 are considerably superior to those of the subject property, it is likely that the market value indication of Index 1 is more similar to the subject property than that of Index 3. Therefore, with 75% weight given to Index 1 and 25% weight given to Index 3, the market value estimated for the subject property, as at February 1, 2008, is $13,873 per acre for an overall market value of 66.52 acres @ $13,873 per acre = $922,832 rounded to $925,000

Conclusion: Hybrid Adjustment Technique The hybrid adjustment technique combines quantitative analysis of three primary variables, market conditions, location, and size, with qualitative analysis of all remaining secondary variables. This hybrid technique was born out of the realities of performing appraisals in the field and the need for practical methods for supporting direct comparison value estimates. In the discussion and illustrations in this lesson we have attempted to parallel what actually occurs in the field for typical appraisal assignments – or perhaps a set of techniques that could reasonably be applied in most appraisal assignments. Keep in mind that there are valuation problems where the primary variables will differ from market conditions, location, and size and also that there are valuation problems that can only be solved qualitatively due to lack of quantifiable market evidence. However, in most instances the hybrid adjustment technique demonstrated in this lesson is appropriate when applying the direct comparison approach to value.

7.27

Lesson 7

Case Study 2 – Disputed Market Value This case study is a December 2010 court decision by the Supreme Court of British Columbia, the case of Kim versus Surrey, B.C. This decision is useful as it highlights the weight that the Court gave in assessing the application of the direct comparison approach by two appraisers, in the context of valuing the property of Mr. and Mrs. Kim. Excerpts from the decision pertaining to the appraisal issues follow. Review this case, and then answer the following questions concerning the decision. Answers can be found following the case study. 1. 2. 3. 4. 5. 6. 7.

What was the highest and best use of the subject property? What buildings were on the property, and what was their value? What appraisal rule of thumb concerning the size of the properties was accepted by the parties? Which appraiser applied a qualitative adjustment analysis, and which quantitative? Which time adjustment analysis was accepted by the Court, and why? What other adjustments were considered by the appraisers? List at least three significant lessons learned from this decision? IN THE SUPREME COURT OF BRITISH COLUMBIA 5

Citation:

Kim v. Surrey (City), 2010 BCSC 1853

Date: 20101231 Docket: S081090 Registry: Vancouver Between: Duk Joo Kim and Sin Suk Kim Plaintiffs And City of Surrey Defendant Before: The Honourable Madam Justice Lynn Smith Reasons for Judgment Counsel for Plaintiffs:

D.K. Plunkett

Counsel for Defendant:

A. Capuccinello

Place and Date of Trial:

Vancouver, B.C. August 3-6, November 12, 2010

Place and Date of Judgment:

Vancouver, B.C. December 31, 2010

5

www.courts.gov.bc.ca/jdb-txt/SC/10/18/2010BCSC1853.htm

7.28

The Cost Approach Part I – Site Valuation

INTRODUCTION [1] The plaintiffs, Duk Joo Kim and Sin Suk Kim, are the former owners of a one-acre piece of land in Surrey, British Columbia, that was expropriated by the City of Surrey in order to widen the King George Highway. They seek damages from the defendant City arising from that expropriation. [2] The land is at the intersection of King George Highway and 156th Street. The plaintiffs used the property not only for their residence, but also for two small business operations, a shop that sold rock specimens called The Rock Shop and a motel called the White Stetson Motel with four small units. [3] The two issues for decision are the fair market value of the property at the time of taking, and what disturbance damages, if any, are payable to the plaintiffs. PROVISIONS OF THE EXPROPRIATION ACT [4] The pertinent provisions of the Expropriation Act, R.S.B.C. 1996, c. 125, are: [Deleted from Case Study] FACTS [5] The plaintiffs immigrated to Canada from Korea in 1989, and on November 2, 1993, they purchased the one-acre parcel of land in Surrey, including the White Stetson Motel, the Rock Shop and a residential dwelling. It appears that they paid $637,000 for the property. They lived there with their family and ran the businesses from 1993 until the expropriation in 2007. [6] In 2006-2007, discussions took place between the City and the plaintiffs regarding the City's desire to purchase the property in order to widen the King George Highway. After the parties failed to reach an agreement, the City moved to expropriate. [7] Mr. Kim testified that he and his wife had had no intention to sell the property. He said that he was shocked by the City's move and by the prospect that his family might lose their property. [8] In October 2007, the City obtained an appraisal from Fred Mussett of Carmichael Wilson Appraisers. Mr. Mussett used an effective date of valuation of March 14, 2007, and appraised the property at $1,563,231.17, which included both $37,000 for the value of the improvements on the land and the City's share of the 2007 property taxes. The City did not file this appraisal as an expert report and does not rely on it. However, it is relevant because the City paid the plaintiffs the amount of that appraisal as an advance payment on October 5, 2007. [9] The expropriation date (the date of the vesting notice, as provided by s. 29 of the Expropriation Act) was November 21, 2007. The plaintiffs vacated the property in the Spring of 2008, and issued their Writ and Statement of Claim on February 22, 2008. [10] On August 31, 2008, the plaintiffs retained Reid Umlah, of Equity Evaluation and Consulting Services Ltd., to provide an appraisal. Using an effective date of valuation of October 10, 2007, Reid appraised the property's fair market value at $1,960,000. [11] On June 1, 2010, the City obtained an appraisal from Dale Hooker of Hooker Craig Lum Garnett. Using an effective date of valuation of October 29, 2007, Mr. Hooker appraised the fair market value of the property at $1,699,000. [12] Based on Mr. Hooker's appraisal, the City made an additional advance payment to the plaintiffs of $144,520.21 on June 30, 2010. [13] The trial of this matter commenced August 4, 2010, with submissions on November 12, 2010. ANALYSIS 1. What was the fair market value of the property as at the date of taking? [14] Mr. Umlah, called by the plaintiffs, found the property to be worth $1,960,000 while Mr. Hooker, called by the defendant, found it to be worth $1,699,000. [15] Mr. Umlah and Mr. Hooker agree that the highest and best use for the Kims= property at the date of valuation was as a short term holding for future commercial use. Neither appraiser attributed any value to the existing improvements. [16] Both appraisers used the direct comparison approach. Mr. Umlah looked at a total of six properties and Mr. Hooker at a total of ten properties. Five of each appraiser's selected comparables were in common. 7.29

Lesson 7

[17] The two appraisers agree that adjustments in percentage terms should be made to take into account the passage of time between a comparable sale and the valuation date, although they disagree as to the data that can properly be used in making time adjustments, and as to the details of the appropriate time adjustments in this case. [18] Because Mr. Hooker's initial report was based upon the date October 29, 2007, rather than the actual date of taking, which was November 21st, 2007, he provided an amended version with time adjustments to the date of taking, and I have relied on that amended version. [19] The appraisers agree that, in general, the per square foot price of land will be higher for a smaller property than for a larger property – a Avolume discount@, as it were. [20] As well, the two appraisers agree about: the size and shape of the subject property; its topography and its proximity to servicing infrastructure; the access point to the property at the valuation date; the absence of easements, rights-of-way or covenants on title; the property's zoning and official community plan designation; and the description of the existing improvements. 1. Appraisals a) Appraisal by Reid Umlah [21] Reid has held Accredited Appraiser Canadian Institute (AAACI@) designation since 1993, and has worked as an appraiser in British Columbia since 1991. He has done appraisals for both claimants and expropriating authorities. Reid testified that he has previously been accepted as an expert by the Expropriation Compensation Board and in two cases in this Court. [22] It was put to Reid on cross-examination that, in a previous case in this Court, his opinion was not accepted over that of Mr. Hooker (Reeves v. British Columbia (Hydro and Power Authority), 2009 BCSC 1285, 47 C.E.L.R. (3d) 288 [Reeves]). In that case, Reid did the appraisal for the City and Mr. Hooker did the appraisal for the owners. Reid agreed that his approach was criticized in that case as lacking in objectivity with respect to one of the comparables that he selected, lacking detailed explanations in important areas including adjustments, and lacking accuracy in his use of information: Reeves at paras. 29 and 33. [23] Reid had prepared his appraisal report for the plaintiffs in this case before the Reeves decision was handed down. He testified that as a result of the Reeves decision, he has changed the way in which he writes his reports, now providing more detail and more support for the adjustments he makes. [24] In the end, the defendant did not object to Reid being accepted as an expert appraiser, qualified to give opinion evidence, but submitted that little weight should be given to his opinion. [25] I accept Reid as qualified to give opinion evidence. I have grounded my assessment of the weight of his opinion in the evidence in this case. However, I take into account the evidence that although Reid has now changed his practice, at the time he prepared the appraisal tendered by the plaintiffs, he was not providing the level of detailed analysis that he now considers necessary. [26] Reid described the Kim property as an irregularly shaped, one-acre lot (43,560 square feet) with a three-bedroom dwelling, four motel units and a small wood frame structure (of about 250 square feet) where the Rock Shop was housed. [27] The South Surrey Sunnyside neighbourhood where the property is located was an area of mixed land use, with various forms of residential and commercial properties. The residences included single family dwellings, townhouses and some mobile homes. There is some commercial development in the immediate neighbourhood, dominated by a retail plaza called APeninsula Village@ just north on 24th Avenue, and including other mostly highway and service commercial enterprises. [28] Reid said that the property had a strong corner location along a main arterial road. He noted that the grade of the property was level and that there was access to it both directly from King George Highway, which was improved to a single traffic lane in each direction, and from 156th Street, which was a local road improved to a single traffic lane in each direction. The intersection of King George and 156th Street did not have a traffic signal. [29] The zoning of the property was RF single family residential. Under the City's current Official Community Plan, the property was designated Aurban. That designation could include local commercial uses and other conditional uses. The property was designated commercial in the King George Highway Land Use Development Concept Plan [KGCP] of April 1994.

7.30

The Cost Approach Part I – Site Valuation

[30] According to Mr. Umlah, the highest and best use of the site would have been for rezoning to allow for short-term commercial development, given the property's strong location on a corner on King George Highway. He described its location as very attractive for traffic-oriented commercial uses such as gas stations, fast food restaurants and drive-through financial institutions. He said that the improvements on the land were older and nearing the end of their economic life but during a rezoning application process the improvements would have been capable of generating interim holding income. [31] Mr. Umlah used the direct comparison approach and compared the expropriated land to six properties sold in the previous few years, all in Surrey. [32] In chief, Mr. Umlah stated that the direct comparison approach was based on the principle of substitution which assumes that a prudent purchaser would not pay any more for a property than the price for which they could obtain an equally desirable property in the marketplace. He said that as an appraiser, he looks for properties which share similar physical characteristics and similar use potential to those of the property being appraised. [33] The sales of the comparable properties were mostly in 2007, although one sale was in September 2005. To compensate for the different dates of the comparable sales, Mr. Umlah made time adjustments of up to 30%. [34] He testified that he based his time adjustments on the noticeable rise in property values throughout the Lower Mainland and on the Housing Price Index prepared by the Fraser Valley Real Estate Board. He said that that index showed that the benchmark price of a typical home had increased, over the three years preceding the date of his report, on average by 1.367% per month for detached homes, 1.156% per month for townhomes, and 2.20% per month for apartments. He said that in Surrey, detached homes had increased by 1.23% per month, with South Surrey and White Rock indicating a rate of 1.39% per month. He agreed that construction costs contributed to the effect and that the housing market was not the same as the commercial market, but said that development land had been following a similar upward trend to that of residential land. [35] Mr. Umlah made time adjustments for the comparable sales as follows: one sale in September 2005 – a 30% adjustment; two sales in March 2007 – a 10% adjustment (he corrected his report during his testimony and said that the adjustments for the two sales in March 2007 should have been both at 10%, rather than what the report had stated, which was one at 5% and one at 10%); one sale in April 2007 -a 10% adjustment; and no adjustment for sales in June, August and November 2007. [36] After making his adjustments for the dates of sales, Mr. Umlah found that the range of per square foot prices paid for comparable properties was between $28.66 and $43.66. [37] In his report, after very brief comments about each of the comparables, Mr. Umlah reached this conclusion: Given our analysis of the commercial real estate market as at the date of expropriation, October 10, 2007, and given the size, general location and the site's corner frontage at King George Highway and 156th Street, all of which create a high profile site suitable for commercial applications such as gas stations, fast food restaurants, drive-thru financial institutions, all of which tend to pay a premium for such corners, we would expect that the value of the land would lie toward the upper end of the range suggested by the comparable sales. Therefore, it is our opinion that market value of the subject site as is- and inclusive of the holding value for the existing improvements, would lie in the order of $45.00 per square foot of gross site area. Accordingly, we have estimated current market value of the subject property as at the date of expropriation is: $45.00 x 43,560 square feet = $1,960,200. [38] Mr. Umlah testified that he emphasized certain comparables in his analysis, namely his Comparable #3 and Comparable #4. Counsel for the defendant objected to this testimony since there was no discussion of this emphasis or the reasons for it in Mr. Umlah's report. I exercised my discretion to hear his evidence about what use he made of the particular comparable properties. This was not a case of an appraiser bringing in a new comparable; rather, he was explaining the analysis underlying his opinion. Further, it did not appear that the defendant was so taken by surprise as to be unable to deal with this evidence. (I do not overlook the point, made by counsel for the defendant, that the two comparables Mr. Umlah said that he emphasized were the ones with the highest per square foot rates.) [39] Mr. Umlah said that he emphasized Comparables #3 and #4 because #3 is a corner property in the Grandview Corners area very close to the subject property and slightly larger, and #4 because it has a corner influence on Fraser Highway, very similar in size and already zoned for highway commercial use.

7.31

Lesson 7

[40] With respect to the two comparables that he testified were most influential, Mr. Umlah wrote as follows: Comparable 3 is located on the northwest corner of 24th Avenue and Croydon Drive within the Grandview Heights neighbourhood, east of Highway 99. This is a newly developed area of South Surrey. This is a somewhat dated transaction, and after adjustment for market conditions, we have arrived at a price of $42.58/ft2 as at the effective date. The City of Surrey Official Community Plan designates the General Land use for the property as Commercial within the Highway 99 Corridor Land Use Plan. The Zoning for the property is RA, a One Acre Residential classification. Like the subject, this site has corner frontage. It is slightly larger than the subject, therefore, a slight upward adjustment to the time adjusted rate per ft2 is warranted. Comparable 4 is located in the north Cloverdale area of Surrey, fronting the south side of Fraser Highway within a developing residential/commercial area. The site includes extensive frontage along Fraser Highway and lies adjacent to an existing retail commercial development. At the time of sale the site was vacant and zoned CHI (Highway Commercial). The March, 2007 selling price equates to $39.69/ft2 for the 45,346 ft2 site. An upward adjustment of 15% has been made to reflect current market conditions, suggesting a current rate in the order of $43.66/ft2. [41] The per square foot value Mr. Umlah estimated for the Kims= property as of the date of taking was $45.00, higher than that of the time-adjusted per square foot value of any of the comparable sales he reviewed. It was not at the Aupper end of the range suggested by the comparable sales, it was above the upper end of the range. The written report does not advert to that fact, nor explain it. In his testimony, Mr. Umlah explained his conclusion that the per square foot price for the subject property would be higher than that of any of his comparables, referring to the sales figures for #3 and #4 and to the market being in an upswing. [42] Because there was pointed disagreement between the two experts as to the method they used for making adjustments, and as to the correct way to apply the direct comparison approach, I permitted a supplementary report to be filed by Mr. Umlah commenting on Mr. Hooker's report (although I have disregarded the portion of Mr. Umlah's supplementary report that was objected to) and a supplementary report to be filed by Mr. Hooker commenting on Mr. Umlah's report. [43] Mr. Hooker's comments on Mr. Umlah's report were that:  use of the Housing Price Index was inappropriate with respect to commercial property because the residential and commercial markets seldom, if ever, move in unison;  Mr. Umlah's application of time adjustments was very inconsistent from one property to the next;  although Mr. Umlah noted various differences between the subject and the comparables, his report did not quantify those differences or explain how they have impacted his opinion of value;  Mr. Umlah's analysis of the six comparables he used failed to take account of significant differences in a number of cases; and  Mr. Umlah's report did not take into account some of the comparables used by Mr. Hooker, which Mr. Hooker says are relevantly similar. [44] Mr. Hooker stated in his supplementary report: In my opinion it is incumbent on the appraiser to at least attempt to quantify adjustments in terms of orders of magnitude when valuing a property by the Direct Comparison Approach so that the reader will understand how positive and negative factors influencing market appeal for any particular property have been interpreted in terms of impact on value. [45] On cross-examination, Mr. Umlah agreed that there were a number of errors in his report, such as references to Maple Ridge rather than Surrey, to the Agricultural Land Reserve (which has no bearing), to Kwantlen Community College rather than Kwantlen Technical University, and to vacant sites in the definition of the direct comparison approach. However, he denied that the report was done on a rush basis. [46] Mr. Umlah said that he made qualitative adjustments, not physical adjustments. He agreed that the Housing Price Index was not the best indicator of how the commercial market was working, although it provided a general trend in how the market was performing for a typical home. He agreed that he had erred in making an adjustment at 5% for one of the comparables sold in March 2007 and 10% for another of the comparables sold in the same month. He agreed that he had not applied a consistent monthly rate for time adjustments, even within the same general time frame.

7.32

The Cost Approach Part I – Site Valuation

b) Appraisal by Dale Hooker [47] Mr. Hooker has been actively employed as a real estate appraiser since 1972. He has AACI designation. He has testified on numerous occasions before the Expropriation Compensation Board and in this Court, both for property owners and for expropriating authorities. I accepted him as qualified to give expert opinion evidence as to the value of the property. [48] Mr. Hooker described the property as a quadrangular parcel of land with 99.7 feet of frontage on the northeast side of King George Highway and 249.1 feet of frontage on the east side of 156th Street, that was level and had a single point of access from King George Highway, which was asphalt paved to a single lane width in either direction with a paved shoulder on each side. He noted that the motel units' original permit was issued in 1954, and that they and the Rock Shop were non-conforming (though assumed legal) uses. His view was that all existing improvements were inconsistent with the highest and best use of the subject property at the date of taking. [49] Mr. Hooker wrote that although there was apparent potential for subdivision into about five urban residential building lots, market appeal would be negatively impacted by commercial encroachment and traffic nuisance. He concluded that the highest and best use was as a short term holding for future commercial use as envisioned in the KGCP and permitted within the Urban designation in Surrey's Official Community Plan [OCP]. [50] His analysis of the neighbourhood and of the prospects for the future was fairly detailed. He noted that the potential of the site for commercial development was limited to those commercial zones permitted within the existing Urban land use designation in Surrey's OCP unless an amendment to that plan was approved. Those uses included housing, local commercial uses, and public amenities, and possibly mixed use neighbourhood centres, multiple residential housing, and home based businesses. The KGCP had served as an unofficial guideline, he said, for Surrey's Council and city staff and the development community, and the site was proposed for future commercial development in the KGCP. Properties in the immediate vicinity of the subject property had been proposed and used for highway commercial development, for commercial purposes, for a mobile home park, and for urban residential purposes. However, he stated, ANotwithstanding the proposed use of the subject site in the KGCP its potential for commercial development was limited to those commercial zones permitted within the existing URBAN land use designation in Surrey's Official Community Plan unless an OCP amendment was approved. [51] As did Mr. Umlah, Mr. Hooker made adjustments for the time of sale and for size. [52] Mr. Umlah's time adjustments were derived from the Housing Price Index, and seem to have been developed on an Aeyeball@ basis. The monthly rates used for the time adjustments varied considerably from one property to another. Mr. Umlah made adjustments for size without stating what the magnitude of the adjustment was. [53] Mr. Hooker's adjustments were made with reference to the market for commercial property; he said that, generally speaking, that market (as with most sectors of the real estate market) was strong leading up to the date of taking, with prices escalating on a fairly consistent basis. He set out a table with paired sales to show the change in pricing over the time period spanned by the comparable sales. He stated that he applied time adjustments to the comparable sales data at an average monthly rate of 1.50% compounded monthly. [54] In submissions, counsel for the plaintiffs advised that they will accept Mr. Hooker's time adjustments since, in any event, they are greater than those of Mr. Umlah. [55] With respect to adjustments for size differences, Mr. Hooker set out percentages by which the values were adjusted to reflect the fact that comparable properties were larger or smaller than the subject property. [56] Similarly, Mr. Hooker made adjustments stated in percentage terms for the comparable properties= location, corner aspect, shape, zoning and other matters. Under the heading Aother@, for example, he made a positive adjustment to his Comparable #1 to reflect the fact that significant road dedication was required in order to proceed with development of that property. [57] After the negative and positive adjustments were made to each of the comparable sales to take account of the various factors, Mr. Hooker stated an Aindicated value for subject@ for each of the ten comparables. These values ranged between $35.57 and $42.54 per square foot. Mr. Hooker wrote that Athis brackets market value for the subject property at the date of taking@ and concluded that the market value of the property was at the midpoint of $39.00 per square foot. [58] Thus, Mr. Hooker concluded, based on his analysis of the ten comparable sales, the subject property was worth $1,699,840 at the date of taking.

7.33

Lesson 7

[59] In his comments on Mr. Hooker's approach, Mr. Umlah made the following points:  using a consistent monthly rate for time adjustments did not take account of the fact that over certain time periods, market prices will rise at differing rates;  no support was provided for the percentage amounts of adjustments made for factors other than time and since the adjustments were all subjective, the process was misleading;  the five comparables used by Mr. Hooker that were not used by Mr. Umlah had less reliability than the others;  Mr. Hooker's adjustments for shape and location were particularly problematic, as he made adjustments where shape did not affect the usability of the property, and where variances due to location were too small to warrant a measureable adjustment; and  a more accurate result is achieved by using fewer comparables that are most similar to the subject property, rather than more comparables where significant subjective adjustments must be made. 2. Positions of the parties as to value of the expropriated property a) Plaintiffs [60] Mr. Plunkett for the plaintiffs argues that the objective of the direct comparison approach is to find properties that are closely comparable to the subject, and which require few adjustments in order to reach an estimated value. He refers to John A. Coates and Stephen F. Waqué, New Law of Expropriation (Toronto: Thomson Carswell, 2009), where the authors, citing a number of authorities, state (at 5-55): Because adjustments invariably introduce a Asubjective factor into the appraisal process@ (Greenslade v. Ontario (Minister of the Environment) (1980), 21 L.C.R. 303) and, where it is given the choice, the tribunal will accept the approach to value which is the least subjective and, therefore, the least prone to error (Glassford v. Ontario (Minister of Transportation & Communications) (1979), 18 L.C.R. 138 at 144), the Ontario Land Compensation Board (now the Ontario Municipal Board) adopted Todd's statement as the general rule relating to adjustments: Athe more the required adjustments, the less reliable is the resultant estimate of value.@ Where an appraiser's assessment is based on too many variables, probabilities and assumptions, it will be disregarded by the tribunal in determining value: Haft's Ltd. v. Sault Ste. Marie (City) (1979), 17 L.C.R. 68 (Ont. L.C.B.), at page 71. Conversely, sales more proximate in location to the expropriated property should be preferable as more reliable to value: General Capital Growth Ltd. v. Burlington (City) (1980), 19 L.C.R. 153 (Ont. L.C.B.), at page 159. [Emphasis added] [61] The ATodd@ referred to in that passage is the work of a British Columbia scholar, E.C.E. Todd, The Law of Expropriation and Compensation in Canada (Scarborough: Thomson Carswell, 1992) at pp. 152-3. [62] The plaintiffs= position is that the better approach is to take properties that are the most comparable, and then rely on the actual data rather than making a large number of adjustments without data to support them. Mr. Plunkett refers to the underlying Aprinciple of substitution@ (that a person will not pay more for a property than it would cost to buy an equally desirable substitute). He submits that the principle of substitution does not work if the comparable properties are so different that a prospective purchaser would not be comparing the same properties. [63] The plaintiffs= position is that their appraisal provides a more accurate assessment of value because Mr. Umlah looked at six comparable properties but primarily weighted two properties that he determined to be the most comparable, while in contrast, Mr. Hooker, after looking at ten properties and making extensive adjustments, calculated an average per square foot value and attributed that to the subject property. b) Defendant [64] Mr. Capuccinello for the defendant argues that the appraisal by Mr. Umlah should not be accepted for a number of reasons, including:  his report makes no adjustments other than time adjustments and provides virtually no analysis or explanation for his conclusions;  his time adjustments are based on the Housing Price Index, which bears no relevance to the market for commercial land or buildings;  his valuation of the property at a higher per square foot number than any of his comparables is unsupported by the evidence; 7.34

The Cost Approach Part I – Site Valuation

 his report and his testimony were not based upon investigation of the subject property regarding development potential and the nature of conditions that the City might impose; and  he did not take into account the risk that the rezoning necessary to permit commercial use would be unavailable. [65] Mr. Capuccinello makes a number of specific submissions with respect to the comparable properties that Mr. Umlah said were closest to the subject. [66] For example, Mr. Capuccinello submits that with respect to Mr. Umlah's Comparable #3 (Mr. Hooker's Comparable #2), although Mr. Umlah adjusted for time and referred to the difference in size, he ignored the fact that the comparable is located in a superior neighbourhood of much more intensive commercial development and has a superior shape with frontage on three sides. For that property Mr. Hooker made negative adjustments of -10% for location and -10% for shape. He quantified his size adjustment at 5%. [67] With respect to Mr. Umlah's Comparable #4 (Mr. Hooker's Comparable #8), Mr. Capuccinello submits that Mr. Umlah did not take into account that the property, compared with the subject property, is located in an area of more intensive commercial development immediately adjacent to a new neighbourhood shopping centre and directly opposite another, has much more frontage (on a primary four-lane arterial road), has a superior shape, is fully serviced and had highway commercial zoning in place at the date of sale. Mr. Hooker made adjustments of -10% for location and -10% for shape. [68] I have disregarded the submissions made by Mr. Capuccinello regarding the Canadian Uniform Standards of Professional Appraisal Practice since those standards were not in evidence and there was no opinion evidence as to their status or the manner in which they should be interpreted. c) Comparison of the two appraisals [69] In assessing the expert opinion evidence as to the value of the plaintiffs= property, I must consider the qualifications and the nature of the opinions of the two experts. [70] Their qualifications seem comparable. Mr. Hooker has had more years of experience, but both men are highly experienced appraisers. [71] Both of the appraisers look at a number of comparable properties, make adjustments to compensate for the passage of time since the dates of sale and for other differences between the subject property and the comparables, and state an opinion as to the value of the subject property based upon those previous sales. Mr. Hooker, however, provides much more information about how he makes the comparisons and reaches his conclusion, and seems to have looked in more depth at the comparable properties. [72] Mr. Umlah's version of the exercise is exemplified by his discussion of Comparables #1 and #2, which is as follows: Comparable 1 involves a transaction that took place shortly after the effective date of valuation. Accordingly no adjustment for differences in market conditions was warranted. Comparable 1 involves three adjacent properties that were acquired by the single purchaser for a price of $32.14/ft 2. The properties are located opposite the subject, fronting the west side of King George Highway and they also front Medrona Place. The land is zoned CHI but designated Urban/Commercial in the OCP. An application has been submitted to the City (07 000137) requesting Rezoning from CHI to RF for a portion of the site to allow subdivision into six (6) single family lots and one (1) consolidated commercial lot for future development fronting King George Highway. Two notable differences exist between the subject and Comparable 1. First the subject is much smaller, and smaller sites will tend to sell at a higher rate/ft2. Second, the subject has a corner orientation and as a result, is more attractive than the interior orientation of Comparable 1. This would also enhance the rate per ft2. As such, we would conclude that the rate above $32.14/ft2 would be warranted for the subject as at the effective date. Comparable 2 involves the sale of three adjacent parcels fronting the east side of King George Highway north of the subject parcel. The three sites are improved with older modest residential dwellings, are current zoned RA and are designated Urban in the OCP. They were purchased collectively at an average price equal to $36.78ft 2 in June/August 2007. No adjustment is considered warranted for market conditions. All three properties are designated Urban in the current OCP, however, they are not intended for commercial development. Thus, Mr. Umlah says that for Comparable #1 a rate above $32.14/ft 2 would be warranted for the subject as at the effective date, and that notable differences between this property and the subject property are size and corner

7.35

Lesson 7

orientation. He does not say how much emphasis he is placing on each of those factors, and does not deal with the differences in zoning. [73] For Comparable #2, Mr. Umlah does not explain why the subject property would be worth over $8.00 per square foot more than the comparable, other than saying (without explanation) that the properties comprising Comparable #2 Aare not intended for commercial development. [74] Mr. Hooker's report sets out more detail about Mr. Umlah's Comparable #1 (which is also Mr. Hooker's Comparable #1), and makes adjustments as follows: none for time; positive adjustment (10%) for the fact that the subject property is on a corner; positive adjustment (10%) because the subject property is smaller; and a positive adjustment (10%) for the fact that development of the comparable property will require a significant road and lane dedication. He arrives at an indicated per square foot price of $37.00 for the subject property based upon this comparable. [75] As to Mr. Umlah's Comparable #2 (which is Mr. Hooker's Comparable #5), Mr. Hooker takes into account that two further lots had been added to the assembly. He notes that there was a large commercial node directly to the south of the comparable. He makes the following adjustments: none for time; a positive adjustment for size (10%) because the subject property is smaller; and a negative adjustment for the superior configuration of the comparable (-10%). He arrives at an indicated per square foot price of $40.74 for the subject property based upon this comparable. [76] Mr. Hooker's report is based on more extensive research about the property and its potential. His time adjustments are based on a paired sales analysis and his understanding of the commercial market, rather than on an index reflecting the residential market. The analysis in Mr. Hooker's report is clear and transparent. [77] I recognize the risk in over-quantifying the appraisal process. Appraisal evidence is necessarily based to a significant extent on the knowledge and experience of the appraiser, and on his or her understanding of the market in question. Mr. Hooker freely admitted that he did not base most of his adjustments (aside from those for time) on data. Allocation of specific percentages for adjustments, as is done by Mr. Hooker, could give a false air of scientific certainty to the appraiser's conclusions. [78] However, knowing what percentage adjustment Mr. Hooker has allocated to a particular factor for a particular property, and knowing what he says in the end the sale of a particular property indicates for the value of the subject property, makes it possible to examine and question his conclusions because his reasons for them are apparent. Mr. Umlah's report has much more of the ipse dixit (Abecause I say so) about it. [79] As well, I recognize the risk in looking at comparables that are not sufficiently similar to the subject property. [80] I do not accept the plaintiffs= position that only two properties were really similar, and that aside from those two (or possibly the total of six that Mr. Umlah used), Mr. Hooker's comparable properties should not be considered. However, it is worth considering the impact of excluding from the analysis the properties with respect to which Mr. Hooker made the highest percentage of adjustments. (Those properties would likely be the least similar to the subject property, and the least relevant to an assessment of the value of the subject property, according to the plaintiffs.) The highest adjustments Mr. Hooker made were to his Comparables #3 (-25%) and #4 (-25%). The indicated values for the subject property were $41.96 for #3 and $40.37 for #4, in his opinion. Those values were higher than Mr. Hooker's average; thus, excluding them as irrelevant would not have the effect of increasing the average per square foot value. [81] Because Mr. Hooker's report states much more clearly the facts and assumptions upon which his opinion is based, and derives from more extensive investigation and analysis, I prefer the evidence of Mr. Hooker over that of Mr. Umlah. I note in particular that Mr. Umlah did not include in his report or testimony any clear explanation for his conclusion that, even after adjusting for time, the subject property was more valuable than all of the comparables. However, it does not follow that I simply accept Mr. Hooker's opinion as to the value of the property as the final word, for the reasons that I will give in the next section. 3. Conclusion as to value of the expropriated property [82] The appraisers agreed, and I find, that the highest and best use of the subject property is for short-term commercial development, and its value should be determined accordingly. [83] For two reasons, I think that the value of the expropriated property is somewhat higher than Mr. Hooker says it is. [84] First, I think that Mr. Hooker likely over-stated the risk of a developer being unable to achieve a change in zoning. Mr. Hooker made negative adjustments of -5% with respect to four of his comparable properties because they 7.36

The Cost Approach Part I – Site Valuation

already had some form of commercial zoning in place. (He did not make a negative adjustment for this in his Comparable #8, for some reason.) Doubtless, there is some element of risk that commercial zoning would be refused for the Kims= property, but the evidence suggests that the risk is very small. The subject property was designated for urban use in the Official Community Plan and for commercial use in the KGCP, which is used as a non-binding guide by City planners. The subject property had operated as a non-conforming commercial property for a long time, and the properties directly across King George Highway from it have already been developed commercially. [85] Second, I think that Mr. Hooker's adjustments for shape may have over-emphasized the value of rectangularity. I accept Mr. Umlah's evidence that the point is not necessarily the shape, but the usability of the property. I accept that this property, even with its odd quadrangular shape, could have been readily usable for highway commercial purposes, with access either from King George Highway or from 156 th Street. I do not overlook Mr. Hooker's evidence, which I accept, that the issue of the undeveloped boulevard between the property and King George Highway would have had to be dealt with. Also, I understand the point made by Mr. Capuccinello that Mr. Hooker's adjustments for shape encompass considerations of road frontage. However, I think that Mr. Hooker's adjustments for shape, which he applied to seven of his comparables (four negative adjustments at -10%, two negative adjustments at -5% and one positive adjustment at 10%) probably overstated the impact of this property's shape on its value. [86] As one example, there is the adjustment for shape with respect to the Fraser Highway property in North Cloverdale used as Mr. Umlah's Comparable #4 and Mr. Hooker's Comparable #8. Mr. Umlah noted that the property includes extensive frontage along Fraser Highway and proximity to an existing retail commercial development. It sold in March 2007 for $1.8 million, at $39.69 per square foot. Mr. Hooker adjusted 12% for time, resulting in a time-adjusted value of $44.46 per square foot. Mr. Hooker then made a negative adjustment of -10% for location and another negative adjustment of -10% for shape, yielding an indicated value for the subject of $35.57. I am satisfied on the evidence that the Fraser Highway property used by Mr. Umlah as Comparable #4 and by Mr. Hooker as Comparable #8 was superior to the subject property in terms of location, and that a negative adjustment was warranted in that respect. However, the additional -10% deduction based on shape seems excessive even taking into account that the comparable property has greater frontage on Fraser Highway than the subject property did on King George Highway. [87] I find that the per square foot value of the subject property at the date of taking was slightly higher than Mr. Hooker opined, and significantly lower than Mr. Umlah opined. On the preponderance of the evidence, I find that the per square foot value of the property was $40.00. [88] The fair market value of the property, therefore, based upon its highest and best use as at the date of expropriation, was 43,560 x $40 = $1,742,400. 4. Can the plaintiffs claim disturbance damages? [Deleted clauses 89-99] [100] I find that the plaintiffs= claim for disturbance damages cannot succeed. CONCLUSION [101] The plaintiffs have received $1,707,751.38 in advance payments, and I have found that the fair market value of the property was $1,742,400. [102] The plaintiffs will receive $34,649, being the difference between the advance payment and the fair market value of the property. [103] The plaintiffs have succeeded in their claim and will have their costs at Scale B unless counsel wish to bring to the Court's attention matters relevant to costs of which I am unaware, or to make submissions. If that is the case, counsel will arrange a time through Trial Scheduling. Lynn Smith J.

Answers to Case Study 2 1. 2. 3. 4.

Short-term holding for future commercial use. A residence, small retail store and 4-unit motel. No value. In general, the per square foot price of land will be higher for a smaller property than for a larger property. Umlah – qualitative. Hooker – quantitative

7.37

Lesson 7

5. The court accepted Mr. Hooker's time adjustment analysis. It was based on paired comparable sales. Mr. Umlah's time adjustment was based on a housing price index, while the subject was a commercial development site. 6. Both appraisers considered size, location and corner influence. Mr. Hooker also considered shape, zoning and other factors (such as the need for road dedication). 7. a. If sufficient market data is available, the quantitative approach is preferred to the qualitative approach as the Court commented that the former is more transparent to the reader. b. The value conclusion is more suspect if it lies outside the range of values defined by the market comparables. c. More reliability is placed on adjustments based on data relevant and comparable to the subject property (e.g., support time adjustment on comparable property or market segment data, not improved residential to vacant commercial). d. Be consistent in the application of adjustments. Don't make arithmetic errors. e. Be thorough in the investigation of comparable sales, to determine all factors relevant to their analysis (e.g., road dedication requirement). f. Be able to justify, not only the comparables used in the report, but the rationale to reject other market transactions as non-comparable.

Frobisher Report The land value analysis is presented in this lesson's excerpt of the Frobisher Report. After reading the material, answer the following questions. Answers to the questions can be found at the end of the excerpt. 1. Why are the comparables numbered 4, 5 and 6 rather than 1, 2 and 3? 2. How could the appraiser prove from the market that there is a nil adjustment associated with variances in lot depth of +/- 5 feet? 3. Is there a trend in the statistical analysis for time that the appraiser has not addressed? Explain your answer. 4. Could/should the appraiser have used data related to sales of land zoned to permit more intensive residential development than single family homes? Explain.

FROBISHER REPORT

Estimate of Land Value In order to estimate the market value of the subject site, as if vacant and ready for development with a single family residence, the direct comparison approach will be applied. A data comparison chart and adjustment chart are presented, followed by an analysis of the adjustments applied in the chart. Then, the adjusted sale prices of the comparable vacant land sales are evaluated in order to reach a conclusion of the market value of the land.

continues on following five pages

7.38

The Cost Approach Part I – Site Valuation

COST APPROACH – LAND VALUE Data Comparison Chart Item

Subject

Comparable no. 4

Comparable no. 5

Comparable no. 6

Address

123 Bering St.

57 Heinz Crescent

863 United Way

64 Heinz Crescent

Legal description

Lot 1, Block 2, Plan 1234A

Lot 19, Plan 9876B

Lot 3, Block 1, Plan 3456C

Lot 24, Plan 9876B

Sale date

n/a

Nov. 2, 2010

Dec. 3, 2010

Jan 29, 2011

Instrument no.

1234555

1234777

1234888

Registration date

Jan. 8, 2011

Jan 25, 2011

Mar 16, 2011

Vendor

Warren

Mason

Warren

Purchaser

Jenkins

Lambert Builders

Stub

Sale price

$65,000 /$1,182 fr.ft.

$69,900 /$1,344 fr.ft.

$71,000 /$1,183 fr.ft

Right conveyed

Fee simple

Fee simple

Fee simple

Fee simple

Financing

N/A

None

None

None

Conditions of sale

N/A

None

None

None

Expenses made immediately after purchase

N/A

None

None

None

Time difference (mos)

0

3 months

2 months

0 months

Zoning

R-1

R-1

R-1

R-1

Location

Good

Good

Good – Superior

Good

Frontage/depth

55' x 120'

55' x 115'

52' x 120'

60' x 125'

Lot area

6,600 sq.ft.

6,325 sq.ft.

6,240 sq.ft.

7,500 sq.ft.

Topography

Level, gently sloping

Similar

Similar

Similar

Utilities

Fully serviced

Fully serviced

Fully serviced

Fully serviced

Interior/corner lot

Interior

Interior

Interior

Interior

Local Improvement Charges

None

None

None

None

Easements/Rights of Way

Utility Caveats

Utility Caveats

Utility Caveats

Utility Caveats

A very similar site in all aspects; requires a time adjustment;

Very similar to the subject except for location; also requires a time adjustment;

Very similar to the subject and requires no adjustments;

Other comments

7.39

Lesson 7

COST APPROACH – LAND VALUE (continued) ADJUSTMENT CHART Item

Comparable no. 4

Comparable no. 5

Comparable no. 6

Sale price

$65,000 / $1186 fr.ft.

$69,900 / $1340 fr.ft.

$71,000 / $1177 fr.ft.

Real property rights conveyed adjustment

0

0

0

Adjusted price

$1,182/ fr.ft.

$1,344/ fr.ft.

$1,183/ fr.ft.

Financing adjustment

0

0

0

Conditions of sale adjustment

0

0

0

Expenses made immediately after purchase adjustment

0

0

0

Adjusted price

$1,182/ fr.ft.

$1,344/ fr.ft.

$1,183/ fr.ft.

Date of sale adjustment

$2,730

$1,957

0

Adjusted price

$67,730 ($1,232/ fr.ft.) $71,857 ($1,382/ fr.ft.) $1,183/ fr.ft.

(+4.2%)

(+2.8%)

Other adjustments as required: - Zoning

0

0

- Location

0

$5,749

- Frontage/depth

0

0

0

- Lot area

0

0

0

- Topography

0

0

0

- Utilities

0

0

0

- Interior/corner lot

0

0

0

- Local Improvement Charges

0

0

0

- Easements/Rights of Way

0

0

0

Total Other Adjustments

0

$5,749

Final Adjusted Sale Price

$ 1,232/ front foot

$ 1,271/ front foot

$ 1,183/ front foot

Adjusted unit sale price per front foot

$ 1,232/ front foot

$ 1,271/ front foot

$ 1,183/ front foot

Adjusted sale price per square foot For reconciliation purposes: Sales indicate a reasonable range of value, greater weight given to sales #1 and #3 as they are most similar.

$ 1,232/ front foot

$ 1,271/ front foot

$ 1,183/ front foot

Total Adjustment

$2,730

$3,792

0

Total adjustment as % of Sale Price

4.2%

-5.4%

0%

7.40

0 (-8%)

(-8%)

0

0%

The Cost Approach Part I – Site Valuation

Adjustment Analysis The order of applying adjustments is: property rights, financing, motivation, expenses made after purchase, market conditions (time) and other. In this situation, all three sales were of the fee simple interest, and financing was typical of the market. Even though sales 4 and 6 were from the same vendor, they were to different buyers and all sales were arms length transactions. All properties were fully serviced sites, ready for development, with no need for extra site fill, clearing or leveling. Therefore, the only adjustments considered were for market conditions and other. First, consider the adjustment for market conditions or time. All three sales occurred within 3 months of the effective date of appraisal. Even so, it is necessary to review market information to determine whether or not a time adjustment is warranted. A complete search for vacant land sales was done through MLS (Multiple Listing Service) records, as well as provincial assessment records on title changes. The best support for a time adjustment is an analysis of resales of comparable residential sites. Two such sales and resales were identified, and are shown in the chart below. These properties were of comparable size, zoning and utility to the subject site, and there were no changes impacting market value between the two sale transactions.

PROPERTY 10 Perry St.

137 Rundell Ave.

Sale Date

Jul 11, 2010

Dec. 28, 2009

Sale Price

$60,600

$53,100

Resale Date

Jan 15, 2011

Dec 30, 2010

Resale Price

$65,500

$62,000

8.0%

16.8%

6 Months

12 Months

1.3%

1.4%

% Price Difference No. of Months % Change/Month

A second method to support time adjustments is the paired sales method, where the sale prices between two highly similar comparable transactions are analyzed to quantify an adjustment. Two sets of paired sales have been analyzed as follows. Sale price per front foot is being used in this analysis, to reflect local buying practices and differences in frontage between the sales.

Paired Set

Address

Sale Date

Sale Price

111 Kvatum

May 1, 2010

$63,900 $1,100/fr.ft.

132 Kvatum

Nov 30, 2010

$69,900 $1,212/fr.ft.

144 North

Jan 15, 2011

$57,600 $1,046/fr.ft.

Mar 14, 2010

$65,000 $1,186/fr.ft.

1

2 138 North

% Price Difference Per Fr. Ft.

Number of Months

% Change Per Month

+ 10.2%

7

+ 1.5%

+ 13.4%

10

+ 1.3%

7.41

Lesson 7

Statistical information is also useful to provide market support for a time adjustment. However, to be most meaningful, the data upon which the statistics are based must be as similar as possible to what is being analyzed, in this case, vacant, single family residential lots in neighbourhoods comparable to that of the subject property. A total of 84 vacant residential lots sold within the year leading up to the effective date of sale. The following table summarizes the data found.

MONTH

NO. OF SALES/MONTH

AVG. SALE PRICE

Jan 2010

5

$50,000

Feb 2010

5

$64,100

Mar 2010

6

$54,100

Apr 2010

11

$59,400

May 2010

11

$59,600

Jun 2010

1

$55,000

Jul 2010

9

$56,800

Aug 2010

1

$54,000

Sep 2010

2

$57,500

Oct 2010

15

$70,700

Nov 2010

10

$66,400

Dec 2010

8

$71,800

NO. OF SALES/ 4 MONTHS

AVG. SALE PRICE/ 4 MONTHS

27

$56,900

22

$56,400

35

$66,600

These sales have been plotted in the graph below. Average Monthly Sale Price June 08 – May 09

The statistical data confirms an upward trend in the value of residential land in 2010. However, given that it is based on a variety of residential zonings, and properties with differing frontage, depth and other characteristics, it is not useful to support the amount of a time adjustment. The analysis of resales and paired sales provides a very narrow range for the monthly time adjustment, from +1.3% to +1.5% per month. A fair and reasonable estimate for a time adjustment based on this analysis is +1.4% per month.

7.42

The Cost Approach Part I – Site Valuation

With the exception of location for comparable 5, the three land sales are all similar to the subject property with respect to any characteristic that may impact market value. A five foot difference in lot depth is not significant to the market value of residential lots. It is necessary to consider location. Comparable sales 4 and 6 are located within the subject neighbourhood, and are subject to its influences and proximity to amenities as is the subject property. Comparable sale 5 is located in a newer development, located closer to the downtown area and major sources of employment. In order to determine whether an adjustment is required for Sale 5, a paired sales analysis was undertaken, comparing the time adjusted sale prices per front foot of lots in its neighbourhood, compared to that of the subject property. The sales paired were identical in utility, price per front foot inherently took frontage differences into account, and other than time, location was the only value-impacting difference between these paired sales.

Paired Set

Sale Price

Sale Price/ Front Foot

863 United

$69,900

$1,344

Dec 3, 2010

$1,344

43 Heinz (Subject Area)

$67,000

$1,168

Sep 5, 2010

$1,233

908 United

$64,000

$1,250

Oct 1, 2010

$1,267

57 Heinz (Subject Area)

$65,000

$1,182

Nov 2, 2010

$1,182

Sale Date

Time Adj. Price

% Difference

9.0%

7.2%

This analysis indicates that Comparable 5's neighbourhood has land values 7.2% to 9.0% greater than that of the subject neighbourhood. Considering this narrow range, an adjustment of 8% is used to adjust for the superior location of Sale 5.

Reconciliation and Estimate of Land Value Our three comparable sales indicated an adjusted value range of $1,183 to $1,271 per front foot. Comparables 1 and 3 are both located in within the subject neighbourhood, and indicate the subject's value at $1,232 and $1,183 per front foot, respectively. Although comparable 2 is in a neighbourhood with superior location, its adjusted sale price per front foot is supportive of the indication of value from the two subject neighbourhood sales. Giving most weight to Sales 1 and 3, the subject site is estimated to have a market value of $1,200 per front foot. This equates to a market value indication of: 55 front feet × $1,200 per front foot = $66,000.

Answers to Questions

1. The comparables in the land value section are numbered 4, 5 and 6 rather than 1, 2 and 3 to avoid confusion with the three improved comparable sales in the direct comparison approach. Since the direct comparison approach was presented first, the comparables used in that approach were numbered consecutively, beginning at number 1. It is much simpler, and clearer for the reader, to begin number the different comparables used in the site valuation consecutively, continuing from the last numbered comparable. It is much easier to refer to "comparable 1" and "comparable 4", rather than "improved sale comparable 1" and "land sale comparable 1". This becomes even more important to be able to convey the analysis clearly and simply when paired sales comparables are introduced, and for income properties, rental rate comparables, capitalization rate comparables, income approach comparables, etc. 2. The appraiser can prove from the market that there is a nil adjustment associated with variances in lot depth of +/- 5 feet by employing a paired sales analysis, comparing the sale price, or sale price per front metre, of sales with differing lot depths (assuming there are other value-impacting characteristics).

7.43

Lesson 7

3. There is a trend in the statistical analysis for time that the appraiser has not addressed.

MONTH

NO. OF SALES/MONTH

AVG. SALE PRICE

Jan 2010

5

$50,000

Feb 2010

5

$64,100

Mar 2010

6

$54,100

Apr 2010

11

$59,400

May 2010

11

$59,600

Jun 2010

1

$55,000

Jul 2010

9

$56,800

Aug 2010

1

$54,000

Sep 2010

2

$57,500

Oct 2010

15

$70,700

Nov 2010

10

$66,400

Dec 2010

8

$71,800

NO. OF SALES/ 4 MONTHS

AVG. SALE PRICE/ 4 MONTHS

27

56,900

22

35

$56,400

$66,600

Note that values remained approximately the same level from January to September, but then experienced a significant increase from October to December. This would have to be addressed by the appraiser if using sales that pre-dated October 2010, as the there appears to have been a leveling of the average sale price prior to that date. And then, there was a spike in both the number of sales and sale prices beginning in October. A quarterly analysis, rather than a 4-month grouping, appears to be more appropriate to this data. 4. Yes, the appraiser could have used data related to sales of land zoned to permit more intensive residential development than single family homes? While the use of such sales may not be appropriate a comparables given that they probably have a different highest and best use than the subject lot, they may be used in the absence of more directly comparable sales. If this is the case, less reliance should be placed on their indication of value for the subject, and this may be a reason to give minimal reliance on the results of the cost approach compared to value indications from other approaches to value. These sales could be used to establish trends and relationships in support of adjustments, again, acknowledging the weakness of their application. Sales of income residential sites, such as apartment building sites, would likely be least relevant to the valuation of the subject property as multi-family residential properties are purchased for their revenue generating potential, more than for the enjoyment of the amenities they offer as the family home.

Summary Lesson 7 has presented the first step in the cost approach to value – the estimate of vacant land value. The theory and various techniques of estimating land value are presented, with the most common approach the direct comparison approach as taught in Lessons 5 and 6. Land valuation approaches are examined through examples, a court case involving a dispute over land value, and the Frobisher Report that provides a practical example of the land valuation of the single-family residential property. Lesson 8 will continue with the cost approach, looking at methods to estimate the cost new of the building(s) and other site improvements on the land.

7.44

The Cost Approach Part I – Site Valuation

Review and Discussion Questions The following questions are for review and discussion purposes only. They are not to be submitted as part of the assignment for this lesson. Answers to these questions can be found on the Course Resources webpage. However, in order to develop your understanding, you are encouraged to attempt answering the questions before accessing the answers. You may also wish to discuss these questions with your fellow students on the course discussion forum through discussing these questions, you will better understand the course materials and be better prepared for the final examination. 1.

Discuss five significant elements of comparison in site valuation, pertaining to the subject site and the comparables. Provide an example of each and relate your answer to concepts from the course materials.

2.

Briefly discuss each of the four factors affecting the value of land. Use a specific example to show how the effects of each factor can change land value.

3.

Stratification is a tool used in land data analysis. How is the strata determined and what is the benefit of this method?

4.

Describe three methods used to value land with insufficient sales. For each method, state under what circumstances that method would or would not be appropriate to use.

5.

Betty Lee, an appraiser, has been asked to value a vacant parcel of land situated on lakefront. The parcel is to be used for a vacation house. There have not been any recent sales of lots of this kind, and so no comparable data is available. However, Betty, who is familiar with the market, has researched sales of lots improved with newer vacation homes, and has ascertained that several have sold between $240,000 and $270,000. Betty has also found out that a developer of lakefront houses in a nearby area can purchase a lot of approximately the same size for $100,000, build a house for $150,000 and make a $50,000 profit. (a)

What is the land-to-property-value ratio of the developed property in the nearby neighbourhood?

(b) What range of land values is indicted for the subject parcel, given the information on improved lots and the land-to-property-value ratio calculated in a)? 6.

A developer wants to subdivide a parcel of vacant land into 35 lots to be used for residential construction. The projected gross sale price of the developed lots is $30,000, for a total value of $1,050,000. The site development costs are as follows: Development costs Management and supervision Contractor's overhead and profit Sales expenses Taxes Entrepreneurial profit

$300,000 $15,000 $100,000 $35,000 $20,000 10% of all costs above

What is the indicated value of the land parcel if all the sales and development costs are incurred at one time?

7.45

Lesson 7

ASSIGNMENT 7 CHAPTER 16: Land and Site Valuation

Marks 1 mark per question. 1.

Which of the following land valuation techniques is NOT an income capitalization procedure? (1) (2) (3) (4)

2.

Which of the following statements is incorrect in relation to a vacant site's physical characteristics, such as site improvements and available utilities? (1) (2) (3) (4)

3.

They affect the timing of the development. They have no effect on its capabilities, development potential, or timing of development. They affect its land use capabilities and the timing of the development. They affect its development potential.

In establishing the value for a vacant site, several tasks must be performed in a certain order when looking for comparable sales. One must: (1) (2) (3) (4)

4.

Extraction Land residual Ground rent capitalization Discounted cash flow analysis

gather data on actual sales, identify only the similarities as they relate to the subject, identify their highest and best use, identify the units of comparison, adjust the sale prices to account for any differences, and then form a conclusion. gather data on actual sales, identify the similarities and differences, identify their highest and best use, identify the units of comparison, adjust the sale prices to account for any differences, and then form a conclusion. gather data on actual sales, identify the similarities and differences, identify the units of comparison, ignore any sales with old improvements that have little or no value, adjust the sale prices to account for any differences, and then form a conclusion. gather data on actual sales, identify the similarities and differences, identify their highest and best use, choose sales which have sold within the last 2 months, and then form a conclusion.

Which of the following statements is FALSE? (1) (2) (3) (4)

Market extraction is most applicable when the improvements are new, their value is known, and there is little or no depreciation evident from any causes. Subdivision development analysis is applicable only where it involves a single land use designation. The land residual method is most commonly used in highest and best use analysis to test alternate uses of the site as though vacant. The ground rent capitalization procedure uses a market-derived capitalization rate to convert rent into an indication of land value.

Assignment 7 continues on next page 7.46

The Cost Approach Part I – Site Valuation

5.

Allocation is based on the principle of balance and contribution. Both affirm that there is a relationship between land value and total property value. For example, if properties sell for an average of $240,000 and the land ratio is 64.6%, what is the typical land value in the neighbourhood? (1) (2) (3) (4)

6.

Site adjustments can be applied in one of three ways. Which of the following is an inappropriate basis for making site adjustments? (1) (2) (3) (4)

7.

(2) (3) (4)

This technique places a base value on the property that is directly related to the location; this is then adjusted up or down based on improvements. Allocation is a technique that allocates certain attributes of the property into certain monetary categories, giving rise to a value based on many separate characteristics. This valuation technique calculates the value of the future cash flows by discounting them to the present using the average rate of interest. In this technique, a ratio of land value to property value is extracted from comparable sales and applied to the sale price of the subject property to arrive at the land value.

Wendy owns a vacant site in south Garlin. The highest and best use of the property would be to develop it into a subdivision. There have been no sales of similar properties in this area in the recent past. Which of the following valuation techniques would she be best advised to use to value her property? (1) (2) (3) (4)

9.

Adding and subtracting dollar amounts. Adding and subtracting percentages. By using factors. Basing adjustments on the appraiser's expertise and general market knowledge.

Henry is appealing the assessment of his property, as he believes the land value is too high, and he has hired an appraiser to provide him with valuation advice. There are no recent sales of vacant parcels in his area, so the appraiser has used the allocation approach. Henry wants to better understand what it is that the appraiser is doing and how this approach works. Which of the following statements would best describe this valuation technique to Henry? (1)

8.

$111,310 $155,040 $64,600 $84,960

Extraction Direct comparison Direct capitalization Yield capitalization

Which of the following is NOT an encumbrance on real property rights on vacant land? (1) (2) (3) (4)

Easement Utilities Zoning designation Rights of way

Assignment 7 continues on next page 7.47

Lesson 7

10.

Tina is considering buying a five acre parcel of land that she believes can be subdivided into 1/2 acre lots. She estimates a value of $70,000 per lot, once serviced and subdivided. She estimates servicing costs to be $120,000, overhead to be 25% of direct costs, and a reasonable allowance for holding costs and profit is 30% of net income. Based on the cost of development method, what is the indicated value of this undeveloped land? (Ignore any issues with respect to timing of cash flows or discounting.) (1) (2) (3) (4)

11.

Which of the following statements is TRUE? (1) (2) (3) (4)

12.

$288,000 $300,000 $385,000 $550,000

Land should never be valued separately from the improved property. On-site improvements such as fences and paved parking areas are always included as part of the appraised market value of the land. Off-site improvements that make it suitable for its intended use or for new construction may be considered in appraising the market value of the site. Site improvements are considered in analyzing the highest and best use of the site.

Which of the following is the most appropriate approach to value land, given the following: A. B. C. D. (1) (2) (3) (4)

13.

Building value can be accurately estimated. There are no vacant land comparables in the subject area. Both building and land capitalization rates are available from the market. Net operating income from the property is known.

Direct comparison Ground rent capitalization Allocation method Land residual technique

Which of the following statements is TRUE? (1) (2) (3) (4)

Land is considered to have a prior claim to the income generated by a property over any return to the improvements. The land residual method is the most commonly used and preferred method of estimating land value when sales data are available. The ground rent paid for the right to use and occupy land corresponds to the lessee's (tenant's) interest in the land. The allocation method is the most commonly used and preferred method of estimating land value when sales data are available.

Assignment 7 continues on next page 7.48

The Cost Approach Part I – Site Valuation

14.

Fred Pharquar, appraiser, has the task of appraising a residential site close to the downtown core of Fernie. Fred has observed a pattern in the ratio of building size to land size in the downtown core. There have not been many recent sales. Which method would the most appropriate to use to establish an approximate land value? (1) (2) (3) (4)

15.

What are the three stages of land development? (1) (2) (3) (4)

16.

the direct comparison method. the allocation method. the land residual method. the extraction method.

Which of the following statements is TRUE concerning rules of thumb such as the "4-3-2-1 rule"? (1) (2) (3) (4)

18.

Purchase, financing, construction Permitting, construction, absorption Construction, marketing, competitive analysis Legal, functional, physical

Estimating land value by subtracting the depreciated cost of the building(s) from an improved sale is called: (1) (2) (3) (4)

17.

Allocation method Land residual approach Ground rent capitalization Direct comparison approach

Such rules of thumb are proven to be universally correct. Such rules of thumb should only be used if they have been supported by available market data in the subject circumstance. Such rules of thumb cannot be used in any appraisal report. Such rules of thumb provide definitive justification for the calculation of adjustments.

Which land valuation method is demonstrated by the following example? Alice Brooks, professional appraiser, based the value of the subject site on market information indicating that for properties comparable to the subject, the land value was 33% of the total property value. (1) (2) (3) (4)

Extraction Land residual Ground rent capitalization Allocation

Assignment 7 continues on next page 7.49

Lesson 7

19.

Frank Murphy completed an appraisal report on a vacant parcel of land, which had a highest and best use of retail development. Five comparables were analyzed, with one significantly larger than the subject and two were significantly smaller. These three comparables were adjusted for size. In analyzing the five comparables, sale price per square foot was chosen as the unit of comparison. Which of the following statements is TRUE? (1) (2) (3) (4)

20.

Improvements that make no contribution to property value typically constitute a _______________ equivalent to the cost of their demolition. (1) (2) (3) (4)

_ 20

There is nothing suspect in the approach taken by the appraiser. The appraiser cannot adjust for size, and then use price per square foot as the unit of comparison. The appraiser must reject the three sales that had a significant size difference. The report must clearly demonstrate that there is no double-adjusting for size.

residual income ground rent value increment value penalty

Total Marks

PLANNING AHEAD Note that Project 1 is due next week, on the same due date as Assignment 8. You should be well advanced into the work required for this project by now. Go to Project 2 and read what is required. You will have to find a residential property and appraise it. This will require significant advance research and you are advised to begin this as soon as possible.

End of Assignment 7 7.50