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.

Our clients have used Principle Valuation for valuations for purchase and sale transactions, compensation relationships, and support for tax purposes. They do straightforward and intelligent work, and are very responsive.

Scott Becker, Partner, McGuire Woods

We selected Principle because of their experience and reputation in the market. They are very knowledgeable about the industry, and particularly HUD financing. They were very thorough and hit their deadlines. Their appraisal went through HUD with no issues, which also made the borrower very happy.

Ken Buchanan, Senior Vice President and Chief Underwriter (Eastern Region), Walker Dunlop

Principle Valuation provides excellent valuations for ongoing healthcare enterprises, as well as placing values on the individual assets. They are very timely, reliable, have a solid understanding of the regulatory implications of their work, and are authoritative in the way they present their information.

Mike Anthony, Partner, McDermott, Will & Emery

Principle Valuation is far superior to any other valuation firm we have worked with. They are knowledgeable about businesses, real estate and equipment. And their reports are always right the first time.

Ken Doran, President and CEO, Spectrum Heatlh Partners

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