Legal and Non-Realty Considerations in Sales Comparison

Chapter: Legal and Non-Realty Considerations in Sales Comparison

This chapter explores the critical legal and non-realty considerations that appraisers must address when employing the sales comparison approach to land and building valuation. Ignoring these factors can lead to inaccurate value conclusions.

1. Legal Considerations in Sales Comparison

1.1 Impact of Zoning and Land Use Regulations

Zoning regulations and land use restrictions significantly influence property value. These regulations control the type, density, and intensity of permissible uses on a given site.

1.1.1 Highest and Best Use Analysis

The concept of Highest and Best Use (HBU) is paramount. HBU is defined as the reasonably probable and legal use of vacant land or an improved property that is physically possible, appropriately supported, financially feasible, and that results in the highest value.

• Legal Permissibility: Zoning regulations dictate the legal permissibility of potential uses.
• Impact on Sales Comparison: If comparable sales have different HBUs due to varying zoning, adjustments are necessary.

1.1.2 Floor Area Ratio (FAR)

FAR is a critical zoning parameter that limits the building area relative to the site area. It is calculated as:

FAR = Total Building Area / Site Area

• Example: A 10,000 sq ft site with an FAR of 1.0 can support a 10,000 sq ft building. An FAR of 0.5 would allow a 5,000 sq ft building.
• Impact on Value: Higher FAR generally equates to greater development potential and higher land value.

1.1.3 Zoning Differences and Adjustments

Differences in zoning regulations can necessitate adjustments to comparable sales.

• Quantitative Adjustments: If sufficient market data exists, quantitative adjustments can be derived. For example, paired sales analysis comparing sites with different FARs.
• Qualitative Adjustments: In cases where quantitative data is lacking, qualitative analysis❓ is used.
  • Example: As shown in Table 21.5 provided in the pdf, the difference in FARs between sales properties influences the price per square foot of potential building area.

1.2 Environmental Regulations

Environmental regulations can significantly affect property value. These regulations address issues such as:

• Contamination: Soil and groundwater contamination remediation costs.
• Wetlands: Restrictions on development in wetland areas.
• Endangered Species: Limitations imposed to protect endangered species habitats.

1.2.1 Environmental Due Diligence

Due diligence is essential to identify potential environmental liabilities.

• Phase I Environmental Site Assessment (ESA): A preliminary assessment to identify potential environmental concerns.
• Phase II ESA: Involves soil and groundwater sampling to confirm the presence or absence of contamination.

1.2.2 Impact on Value and Adjustments

Environmental issues can negatively impact property value. Adjustments should reflect the costs associated with remediation or limitations on use.

• Example: If a comparable sale has known contamination issues, a downward adjustment is made to reflect the cost of remediation.

1.3 Water Rights

In regions where water is scarce, water rights can significantly impact property value.

1.3.1 Types of Water Rights

• Riparian Rights: Rights associated with land bordering a river or stream.
• Appropriative Rights: Rights to divert water for beneficial use.

1.3.2 Impact on Value and Adjustments

Properties with secure water rights are generally more valuable.

• Example: If a comparable sale has superior water rights, an upward adjustment is made.

1.4 Access and Easements

Access and easements affect property value.

1.4.1 Types of Easements

• Access Easements: Granting the right to cross another person’s property.
• Utility Easements: Allowing utility companies to install and maintain infrastructure.
• Conservation Easements: Restricting development to preserve open space or natural resources.

1.4.2 Impact on Value and Adjustments

Properties with limited access or burdened by easements may be less valuable.

• Example: If a comparable sale has restricted access, a downward adjustment is made.

1.5 Restrictive Covenants

Restrictive covenants are private agreements that limit the use of property.

• Examples: Restrictions on building height, architectural styles, or types of businesses permitted.

1.5.1 Impact on Value and Adjustments

Restrictive covenants can either enhance or diminish property value.

• Example: If a comparable sale is subject to restrictive covenants that limit its development potential, a downward adjustment is made.

1.6 Flood Zones

Properties located in flood zones are subject to increased risk and insurance costs, affecting property value.

• Flood Insurance Rate Maps (FIRMs): Maps that delineate flood zones.

1.6.1 Impact on Value and Adjustments

Properties in high-risk flood zones are generally less valuable.

• Example: If a comparable sale is located in a high-risk flood zone, a downward adjustment is made to reflect the increased risk and insurance costs.

2. Non-Realty Considerations in Sales Comparison

Non-realty items, also referred to as personal property or intangible assets, can significantly influence the overall value of a property, particularly in certain types of real estate transactions. It’s crucial to identify and account for these items during the sales comparison analysis to ensure accurate valuations.

2.1 Identifying Non-Realty Items

Non-realty items are assets that are not permanently affixed to the real property and are typically movable.

• Examples:
  • Furniture, fixtures, and equipment (FF&E) in hotels and restaurants.
  • Inventory in retail stores.
  • Business licenses and goodwill.
  • Trade fixtures in commercial properties.

2.2 Impact of Non-Realty Items on Value

Non-realty items can contribute significantly to the overall value of a property, especially when the business operation is integral to the real estate.

• Contributing Value: The value of non-realty items is typically determined by their “contributing value,” which is the incremental value they add to the real property as a whole.
• Separate Valuation: In some cases, a separate valuation of non-realty items is necessary, especially when their economic lives, investment risks, or rates of return differ significantly from those of the real property.

2.3 Adjustments for Non-Realty Items in Sales Comparison

When analyzing comparable sales, it’s crucial to determine whether non-realty items were included in the sale price.

2.3.1 Separating Non-Realty Value

• If non-realty items are included in the sale price, the appraiser must estimate their value and subtract it from the overall sale price to arrive at the real estate value.
• Methods for estimating non-realty value:
  • Cost approach (depreciated replacement cost).
  • Market extraction (analyzing sales of similar items).
  • Income capitalization (estimating the income attributable to the non-realty items).

2.3.2 Disclosure and Transparency

• If the contributing value of non-realty items cannot be reliably separated from the real estate value, the appraiser should clearly disclose this limitation in the appraisal report.
• The report should explicitly state that the value indication reflects both the real estate and the business operation.

2.4 Examples of Non-Realty Adjustments

2.4.1 Hotels

Hotels often include significant non-realty components (FF&E, operating supplies, brand affiliation, etc.).

• Comparable Sale Adjustment: If a comparable hotel sale included FF&E valued at $500,000, this amount should be deducted from the sale price before comparing it to the subject property.

2.4.2 Restaurants

Restaurants also have substantial non-realty value associated with FF&E, inventory, and goodwill.

• Comparable Sale Adjustment: If a comparable restaurant sale included FF&E and inventory valued at $100,000, this amount should be subtracted from the sale price.

2.5 Properties with Significant Business Value

Properties where the business operation is essential to the real estate’s use may have a significant business value component.

• Examples:
  • Hotels
  • Restaurants
  • Timeshare condominium units
  • Gas stations
  • Car washes

2.5.1 Impact of Business Value on Expense Ratios

These properties typically have higher expense ratios attributable to the business operation, which must be considered in the valuation process.

2.6 Formulas and Equations

While direct mathematical formulas for adjusting for non-realty items are rare, the underlying principle involves extracting the value of the non-realty components from the overall sale price.

Adjusted Sale Price (Real Estate Only) = Sale Price (Including Non-Realty) - Value of Non-Realty Items

Example:

Sale Price (Including FF&E): $1,000,000

Value of FF&E (estimated): $200,000

Adjusted Sale Price (Real Estate Only): $1,000,000 - $200,000 = $800,000

Conclusion

Understanding and addressing legal and non-realty considerations is crucial for accurate and reliable appraisals using the sales comparison approach. Ignoring these factors can lead to skewed valuations and flawed decision-making. Thorough due diligence, careful analysis, and clear disclosure are essential components of a sound appraisal process.