By Thomas J. Griffith, MAI, ASA
In our last post we discussed the concept of establishing fair market value (FMV) for rent (http://principlevaluation.com/establishing-fair-market-value-for-rent/). The example below represents a real project we recently did that resulted in expert testimony (we changed the actual numbers, but the percentage differences are the actual percentage differences).
In this situation, we represented a hospital that had leased ground to a developer to construct a medical office building adjacent to the hospital. The original 25-year ground lease was expiring, and the hospital was looking to exercise the purchase option, which called for each side to obtain a FMV appraisal. Both the hospital (buyer) and developer (seller) had appraisals performed. Another key point was that the hospital master leased about 90% of the building. Here is what happened, demonstrating why correctly establishing fair market value is so important.
After doing our analysis, we determined a FMV of $25.5 million for the purchase. The developer’s appraisal came in with a value of $40.5 million. That’s almost a 60% premium to what we were proposing. That magnitude of difference is very uncommon and safe to say the two sides couldn’t come to an agreement.
The dispute was headed toward “baseball arbitration” where an independent arbiter would rule for one side or the other (in baseball salary arbitration, both sides submit proposals and the arbiter decides on one or the other). There were some indications that the arbiter would side with us, so both sides resumed negotiations and ended up with a price of about $27 million, or just 5% above what we had proposed.
The primary factor that led to this settlement had to do with the anticipated rents utilized in each appraiser’s projections. As mentioned, the hospital master leased 90% of the medical office building, and the lease was expiring within a month of both the appraisal dates. The developer’s appraisal value assumed that the hospital would renew the lease and did not factor in the risk with the potential turnover of the lease. In actuality that was not a given, and a fair market value determination needed to factor in the reasonable possibility that the hospital would not renew the lease. So our valuation appropriately took into account the risk with the hospital potentially not renewing the lease. Our appraisal accounted for this risk in the potential revenue lost due to the 90% turnover, the costs to potentially re-lease the space (marketing, commissions and tenant improvements) and in the capitalization rate.
We were able to successfully testify as an expert witness based on the strength of our appraisal and ultimately get a “win” for our client.