William Henry Perspectives What Is Real Estate Worth?
How Do You Know What The Real Estate Is Really Worth?
By William Henry PhD
Design and Construction Due Diligence Can Provide a More Accurate Answer. MAI Appraisals Mostly Take the Past and Project It Forward.
Practice and logic over the years has established that market value is a product of both demand and availability or scarcity of a good. Without going into a treatise concerning valuations, as an architect I sometimes have become very frustrated about the practice of appraising. This stems from my belief that appraisers may not take into account intrinsic, latent, and opportunity based value in the real estate that they are valuating.
Industry standards dictate that MAI appraisals take into account comparable recent sales, replacement costs, and for commercial real estate, something called an “income approach”. As an architect you may think that I would put more stock in the replacement cost method. After all, doesn’t that conger the notion of “sticks and bricks”? Probably due to my business training and background I tend to look harder at the latter, “the income approach”. The income approach takes into account a future stream of net operating income (NOI) and then “capitalizes it” using something termed a “cap rate”. Paradoxically the lower the cap rate the higher the valuation. A high cap rate might be twelve, a low one today might be a five.
The reason that I would do this is that most “comps” are not comparable in terms of long term value and latent value. These may only be captured at some future date. In short, hidden opportunity based value may exist in the holdings that may provide some unique safe harbor and/or resale value that most “comparable properties” may not share.
Likewise, I don’t really care so much about replacement costs. It may have cost a fortune to produce but if the “dog just doesn’t like the dog food”, what real value does the product have? Unlike many of my fellow architects, I am not a great fan of Taj Mahal building. When I hear that the money was over-spent for a design, ”for design sake”, I don’t react well. What these two methods both share, namely comparable sales and replacement costs, is that they fundamentally are focused on the past. In short they take the past and project it forward.
Successful Real Estate Investors That I Have Known Conduct In-Depth Research and Due Diligence
Successful speculators often have a second sense about properties that possess latent value. Several of my clients seem to have a “nose” for this type of hidden value and they are always in the hunt for them. I would love to mention them by name but can’t break that confidence. However, you may think that they possess some rare talent and/or were better trained than the average investor. Perhaps they made their money the old fashioned way, “they inherited it”! They augment the real estate brokers representations with in-depth research and due diligence to mine latent and hidden value.
Great Investors Don’t Overpay!
What I have gleaned from my most successful clients is the following- in addition to doing a great amount of research and due diligence prior to entering into a contract; they are never embarrassed to offer a ridiculously low price for real estate that they know could be worth exponentially more. I will quote one of my most shrewd clients when tendering such a below market offer. After I will state that, “it will only result in a backup contract”, he will retort that “yes, but it will be a really good back up contract”.
The aspect that separates them from the reactionary herd—is that they become aware of every aspect of the product’s advantages and disadvantages with respect to the competition prior to acquisition- not afterwards. So am I saying that you can’t rely on the brokerage community for accurate information? No, I am not saying that. What I am saying is that since brokers are obliged to disclose latent defects if they know about them, some less scrupulous ones want to remain blissfully ignorant of them so they don’t have to disclose them.
Experienced and Business Savvy Architects Can Be Useful in Providing Due Diligence and Assessing Lasting Value
Here is where experienced and business oriented architects can be useful. We don’t look backwards as much as we look forward! As one politician who lacked if famously demurred, “maybe it’s the ‘vision thing’.” Here is a short check list of issues to discover the deficiencies and/or the latent value:
1) The underlying plan use vs. the apparent current zoning–you may discover that while the property is only zoned for single family residential development the underlying land use that the government planners have agreed to conform the zoning in the future to, provides for a much denser development entitlement. Therefore there could be a huge upside in a future, more intense redevelopment of the property. This is what I mean by “latent value”.
2) Design aspects may be so uniquely applied that they are hard or impossible to reproduce AND may determine lasting value. In short the building design may have an intangible quality difficult to quantify that users respond to and then demand. These tend to grow over time giving rise to the term ‘lasting value’.
3) The surrounding properties are characterized by the same aspects as above and purchasing the lowest priced property in a higher priced neighborhood could yield great returns.
4) Lastly what may appear to be incurable construction defects to unsophisticated investors may actually be easily addressed by determining the root of the actual defects and then properly addressing them by utilizing up-to-date, cost effective technologies.
What do all these strategies share?—DETERMINE WHAT THE REAL ESTATE REALLY IS – THEN LOOK FORWARDS NOT BACKWARDS.
Reliable Group, LLC Architects AA# 0003523 is a well-known architectural and construction management firm based in Tampa, Florida. RGA is headed by Dr. William Henry, both an architect and certified expert witness who issues opinions and testimony concerning design and construction related matters. Having designed over 250 landmark buildings in the state of Florida, he has represented and testified for both plaintiffs and defendants in cases involving code violations such as associated with design and construction defects as well as American Disabilities Act – ‘ADA’ violations. William Henry, PhD (Bill) may be reached at (813) 226.2220 or bhenry@rga-design.com.
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