63rd Annual Appraisal Institute Fall Conference Tuesday, October 29, 2013 Fee (Not So) Simple

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1 63rd Annual Appraisal Institute Fall Conference Tuesday, October 29, 2013 Fee (Not So) Simple Premise: Objectives: California law specifies that the basis for the assessment of taxable real property must be the fee simple value. 1) To introduce appraisers to a major concept that underlies the assessment process, enabling them to expand their practice to include property tax appeals; 2) to review fee simple valuation techniques for practicing tax appraisers; 3) to provide a session that will be particularly appealing to appraisers from the assessors offices; 4) To investigate the methodologies being used in ad valorem valuation to estimate fee simple value; 5) To provide clarity regarding the appropriateness of the methodologies Moderator: Wayne F. Prescott, MAI, CCIM Member, Assessment Appeals Board I, Santa Clara County The Schmidt Prescott Group, Inc North First Street, Suite 390 San Jose, California wprescott@valuationconsultant.net Panelist: Charles Moll, Partner Charter Member, National Association of Property Tax Attorneys Winston & Strawn LLP 101 California Street San Francisco California cmoll@winston.com Stan Tish, MAI Chair, Assessment Appeals Board I, Santa Clara County Berliner, Kidder & Tish 2867 Kearney Avenue Santa Clara, California stish@berlinerkiddertish.com David Yeung, Principal Property Appraiser Property & Special Taxes Department California State Board of Equalization P.O. Box , MIC 61 Sacramento, California david.yeung@boe.ca.gov

2 The Nature of Fee Simple Estate Questions in this section address our understanding of the concept of fee simple estate Moderator Fee Simple Interest (or estate): Absolute ownership unencumbered by any other interest or estate, subject only to the limitations imposed by governmental powers of taxation, eminent domain, police power, and escheat. Source: Dictionary of Real Estate Appraisal, 5 th Edition (2010) Appraisal Institute Q1: What is your understanding of the term fee simple? Q2: Did the State Board of Equalization have any other definition in mind when they decided that real property would be assessed at fee simple value, regardless of the presence of a leased fee estate, economic obsolescence, vacancy, or any other factor affecting the price people would pay to obtain the real property? Q3: Do we agree that today we are speaking about Fee Simple in the context of CA property tax assessment? Q4: What is your understanding of the term leased fee interest? A freehold (ownership interest) where the possessory interest has been granted to another party by creation of a contractual landlord tenant relationship (i.e. a lease). Moderator: Can we agree that the fundamental difference between FS and LF is that the FS value reflects value at market rent, regardless of whether or not there is a lease in place; and the LF interest reflects the effect of lease terms on the selling price? Applying the Concept of Fee Simple in Assessed Valuation Matters Q5: Is the FMV of the fee simple interest in a property the same without regard to whether the property is leased at market, below market, or above market, i.e., should an appraiser disregard the leases in place, or lack of leases, to estimate fee simple value? Q6: You have 3 adjacent properties that are physically identical and each occupied as follows: Vacant at Purchase Occupied at Stabilized Occupancy at Purchase Leased to 50% Occupancy at Purchase

3 Q7: Does the FMV of the fee simple interest in a property remain the same whether the property is vacant, occupied at stabilized occupancy, or occupied at a level below stabilized occupancy? (See handout) FU: Should the fee simple value be the same or different? Q8: Should the FMV of the fee simple interest vary with the purchaser, i.e., is it different for an owner user than for an investor? Q9: Is the fee simple value of a property leased at market rent the same as an owner occupied property, where the owner is effectively leasing to himself at market rent? Q10: Should the technique to determine the FMV differ depending upon whether the property is owned by an investor or owner occupant? Q11: Is an owner occupied building typically occupied or vacant at the time of purchase? Q12: Is it appropriate to adjust the FMV of the fee simple interest in the investor purchased property for lease up costs? FU: Should the owner user purchaser be entitled to the application of the same process to determine assessed value, if he buys a vacant building? FU: Should the assessed value of vacant props purchased by owner users be adjusted for the cost to achieve stabilized occupancy? Methodologies Used to Estimate the Fair Market Value of the Fee Simple Estate Q13: What are the methodologies for the valuation of the fee simple interest at stabilized occupancy and market rent? Q14: If not at stabilized occupancy, is it the appropriate methodology to estimate fee simple interest by making adjustments for the costs to achieve stabilized occupancy, e.g., leasing commissions, revenue loss during lease up, refurbishing costs, etc.? Q15: What are the appropriate methodologies for estimating the FMV of the fee simple interest when the property is not at stabilized occupancy, or when one must reflect external obsolescence? FU: Should you disregard occupancy and absorption to reflect fee simple estate? Q16: What property interests typically exchange in the market? Do those exchanges provide evidence of what the cap rate should be for the fee simple interest?

4 Q17: What is the relationship of the overall rate to market rent? Q18: What adjustments are appropriate to leased fee sales to obtain an indication of the value of the fee simple, and/or extract an overall rate of capitalization? (see hand out) Q19: How do you derive a fee simple cap rate when you have only cap rate data derived from leased property sales? Recent Opinions of the State Board of Equalization Regarding Assessed Values After making adjustments to sale prices of comparable properties so that the adjusted sale price reflects a value as if rented at market rent, to ensure that the appraisal is of the unencumbered fee simple interest (that a full bundle of rights are being captured), the appraiser must take into consideration the actual economic conditions of the subject property to derive an estimate of what one would pay for the full bundle of rights. Q20: Does or does not the fee simple estate by definition account for the full bundle of rights? Q21: Does the fee simple estate account for actual economic conditions? Q22: Does market rent account for actual market conditions? Q23: Do the concepts of, and definitions of, Market Rent and Fair Market Value presume the consideration of all locational, physical, and economic conditions of the property? Or, should market rent be measured or estimated, and then economic conditions applied to adjust market rent? Adjustments for economic characteristics should not be confused with differences in property rights conveyed (e.g. rents that are not at current market) or market conditions. Q24: Should adjustments to comps be made for economic characteristics and/or market conditions to estimate market rent for the subject property?

5 Assessor s Handbook 502 explains the effect of non stabilized occupancy as follows: Occupancy level has a significant effect on market value. All else being equal, a property at stabilized occupancy is more valuable than a property at a lower level of occupancy. Consider two otherwise identical properties. One is at stabilized occupancy of 90% (i.e. the normal vacancy), the other at a non stabilized occupancy of 40%. Most buyers would pay more for the property at higher, stabilized occupancy level. The property with the lower occupancy level would sell for less because of the additional costs most prudent buyers would anticipate as necessary to bring it to stabilized occupancy. If the property is at a non stabilized occupancy level, the market value estimate should reflect this condition. Q25: Does this model fit the premise of a fee simple estate or a lease fee estate? Q26: Are most buyers buying a fee simple estate or a leased fee estate? Q27: When appraising the fee simple estate for assessment, does it matter whether or not the buyer is buying a leased fee, or a fee simple, estate? Q28: If a property is at a non stabilized occupancy level (for example, a vacant building being purchased by an owner user) how should the market value estimate reflect this condition? Q29: If the seller occupied the balance (50%) of the 40% occupied building prior to sale, and the buyer was intending to occupy that same vacant space, what affect would or should that have on the assessed value? The BOE says The market value of the property for property tax purposes must reflect an adjustment for the occupancy level of the property on the valuation date. Q30: Does an adjustment for lease up comport with the definition of fee simple estate? Q31: Should the owner of a property with high vacancy and/or below market rents pay lower taxes than owners of nearly identical properties that are fully occupied, considering the Equalization provisions of the property tax code? Final Question: Have we reached a consensus about how the definition of fee simple estate should be applied to properties operating at less than stabilized occupancy in appraisal practice for ad valorem taxation?

6 Questions for Attendee s Consideration (Session may not address these) Q: Is Market Rent independent of the rights conveyed? Q: Do owner occupied and leased properties compete in the market place, or is there a distinct market for each? Q: Can a property have more than one fee simple value, depending upon the degree to which it is occupied, rented, or leased? Q: Two properties are the same, side by side, last sold on the same date: One is occupied and rented at market rent and the other had been vacant upon purchase but became occupied by the purchaser on the date of value. Are the assessed/fee simple values the same? Q: If an owner occupied property was vacant when the owner purchased it (it would have to be), would and should that reduce his assessed/fee simple value by an amount called lease up costs? Q: When a rented property is subject to a long term, below market lease on the date of value, does that affect your conclusion about its fee simple value? Q: Does the assessor have a duty to equalize the tax roll? Does Equalize mean assessing the same value for equivalent real property?