Chapter: Which approach to value would be most appropriate when appraising a church? (EN)

Chapter: Which Approach to Value Would Be Most Appropriate When Appraising a Church? (EN)

Understanding Church Property Appraisal

Appraising church property presents unique challenges compared to standard real estate valuation. This stems from the specific use, infrequent market transactions, and often, the emotional or historical significance attached to the property. Choosing the most appropriate valuation approach requires a nuanced understanding of real estate appraisal principles and the specific characteristics of church properties.

The Three Standard Appraisal Approaches

Real estate appraisal generally employs three main approaches to determine value:

1. Sales Comparison Approach (Market Approach): This approach estimates value by comparing the subject property to similar properties that have recently sold. This is based on the principle of substitution: a buyer will pay no more for a property than they would pay for an equally desirable substitute.

2. Cost Approach: This approach estimates value by determining the current cost to reproduce or replace the subject property, less accrued depreciation. It relies on the principle of contribution, which states that the value of any component of property is what it contributes to the overall value.

3. Income Capitalization Approach: This approach estimates value based on the expected income stream the property can generate. It’s grounded in the principle of anticipation, which assumes that value is created by the expectation of future benefits.

Applicability to Church Properties

Each approach has limitations and strengths when applied to church properties.

1. Sales Comparison Approach

• Theoretical Basis: The Sales Comparison Approach directly applies the principle of substitution. Its accuracy depends on the availability of comparable sales.
• Challenges with Churches: Finding truly comparable sales of church properties is often difficult. Churches have unique architectural designs, specialized interior layouts (e.g., sanctuary, classrooms, fellowship halls), and location-specific factors (e.g., proximity to a congregation, zoning regulations). Sales data are also limited due to the relatively infrequent transactions of church properties.
• Data Required: Requires detailed information on comparable sales:
  • Sale Price (SP): The price at which the comparable property sold.
  • Date of Sale (DoS): The date the transaction closed.
  • Location (L): The geographical location of the comparable property.
  • Building Size (BS): The gross building area of the comparable in square feet or meters.
  • Land Size (LS): The area of the land associated with the building.
  • Condition (C): The physical condition of the comparable property.
  • Use (U): The present use of the comparable property and any changes in use.
• Adjustments: Once comparable sales are identified, adjustments are made to account for differences between the subject property and the comparables. These adjustments can be quantitative (dollar amount or percentage) or qualitative (rating the comparable as superior, inferior, or equal).

• Formula:

  Adjusted Sale Price (ASP) = SP ± Adjustment Factors
  * Practical Application and Experiment:
  * Data Collection: Collect data on recent sales of properties potentially comparable to the subject church within a reasonable radius.
  * Qualitative Analysis: Evaluate each potential comparable based on key factors (size, age, condition, location, features).
  * Quantitative Analysis: Where data permits, perform regression analysis. Use sale price as the dependent variable and building size, land size, and condition ratings as independent variables. This can give a statistical basis for adjustments.

2. Cost Approach

• Theoretical Basis: The Cost Approach relies on the principle of substitution and the concept of depreciation. A buyer would theoretically pay no more for an existing property than the cost to build a new one of equivalent utility, less any accrued depreciation.
• Steps Involved:
  1. Estimate the Land Value: Determine the market value of the land as if vacant and available for its highest and best use. This usually involves the Sales Comparison Approach applied to land sales.
  2. Estimate the Reproduction or Replacement Cost: Determine the current cost to reproduce the property exactly (reproduction cost) or to replace it with a similar property that provides the same utility (replacement cost). Replacement cost is generally preferred, as it avoids replicating obsolete or inefficient features.
  3. Estimate Accrued Depreciation: Calculate the total depreciation, which includes physical deterioration, functional obsolescence, and external obsolescence.
  4. Calculate Value: Value = Land Value + (Reproduction/Replacement Cost – Accrued Depreciation)
• Accrued Depreciation:
  • Physical Deterioration: Loss in value due to wear and tear, deferred maintenance, and the aging of physical components.
  • Functional Obsolescence: Loss in value due to deficiencies in the property’s design, layout, or utility. This can include features that are outdated or no longer desirable (e.g., inefficient heating/cooling systems, inadequate parking).
  • External Obsolescence: Loss in value due to factors outside the property itself, such as changes in zoning, neighborhood decline, or environmental contamination.
• Formulas:
  • Depreciation Rate (DR) = Depreciation Amount / Replacement Cost
  • Value (V) = Land Value (LV) + (Replacement Cost (RC) - Depreciation Amount (DA))
• Challenges with Churches:
  • High Construction Costs: Churches often have unique architectural features and specialized construction, leading to high reproduction or replacement costs.
  • Depreciation: Accurately estimating depreciation, especially functional and external obsolescence, can be subjective and challenging.
  • Functional Obsolescence: Many churches have older designs and layouts that may not be suitable for modern needs, leading to significant functional obsolescence.
• Practical Application and Experiment:
  • Cost Estimation: Obtain detailed cost estimates from qualified contractors for reproducing or replacing the church building.
  • Depreciation Analysis: Conduct a thorough physical inspection to assess physical deterioration. Consult with building experts to evaluate functional obsolescence (e.g., energy efficiency audits). Research neighborhood trends and zoning regulations to identify external obsolescence factors.
  • Sensitivity Analysis: Vary the depreciation rates and replacement cost estimates to assess the impact on the final value estimate.

3. Income Capitalization Approach

• Theoretical Basis: This approach estimates value based on the present worth of future income streams. It relies on the principle of anticipation.
• Formulas:
  • Net Operating Income (NOI) = Gross Potential Income (GPI) - Vacancy & Collection Losses (V&C) - Operating Expenses (OE)
  • Capitalization Rate (CR) = NOI / Property Value
  • Property Value (V) = NOI / CR
• Application to Churches:
  • Limited Income Generation: Churches typically generate income primarily through donations and fundraising activities, which are not consistent or easily predictable. Rental income from ancillary spaces (e.g., classrooms, halls) may be generated, but it often represents a small portion of the total operating budget.
  • Non-Profit Status: Churches are generally non-profit organizations, and their financial operations are not driven by profit maximization. This makes it difficult to apply traditional income capitalization methods.
• Modified Income Capitalization Approach (If Applicable):
  • If a church generates significant and stable rental income from ancillary spaces, a modified income capitalization approach may be considered.
  • This involves projecting future rental income, deducting operating expenses, and applying a capitalization rate derived from comparable rental properties.
• Challenges with Churches:
  • Predictability of Donations: Donations are the main source of funds, but they are extremely difficult to forecast due to varied congregations.
  • Volunteer Labor: A large portion of church labor may be unremunerated.
  • Tax Exemptions: Tax exemptions need to be correctly accounted for.
• Practical Application and Experiment:
  • Rental Income Analysis (If Applicable): Collect data on rental rates, occupancy rates, and operating expenses for comparable rental properties in the area.
  • Capitalization Rate Derivation: Derive a capitalization rate from comparable rental properties using the formula: CR = NOI / Sale Price.
  • Sensitivity Analysis: Vary the projected rental income and capitalization rate to assess the impact on the final value estimate.
  • Comparative Analysis: Compare the value estimate derived from the modified income capitalization approach with value estimates derived from the Sales Comparison and Cost Approaches.

Which Approach Is Most Appropriate?

In most cases, the Cost Approach is often the most reliable method for appraising church properties. This is because:

• Churches are typically special-purpose properties with limited comparable sales.
• The Cost Approach can provide a reasonable estimate of value based on the cost to replace the building, less depreciation.
• The Sales Comparison Approach may be used to value the land, and can be used to find similar value from comparable sales of building, however, this is often difficult due to specialized uses.

The Sales Comparison Approach is valuable if sufficient comparable sales of church properties or similar special-purpose properties exist in the market area. However, due to the unique nature of church properties, this is often not the case.

The Income Capitalization Approach is generally the least reliable method for appraising church properties due to the limited income generation and the non-profit status of most churches. It should only be considered if the church generates significant and stable rental income from ancillary spaces.

Hybrid Approach

A hybrid approach is often the most effective strategy. This involves:

1. Using the Sales Comparison Approach to value the land.
2. Using the Cost Approach to value the building (replacement cost less depreciation).
3. Reconciling the values derived from the different approaches to arrive at a final value estimate.

Important Considerations

• Highest and Best Use: Determine the highest and best use of the property, considering its physical characteristics, zoning regulations, and market demand. This may not always be its current use as a church.
• Zoning Regulations: Investigate zoning regulations to determine any restrictions on the property’s use or development potential.
• Historical Significance: Consider any historical or architectural significance of the property, which may affect its value.
• Environmental Issues: Assess any potential environmental issues, such as soil contamination or asbestos, which could impact the property’s value.
• Qualified Appraiser: Engage a qualified appraiser with experience in appraising church properties or other special-purpose properties.

Conclusion

Appraising church property requires a careful and thorough analysis of the property’s unique characteristics and the relevant market conditions. While the Cost Approach is often the most reliable method, a hybrid approach that incorporates elements of the Sales Comparison Approach and, where applicable, a modified Income Capitalization Approach, can provide the most accurate and defensible value estimate. The choice of approach ultimately depends on the availability of data and the specific circumstances of the property.