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METHODOLOGYGUIDEVALUINGOFFICEBUILDINGSINONTARIO
ValuationDate:January1,2016
AUGUST2016
August22,2016
TheMunicipalPropertyAssessmentCorporation(MPAC)isresponsibleforaccuratelyassessingandclassifyingpropertyinOntarioforthepurposesofmunicipalandeducationtaxes.
InOntario’sassessmentsystem,MPACassessesyourpropertyvalueeveryfouryears.Thisyear,MPACisupdatingthevalueofeverypropertyintheprovincetoreflectthelegislatedvaluationdateofJanuary1,2016.
MPACiscommittedtoprovideOntariopropertyowners,municipalitiesandallitsstakeholderswiththebestpossibleservicethroughtransparency,predictabilityandaccuracyinvalues.Aspartofthiscommitment,MPAChasdefinedthreelevelsofdisclosureofinformationinsupportofitsdeliveryofthisyear’sassessmentupdate.ThisMethodologyGuideisthefirstlevelofinformationdisclosure.
ThisguideprovidesanoverviewofthevaluationmethodologyundertakenbyMPACwhenassessingofficebuildingsforthisyear’supdateensuringthemethodologyforvaluingthesepropertiesiswelldocumentedandinalignmentwithindustrystandards.
Propertyownerscanaccessadditionalinformationabouttheirownpropertiesthroughaboutmyproperty.ca.Logininformationforaboutmyproperty.caisprovidedoneachPropertyAssessmentNoticemailedthisyear.AdditionalinformationaboutMPACcanbeaccessedatmpac.ca.
AntoniWisniowski
PresidentandChiefAdministrativeOfficer
RoseMcLean,M.I.M.A.
ChiefOperatingOfficer
TableofContents
1.0INTRODUCTION................................................................................................................4
1.1PROPERTIESCOVEREDBYTHISMETHODOLOGYGUIDE.......................................................................4
1.2LEGISLATION.............................................................................................................................5
1.3CLASSIFICATION.........................................................................................................................5
1.4THEUSEOFTHISMETHODOLOGYGUIDE........................................................................................6
1.5CONSULTATIONANDDISCLOSURE..................................................................................................7
2.0THEVALUATIONPROCESS.................................................................................................8
2.1OUTLINE..................................................................................................................................8
2.2APPROACH...............................................................................................................................9
2.3DATACOLLECTION.....................................................................................................................9
2.4DATAANALYSIS.......................................................................................................................11
2.5GRADINGSYSTEMFOROFFICEBUILDINGS.....................................................................................11
3.0THEVALUATION..............................................................................................................13
3.1DETERMININGPOTENTIALGROSSINCOME(PGI)............................................................................13
3.2ESTABLISHINGEFFECTIVEGROSSINCOME(EGI).............................................................................14
3.3ESTABLISHINGNETOPERATINGINCOME(NOI)..............................................................................15
3.4CAPITALIZINGNOIINTOVALUE...................................................................................................17
3.5CURRENTVALUEASSESSMENT....................................................................................................18
3.6PROPERTYVALUEREVIEW..........................................................................................................18
3.7CONCLUSION...........................................................................................................................18
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1.0Introduction
TheMunicipalPropertyAssessmentCorporation(MPAC)–mpac.ca–isresponsibleforaccuratelyassessingandclassifyingpropertyinOntarioforthepurposesofmunicipalandeducationtaxation.
InOntario,propertyassessmentsareupdatedonthebasisofafour-yearassessmentcycle.In2016,MPACwillupdatetheassessmentsofOntario’snearlyfivemillionpropertiestoreflectthelegislatedvaluationdateofJanuary1,2016.Assessmentsupdatedforthe2016baseyearareineffectforthe2017–2020propertytaxyears.
ThelastAssessmentUpdatewasbasedonaJanuary1,2012,valuationdate.Increasesarephasedinoverafour-yearperiod.Anydecreasesinassessmentareappliedimmediately.
Itisimportanttoensurethatthevaluationmethodologyappliediscapableofprovidingarealisticestimateofcurrentvalueattherelevantvaluationdate,which,inturn,enablesallstakeholderstounderstandthevaluationprocessandhaveconfidenceinthefairnessandconsistencyofitsoutcome.
ThisMethodologyGuidehasbeenpreparedforthebenefitofMPACassessors,propertyownersandtheirrepresentatives,municipalitiesandtheirrepresentatives,AssessmentReviewBoardmembers,provincialofficials,andthegeneralpublic.
Thisguideoutlinesthevaluationprocesstobefollowedbyanassessor,includingstepsthatrequireappraisaljudgment.Itisincumbentupontheassessortomakeinformeddecisionsthroughoutthevaluationprocesswhenarrivingatestimatesincurrentvalue.
1.1PropertiesCoveredbyThisMethodologyGuide
ThismethodologyguideappliestoofficebuildingsinOntario.ThefollowingMPACpropertycodesareusedtocategorizethevarioustypesofofficebuildingsinOntario:
• 402Largeofficebuilding(generallymulti-tenanted,over7,500sq.ft.)
• 403Largemedical/dentalbuilding(generallymulti-tenanted,over7,500sq.ft.)
Itshouldbenotedthatthesearegeneralguidelinesthatvarydependingonthespecificcircumstancesofaparticularproperty.
AnassessormayalsomakereferencetoadditionalMethodologyGuidesforpropertiesthatdonotfallpreciselywithinthedescriptionofoneofthepropertycodeslistedabove.
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1AssessmentAct,R.S.O1990,cA.31:https://www.ontario.ca/laws/statute/90a31.2OntarioRegulation282/98,GENERAL:https://www.ontario.ca/laws/regulation/980282.3MunicipalAct,2001,S.O.2001,c.25:https://www.ontario.ca/laws/statute/01m25.
1.2Legislation
ThemainlegislationgoverningtheassessmentofpropertiesinOntarioforpropertytaxpurposesiscontainedintheAssessmentAct.1
TheActcontainsimportantdefinitionsandstatesthatallpropertyinOntarioisliabletoassessmentandtaxation,subjecttosomeexemptions.Section19(1)oftheActrequiresthatlandbeassessedatcurrentvalue,whichisdefinedtomean,inrelationtoland,“theamountofmoneythefeesimple,ifunencumbered,wouldrealizeifsoldatarm'slengthbyawillingsellertoawillingbuyer.”
TheMinisterofFinancefiledOntarioRegulation430/15onDecember18,2015,whichaddedadditionalrulesaffectingthevaluationandclassificationofpropertiesonwhichathird-partysign(billboard)islocated.Tocomplywiththeregulation,theincomeattributabletoathird-partysignwillnotbeincludedinthevaluationofanypropertyforassessmentpurposes.
1.3Classification
MPAC’sroleistoaccuratelyassessandclassifyallpropertiesinOntarioinaccordancewiththeAssessmentActanditsassociatedregulationsestablishedbytheGovernmentofOntario.Theclassificationofapropertywilldeterminewhichtaxratewillbeappliedbythemunicipalityortaxingauthority.Allpropertiesareclassifiedaccordingtotheiruse,andOntarioRegulation282/98oftheAssessmentActsetsouthowvariouspropertyusesareclassified.
OfficeBuildingsareincludedintheCommercialPropertyClassinaccordancewithSection5(1)1ofOntarioRegulation282/98as“landandvacantlandthatisnotincludedinanyotherpropertyclass.”2TheclassificationofofficebuildingsiscoveredinSection11(1)ofOntarioRegulation282/98.Theofficebuildingpropertyclassonlyappliesifthecouncilofamunicipalitypassesaby-lawoptingtohavetheoptionalclassapply.Section11(1)ofOntarioRegulation282/98requiresthecouncilofamunicipalitytopassabylawestablishingthetaxratiosfortheofficebuildingpropertyclasspursuanttoSection308oftheMunicipalAct,2001.3Ifamunicipalitydoesnotopttohavetheofficebuildingpropertyclassapply,thepropertyisincludedinthedefaultCommercialPropertyClassinaccordancewithSection5(1)1ofOntarioRegulation282/98.
Theofficebuildingpropertyclassonlyappliestotheportionofthepropertythatexceedsthe25,000squarefeetthreshold.Asaresult,theeligiblepropertywillalwaysbeapportionedbetweencommercialandofficebuildingasfollows:thecommercialclassificationisappliedto
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thefirst25,000squarefeetandtheofficebuildingclassificationisappliedtotheportionofthepropertythatisinexcessof25,000squarefeet.
Fornewconstruction,dependingonthepercentageincreaseoftheimprovementandthebuildingpermitissuancedate,anofficebuildingmaybeincludedintheNewCommercialPropertyClassunderOntarioRegulation400/98.
Irrespectiveofwhetherthemunicipalityhasadoptedtheoptionalofficebuildingpropertyclass,MPACwillstillapplytheoptionalclasstotheportionsofthepropertythatmeetthelegislativerequirements.
1.4TheUseofThisMethodologyGuide
ThisMethodologyGuideisintendedto:
• EnsureMPAC’sassessedvaluesforthesepropertiesarefair,accurate,predictableandtransparent.
• Providedirectiontoassessorsandclearexplanationstomunicipalities,taxpayersandAssessmentReviewBoardmembers.
• EnsurethatMPAC’smethodologyforvaluingthesepropertiesiswelldocumentedandalignswithindustrystandards.
• Explainthethoughtprocess/decision-makingprocessthatanassessorshouldundertaketoapplythevaluationmethodology.
• Ensureaconsistentapproachtovaluingthesepropertytypes.
• SupportMPACassessorsinconductingtheirduediligencein:
Ø applyingOntario’slegislationandregulationsØ adheringtoindustrystandardsformarketvaluationinamassappraisal
environment.
ItshouldbenotedthatthisMethodologyGuideisnotintendedtobeasubstituteforanassessor’sjudgmentinarrivingatamarketvalue–basedassessment(i.e.,currentvalue)foraparticularproperty.However,giventhattheMethodologyGuideexplainsindustrystandardsforpropertyassessment,conformstovaluationindustrynorms,andadherestoprovinciallegislationandregulation,MPACassessorsareexpectedtofollowtheproceduresintheMethodologyGuideandbeabletoclearlyandsatisfactorilyjustifyanydeviationsfromit.
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1.5ConsultationandDisclosure
MPACiscommittedtoprovidingmunicipalities,taxpayersandallitsstakeholderswiththebestpossibleservicethroughtransparency,predictabilityandaccuracy.Insupportofthiscommitment,MPAChasdefinedthreelevelsofdisclosureaspartofitsdeliveryofthe2016province-wideAssessmentUpdate.
• Level1–MethodologyGuidesexplaininghowMPACapproachedthevaluationofparticulartypesofproperty
• Level2–MarketValuationReportsexplaininghowthemethodologyoutlinedinLevel1hasbeenappliedatthesectorlevelforthepurposesofeachassessment
• Level3–PropertySpecificValuationInformationavailabletopropertytaxpayers,theirrepresentativesandmunicipalities
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2.0TheValuationProcess
Thevaluationprocessalwaysbeginswithadeterminationofthehighestandbestuseofthesubjectproperty.
Anyrelianceuponthisguideismadeonlyaftertheassessorhasdeterminedthatthehighestandbestuseofthesubjectpropertyisthatofanofficebuilding.
Assessorsdeterminethevalueofapropertyusingoneofthreedifferentapproachestovalue:
• thedirect(sales)comparisonapproach
• theincomeapproach
• thecostapproach
2.1Outline
Inthedirect(sales)comparisonapproach,valueisindicatedbyrecentsalesofcomparablepropertiesinthemarket.Inconsideringanysalesevidence,itiscriticaltoensurethatthepropertysoldhasasimilaroridenticalhighestandbestuseasthepropertytobevalued.
Intheincomeapproach(or,moreaccurately,theincomecapitalizationapproach),valueisindicatedbyaproperty’srevenue-earningpower,basedonthecapitalizationofincome.Thismethodrequiresadetailedanalysisofbothincomeandexpenditure,bothforthepropertybeingvaluedandothersimilarpropertiesthatmayhavebeensold,inordertoascertaintheanticipatedrevenueandexpenses,alongwiththerelevantcapitalizationrate.
Inthecostapproach,valueisestimatedasthecurrentcostofreproducingorreplacingimprovementsoftheland(includingbuildings,structuresandothertaxablecomponents),lessanylossinvalueresultingfromdepreciation.Themarketvalueofthelandisthenadded.
MPACprimarilyusestheincomeapproachtovalueofficebuildings.Thevalueofanincomepropertysuchasanofficebuildingisbasedonthepresentworthofanticipatedfutureincome.
MPACusesthedirectcapitalizationmethodtoestablishcurrentvalueassessmentsinamassappraisalcontext.
Thismethodestimatestheannualfairmarketrentalincomeandotherpotentialincomethatcanbegeneratedbytheofficebuilding,deductsoperatingexpensesandthenappliesacapitalizationratetothenetincometoarriveatanestimateofcurrentvaluefortheproperty.
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Thedirectcapitalizationapproachinvolvesthefollowingsteps:
1. Determinethepotentialgrossincome(PGI)usingmarketrents.
2. Adjustfortypicalvacancyexpenseallowanceaccordingtothetypeandqualityofofficebuildingtodeterminetheeffectivegrossincome(EGI).
3. Deducttypicalnon-recoverableexpensestodeterminethenetoperatingincome(NOI).
4. Establishthecapitalizationratefromsalesdata.
5. CapitalizetheNOIintoanestimateofcurrentvalue.
2.2Approach
TherearefourmainphasesintheprocessusedbyMPAC:
• datacollection
• analysisofthedatacollected
• valuation
• propertyvaluereview
2.3DataCollection
Thedatarequiredforofficebuildingvaluationscomesfromanumberofsources:
• MPACconductsperiodicinspectionsofofficebuildings.
• PropertyownersarerequiredtoprovideMPACwithdetailsincludingtheactualincomeandexpensesthroughthePropertyIncomeandExpenseReturn(PIER)forms.
• MPACalsocollectsinformationaboutsalesortransfers.
MPACgenerallycollectsthefollowingtypesofdataforofficebuildings:
• generaldata(tenantlist,occupancy,leasetypes,etc.)
• financialdata(rent,vacancy,expenses,retailsales,etc.)
• propertydescription(siteplans,floorplans,etc.)
• salesdata(whereapplicable)
• grossleasablearea(GLA)
• furthertotheabove,MPACwillreviewthirdpartyreportsfromvariousreputablesourcessuchasCoStarandAltusInsite.
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Confidentiality
Asoutlinedabove,itisimportanttobeawarethat,inordertoenableMPACtoproduceanaccuratevaluationofthepropertyconcerned,informationneedstobeobtainedfromavarietyofsources.
ThiswillincludeinformationfromMPAC’srecords,fromtheowneroroperatoroftheproperty,fromthemunicipalityinwhichthepropertyislocated,fromtheassessor’svisittotheproperty,andfromothersources.
AllstakeholdersinthepropertyassessmentsystemhaveaninterestinensuringthatthecurrentvalueprovidedbyMPACiscorrect;inordertoachievethis,itisnecessaryforallpartiestocooperateintheprovisionofinformation.
Itisappreciatedthatsomeoftheinformationoutlinedabovemaybeofacommerciallysensitivenature.MPACrecognizestheneedtoensurethatanyinformationprovidedtoitisproperlysafeguardedandonlyusedforthepurposeforwhichitissupplied.Assessorsmustappreciatethenatureofthisundertakingandensuredataistreatedaccordingly.
If,afteranappealhasbeenfiled,MPACreceivesarequestforthereleaseofactualincomeandexpenseinformation,orothersensitivecommercialproprietaryinformation,theusualpracticeistorequirethepersonseekingtheinformationtobringamotionbeforetheAssessmentReviewBoard(ARB),withnoticetothethirdparties,requestingthattheARBorderproductionoftherequestedinformation.ThereleaseofsuchinformationisatthediscretionoftheARBandcommonlyaccompaniedbyarequirementforconfidentiality.
TheAssessmentActoutlinesinSection53(2)thatdisclosedinformationmaybereleasedinlimitedcircumstances“(a)totheassessmentcorporationoranyauthorizedemployeeofthecorporation;or(b)byanypersonbeingexaminedasawitnessinanassessmentappealorinaproceedingincourtinvolvinganassessmentmatter.”
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2.4DataAnalysis
ForMPACtogainfullvaluefromthedatacollected,thedatahastobeorganizedinsuchawaythatmeaningfulcomparisonscanbemadeandconclusionsdrawnthroughstatisticalanalysis.
Theanalysisprocessinvolvesseveralsteps.Thefirsttaskistovetthedata(i.e.,checkforaccuracy)beforeitisusedtohelpestablishthefairmarketrentsandfactorsthatwillbeusedtovaluetheproperties.ThesecondstepistoenterthedataintoMPAC’sdatabase.Next,MPACclassifiesthedatasothatitcanbesortedintoappropriatemarketareas,whichreflectconditionswheredatacomparisonscanbemadeandconclusionsdrawn.Finally,MPACdevelopscertainvaluationparametersthroughstatisticalanalysisormultipleregressionanalysisthatcanbeusedinthevaluationofofficebuildings.Aftercollectingfairmarketrentdatafrompropertyowners,thenextstepsinclude:
1. Classifyandconfirmthetypesoftenantsbymarketarea,propertycodeandoccupancycode.
2. Analyzedatatoreachconclusionsforallowances.
3. Establishrentsbytenanttypeforeachclassofofficebuildingthroughmultipleregressionanalysis.
4. Establishtypicalmarketvacancyratesforeachclassofproperty.
5. Establishtypicalnon-recoveredoperatingexpenseallowances.
6. Establishthecapitalizationrates.
2.5GradingSystemforOfficeBuildings
Officebuildingsaregradedaccordingtophysicalcharacteristicsandsize.Althoughnoformalizedindustrydefinitionsexistforofficebuildings,thefollowingclassesaretypicallyrecognizedthroughouttherealestateindustry.
PremiumClass
Premierofficepropertiesaretypicallygreaterthan400,000squarefeetinsizeandareusually21storeysorgreater.Olderofficepropertiesmayqualifyiftheyhavehadextensiverenovationsandupgradedamenities.Theofficesaregenerallylocatedinthemostdesirableareaswithinanurbanarea.Thesepropertieshaveaveryhighqualityofconstruction,materialsandfinishes.
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ClassA
Propertiestendtobelocatedinlargeurbancentreswitheasyaccesstopublictransportation.Theyareprestigiousbuildings,professionallymanaged,withthemostamenitiesinthebestlocations.Theygenerallyarethemostattractivebuildingsbuiltwiththehighestqualitymaterialsandconstructionmethods.
ClassB
ThesebuildingsareagradebelowClassA.Generally,theyareslightlyolderbuildingswithgoodmanagementandqualitytenants.ClassBbuildingsarewell-maintainedoverallandquitefunctional.ClassBofficebuildingscommonlyhaveanacceptablecurtainwallfinish,adequatemechanical,electricalandsafetyandsecuritysystems,andamid-qualitylevelofinteriorfinish.ClassBbuildingscompeteforawiderangeofuserswithintheirmarketarea.
ClassC
Theseofficebuildingsaregenerallyolderandmaybelocatedonlessdesirablestreetsinthecity.Manyofthesebuildingsusuallyhavehigherthanaveragevacancyratesfortheirmarketandaredefinedbyolder,lessdesirablearchitecture,limitedinfrastructureandantiquatedtechnology.Forthesereasons,ClassCbuildingsofferlowrentalratesandcanbemoredifficulttolease.Thecurtainwalls,mechanical,electricalandsecuritysystemsaregenerallydated,andthequalityoffinishisoftenbelowaverage.Thesebuildingsattracttenantswhosignshort-termleasesforfunctionalspaceatbelow-averagerentalrates.
ClassD
Typically,theseofficebuildingsareinneedofmajorrenovations.Electricalandmechanicalsystemsareveryoutdated.ClassDbuildingslackamenitiestoattractlong-termtenantsandmaysufferfromeconomicobsolescence.
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3.0TheValuation
3.1DeterminingPotentialGrossIncome(PGI)
Indeterminingthepotentialgrossincome(PGI)foranofficebuilding,MPACreviewsopenmarketrentstakenfromcurrentrentrollinformationforthepropertyprovidedbythepropertyowner.InestablishingthePGI,itisassumedthereistypicalandcompetentmanagementandleaseswereestablishedbyawillinglessorandlesseewhowerebothknowledgeableandfreefromduress.Thisdataisanalyzedthroughstatisticalanalysisusingmultipleregressionanalysistoarriveatanestimateoffairmarketrent(FMR).
ItisimportanttonotethatwhentheassessorisdevelopingFMRsfromactualrentalinformation,athoroughreviewoftherentrollsisconductedtoensurerentsarereflectiveofcurrentmarketconditions.
Itemstoconsiderandreview:
• overalleconomiccircumstancesofgeographicalareaandpropertytype
• whetherrentsreflectexistingmarketconditions
• thelengthandtimeoftheleasetransactions
• rentspaidforothersimilar-sizedofficespaces
• fullfloorofficerentstothatofpartialfloorofficerents
AspertheAssessmentAct,whenvaluingofficepropertiesasunencumbered,itisimperativethattheassessorestimateFMR,reflectiveofthemarketplaceasoftheeffectivevaluationdateandinclusiveofallinterestsintherealproperty.TheFMRsareappliedtotheofficegrossleaseableareas(GLA)toarriveatanoverallPGIfortheproperty.
ThenationallyrecognizedstandardandapproachtomeasuringofficebuildingFMRsanddeterminingGLAhasbeenestablishedbytheBuildingOwnersandManagersAssociation(BOMA).
AdditionalincomegeneratedfromthepropertyforsuchitemsasparkingorstoragefeesshouldalsobeaddedtothePGI.Thisadditionalincomeshouldreflectthesamemarketconsiderationsastheofficegeneratedrevenue(i.e.,shouldbedeterminedfromopenmarketrates).
InestimatingthepropertiesPGI,thepropertyshouldbeconsideredasthoughfullyleasedandoccupiedandoperatingatitsmaximumpotential.
In instances where current rent roll information has not been supplied, is not complete or is notavailable for an office building, typical market rents can be established by analyzing the rent rollreturns from similar properties in the vicinity. The assessor may stratify properties by location,age, classification, etc. in the vicinity. The resulting stratified FMRs are then applied to similar orcomparable properties to determine the PGI for those properties.
Figure 3.1 – Example of PGI
Suite Type of Space GLA FMR Income
100 Office 5,000 $18.00 $90,000
101 Office 5,000 $18.00 $90,000
105 Office 5,000 $18.00 $90,000
200 Office 10,000 $18.00 $180,000
205 Office 5,000 $18.00 $90,000
300 Office 15,000 $18.00 $270,000
400 Office 15,000 $18.00 $270,000
B-100 Storage 10,000 $16.00 $160,000
Monthly parking rate 100 Spaces $200.00 $240,000
Total PGI $1,480,000
It should be noted that rates and other information shown are for illustrative purposes only.
3.2 Establishing Effective Gross Income (EGI)
Once the PGI from a property has been established, the next step is to determine an effective gross income (EGI). EGI is the amount of income the owner expects to receive over the long term; this is the EGI reduced as a result of expected vacancy and bad debt.
Effective Gross Income = Potential Gross Income – Vacancy and Collection Loss
Market Vacancy
Market vacancy reflects the amount of space that is typically vacant in a particular type of office building. Three issues arise when considering vacancies:
• A vacancy estimate is intended to reflect the likely average for a property type over a typical holding period and recognizes that, because of economic cycles, there will be periods when demand is good and periods when demand softens.
• Vacancy rates at individual office buildings may differ from the norm.
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• ThevacancyandcollectionlossisanallowanceforreductionsinPGIattributabletovacancies,tenantturnoverandnon-paymentofrent.
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EstablishingtheTypicalMarketVacancyRate
MPACassessorsapproachthevacancyrateusingthepercentageoflossofincometypicallylostduetovacanttenancies.Whencalculatingvacancybasedonlostincome,theassessorwillcalculatethelossofincomeasapercentageofthetotalpotentialrentalincomethatwasreportedonaproperty’sincomeandexpensereturn.
OncelostrevenuehasbeenconvertedintoapercentageofthePGI,thepropertiesarethenstratifiedbylocation,ageandqualitytoproducerangesofvacancypercentages.Themeanvacancyrateisthenselectedandappliedtotheentireinventoryofsimilarproperties.
Baddebtrepresentsrentalandotherpaymentsthatthelandlordcannotcollectfromthetenants.Itistypicaltoincludevacancyandbaddebtasasingleblendedrate.
DeterminingEGI
TodeterminetheEGI,theassessorstartswiththePGIanddeductsvacancyandcollectionlossallowance.TheresultistheEGI.
Figure3.2–ExampleofEGICalculation
TotalPGI $1,599,100Vacancy -7.0% -$111,937TotalEffectiveGrossIncome $1,487,163
Notethatunlessthereareextenuatingcircumstances,whichwillbenotedbytheassessor,marketvacancyratesshouldbeusedasopposedtoactualvacancyratesinordertoderivetheappropriatedeductionforvacancy.
Itshouldalsobenotedthatratesandotherinformationshownaboveareforillustrativepurposesonly.
3.3EstablishingNetOperatingIncome(NOI)
Theobjectiveoftheincomeapproachistodetermineaproperty’snetoperatingincome(NOI).TheprocessbeginsbyestablishingtheexpectedPGI,thendeterminingtheeffectiveincomebymakingadeductionfortypicalvacancy.Thefinalstepistoadjusttheincomeforexpensesthatcannotberecoveredfromthetenants.
NetOperatingIncome=EffectiveGrossIncome–Non-recoverableOperatingExpenses
Non-recoverableoperatingexpenseisthedifferencebetweenthetotaloperatingexpensesandthetotalincomerecoveredfromtenants.
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Non-recoverableOperatingExpenses
Non-recoverableoperatingexpensesareexpensestothepropertyownerthatarenotrecoveredfromtenantsinordertomaintainandgenerateanincomestream.Inatypicaloffice,tenantsareonnetleasesandtheoperatingcosts,suchasrealpropertytaxes,heating,airconditioning,andcleaning,arecollectedfromthetenant,independentoftherentpaidfortheoccupiedspace.
Therearetypicallytwoareaswherethepropertyownerhastocoverexpenses:
• non-recoverableoperatingexpenses,whicharenotpassedontothetenants,suchaslegalandauditfees,advertisingandpromotionalfees;and
• expensesassociatedwithoperatinganyvacantspace.
Itispossibletoexpressallnon-recoverableoperatingexpensesasapercentagereductionfromtheEGI.AstudyofthetypicaldifferencebetweenoperatingrecoveriesandoperatingexpensesproducestheexpecteddifferencebetweenEGIandNOI.Ifthisdifferenceisfairlyuniformandconsistent,thenitisappliedasaone-timededuction,muchlikethevacancydeduction.
ExcludedExpenses
Thereareseveralexpenseitemsthataretypicallyexcludedfromanyoperatingexpensestudy,astheydonotformpartoftheday-to-dayoperationorongoingmaintenanceofaproperty.Theseitemsinclude:
• incometaxandtaxesassociatedtothebusiness
• mortgageordebtservice
• depreciationonthebookvalueofthebuilding
Notethatstructuralrepairsandcapitalcostitems(notregularbuildingmaintenance)aretypicallyexcludedfromleasearrangementsmadewithtenants.
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ThedeterminationofNOIshouldnotbeundulydistortedbylarge,one-timeorinfrequentexpenseitems,suchasmajorstructuralrepairsorcapitalcosts.However,ifadeductionisdeterminedappropriateforsuchexpenses,theassessormayproratetheexpenseamountoverthelifeexpectancyoftheitem.
Figure3.3–ExampleofNOICalculation
Totaleffectivegrossincome $1,487,163
Totalnon-recoverableexpenses –5% $74,358
Netoperatingincome $1,412,805
Itshouldbenotedthatratesandotherinformationshownareforillustrativepurposesonly.
3.4CapitalizingNOIintoValue
OncetheNOIhasbeenestablished,thefinalstepfortheassessoristoapplytheappropriatecapitalizationratetoconverttheincomeintoapresentvalue.Theassessorwillestablishthecapitalizationratebystudyingsalesofpropertiesthatpresentsimilarinvestmentopportunitiesandthereforesimilarincomeprofiles.Anincomeprofileisthedegreeofrisk,aswellasthepotentialforgrowth,associatedwiththeincomestream.
SelectinganAppropriateCapitalizationRate
Selectionofanappropriatecapitalizationrateisessentialtotheproductionofanaccurateandequitablevalueforaproperty.Selectinganappropriaterateconsiderssuchfactorsasage,stateofrepairandlocationoftheproperty,incomparisontotheaverageortypicalproperty.
Figure3.4–CapitalizationofNetIncomeintoValue(V=I/R)
NetOperatingIncome(I) $1,373,083
CapitalizationRate(R) 8.0%
IncomeValuation(V) $17,164,000(Rounded)
Itshouldbenotedthatratesandotherinformationshownareforillustrativepurposesonly.
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3.5CurrentValueAssessment
Thefinalstepintheprocessistoconsolidateacurrentvalueassessmentfortheproperty.Oncethedeterminationofincomevaluehasbeencompleted,theassessorwillconsiderwhetherthereisanyothervalueintherealestatethathasnotbeencapturedbytheanalysisofincome.
ExcessLand
Excesslandisundevelopedlandthatissurplustocurrentneeds.Thislandisnotcapturedbytheincomeapproach,astherentsandotherpaymentsmadegotosupportalltherealestateelementsneededtooperatetheoffices.Landthatisnotrequiredtooperatetheofficebuildingissurplusorexcesstocurrentneeds.Thevalueofexcesslanddependsonitslocationwithinthesiteandhowwellitsuitsfuturedevelopmentsorexpansion.
3.6PostValuationReview
Havingarrivedatthevalueoftheofficebuildingthroughtheaboveprocess,MPACassessorswillconductadetailedreviewofthevaluationandaddressanyanomaliesthroughaprocesscalledpostvaluationreview.Throughthisprocess,theassessorwillreviewthepropertyspecificdatatoensureaccuracy,compareresultstosimilarpropertiesandensurethevalueisreflectiveoflocalmarketconditions.
3.7Conclusion
ThisguidesetsouthowMPACassessorsapproachthevaluationofofficesforpropertyassessmentpurposes.
Althoughitoutlinesthegeneralapproachadopted,itdoesnotreplacetheassessor’sjudgmentandtheremaybesomecaseswheretheassessoradoptsadifferentapproachforjustifiablereasons.
ForfurtherinformationaboutMPAC’srole,pleasevisitmpac.ca.
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