Insights and Updates from a Commercial Appraiser Real Property Broker Expert

TASA ID: 1417

Will Building Energy Disclosure Laws Affect Real Property Value?

Of course the answer to the question "will building energy disclosure laws affect real property value" is yes.  There is no doubt in my mind that inefficient buildings,  like gas guzzling cars, will be shunned by real property buyers and building tenants when they have the opportunity to see the results on energy disclosure reports.  In the recent past, few buyers have paid a great deal of attention to annual energy costs since energy costs have been relatively low.  

Times are, however, changing, and as oil and other energy costs continue to move up, and as disclosure laws start to affect us all, it is likely that building owners, potential buyers and tenants will focus on just how expensive energy is.  As a proof of this conclusion I would ask, did anyone pay attention to gas mileage ratings when the price of gas was under a dollar a gallon?  Not really, but now that it has reached and exceeded $ 4.00 per gallon, gas mileage ratings are one of the first things that buyers ask about.   If owners don't focus on the increasing cost of building operation on their own over the next few years, then soon-to-be required energy disclosure law or laws will be put it "in their face."

Disclosure laws are not going to be something that a building owner can ignore since energy consumption dips into the pocket of each and every tenant and thus even into the owner's bottom line.  If the market rental rate for a commercial building is $ 1.00 per square foot per month, and you pass the energy cost along to tenants, do you think tenants might be interested in building energy costs and their disclosure?

How much of a difference can energy savings make?  Today energy costs are about 19% of total annual building operating costs.  Government studies indicate that a savings of 35% to 50% of energy costs can be saved with attention being paid to energy efficiency.  So if you can save about half of the 19% bill, that's a 10% savings in operating cost.  It's a great deal on an annual basis but it's a very big number over the life of a building. 

If market participants pay attention to energy disclosures and react to them as anticipated, appraisers will have to consider the adjustment of property sales to reflect market preferences. Appraisers may also pay more attention to expense analyses in the income approach, since the net operating income of energy saving buildings will be higher, and thus, capitalization will provide a higher value indication for those buildings.

Asking Price versus Sales Price

From an appraiser's perspective, the asking price of a comparable or competitive property may provide some indication of market value. but it is not evidence that anyone was willing to actually purchase the property at that price.  Real estate agents constantly point to asking prices as if they were market evidence, and yes, at times it is, but agents often tell their clients when they list a property to push the last, highest pending sale.  Owners want the most that they can get.  It's common sense that the next seller up will push the value achieved from the last sale and pending deal.  Thus there is a de-facto, built-in, upward asking price bias in most real estate markets. 

One of the real estate agent versus real estate appraiser conflicts that is most often talked about has to do with that built-in market asking price bias.  Agents ask appraisers, "Why can't you see that the direction of the market is up?"  I have even had that question asked when prices were falling by 20% per year for 3 years consecutive years.  For the appraiser, there are times when you have to shake your head and ask, "What are they talking about? Are they living in another world?" 

Part of the reason that broker price opinions (BPOs) are so popular, and so dangerous, is that agents / brokers doing them use asking prices and not sales as the basis for their opinions.  If you consider an absurd market, like the market for Trump Tower condominiums, you would find that the average sales price may be $350 per square foot while the average asking price is $550 per square foot.  If that example doesn't make my point about asking prices, I don't think anything I say will convince you that asking price does not equal sales price.  That is why appraisers conclude "market value" while agents completing broker price opinions (BPO's) conclude "market price." 

It is in fact difficult for an appraiser to conclude a market value opinion that is not substantiated by closed sales.  Yes, appraisers "review and consider" asking prices. In fact many appraisers are taught to consider current listings and pending sales.  Appraisers consider the fact that "sales" by their very nature are "historical," that the market may, or may not have already moved in one direction or another.  Let's be clear. There are static markets that are not changing, and there are markets where prices are increasing or falling.  If it is your opinion as an appraiser that the market is moving up, and you want to include an adjustment to sales for that movement, then it shouldn't be that hard to prove it with multiple examples of funded pending sales, or by providing market supply and demand information that supports your opinion.  Remember the question, "Is the adjustment supportable?" You can rest assured that if as an appraiser, you begin using listings and pending sales as a basis for an upward adjustment, someone is going to want to see your support for that adjustment.

When appraisers use market condition (time) adjustments, those adjustments are supposed to be based on actual data.  That means they are supposed to have looked at the market data and considered paired sales, grouped sales or statistics that isolate time.  A great example of that type of consideration is the comparison of properties that sell and then are resold. Often everything except time has remained the same, and the difference can be attributed to the change in time.

The change in asking prices over time has to do with human nature. Even when everyone in a tract home development is asking $200,000 for the same model, no one may have ever sold one of those properties for that price.  If someone does sell one for $200,000, all of the listings will go to $205,000 or more, and it becomes a baseline.

Why Having More Divided Parcels Does Not Always Mean More Money

Clients ask me whether a parcel of vacant land that they own should be divided, without incurring the substantial cost of a full blown subdivision, into a few or several smaller parcels as may be allowed by the City or County government.  They point to valid comparable sales and say, "Why not sell multiple parcels at the higher price per acre?"

It's a good question since there appears to be a common sense answer: "Why sell say 10 acres at a lower price per acre when you can sell four 2.5 acre parcels at a higher price per acre? Common sense would tell you to always divide the property.

Anyone who has lived through a downward market swing (that should include most of us by now) knows that selling any vacant property, no matter how small the parcels may be, when the market stalls is unlikely.  What appraisers consider in an analysis of the property value, besides the comparable sales prices, is marketing and exposure time.  If it is taking a year to sell a typical parcel of land in the market, because so little demand exists or the supply so far exceeds demand, how long will it take to sell four parcels?  Often the answer is "much longer."  So why do you want to have to make four sales when getting one would be difficult?

The fact of the matter is, as home builders will tell you, the holding cost associated with the development, marketing and sales of smaller parcels of land over an extended period of time can consume the potential gains associated with a split.

Living through a boom market, you would receive the opposite answer: "Can't I split this property at a reasonable cost because my phone is ringing off the hook and I know I can get more on a per acre basis for smaller parcels?"  Of course, the answer in this scenario is often "yes."

So the answer to the question, "will dividing my property make me more money?" usually has to do with market supply and demand and secondarily with the simple ability to divide.  Appraisers using a "subdivision analysis" can consider development costs, holding costs, sales costs and the present value of the money that will potentially be made.

Vacant land is often an illiquid asset, so even projecting the price and absorption of parcels over time is fraught with risk. A well-reasoned subdivision analysis completed by an appraiser in touch with the market is likely better than a simple guess since it will rely on current market data and forecasting based on historical information.

This article discusses issues of general interest and does not give any specific legal or business advice pertaining to any specific circumstances.  Before acting upon any of its information, you should obtain appropriate advice from a lawyer or other qualified professional.  

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