This is Diana with ABC – The Appraiser’s Business Companion. There was an interesting question that came my way. Sharing the answer had a shorter life than sharing it with you, the practicing appraiser. Even those who read this article who aren’t appraisers can sometimes become bumfuzzled when data appears sufficient but the approach or analyses is not performed.
The subject is a 10-year-old condominium unit. The condo project is active and continues demand from its surrounding market. The Days on the Market throughout the year have a maximum 5-month exposure prior to close with a 98% Sale to List Price Ratio. In the neighborhood location the condominium market makes up about 30% of the residential improvements in the neighborhood, the remainder is both detached single-family with a few townhouse projects as well. There are no apartments. The desire for the area is tied to the ease of getting almost anywhere in town in under 30 minutes due to the excellent transportation arteries. The elementary and middle schools are also noted as highly sought after.
The subject is being purchased with the intent of owner-occupancy. In the condo market, in this location, approximately 25% of the units throughout the various condominium projects are tenant occupied. There are sufficient sales with tenant occupancy in order to procure a credible Gross Rent Multiplier (GRM). However, none of those tenant occupancies are in the subject’s condominium project. Further reading of the Condominium’s Regime reveals that tenant occupancy is not allowed in the subject’s condo project. Now here comes the question, may an Income Approach be performed under a hypothetical condition, given there are units within a ¼ mile that are tenant occupied? There is evidence of closed sales where there was tenant occupancy at the time of the sale in nearby condominium projects.
Answer, “NO”, the Income Approach should not be performed. Why? Because the Condo Regime said so. Consider what USPAP states in applicable Standard Rules (SR) and Definitions.
Hypothetical Condition – A condition, directly related to a specific assignment, which is contrary to what is known by the appraiser to exist on the effective date of the assignment results but is used for the purpose of analysis.
SR 1-2 (g) Identify any hypothetical conditions necessary in the assignment; and
Comment: A hypothetical condition may be used in an assignment ONLY if:
- Use of the hypothetical condition is clearly required for legal purposes, for purposes of reasonable analysis, or for purposes of comparison
- Use of the hypothetical condition results in a credible analysis; and
- The appraiser complies with the disclosure requirements set forth in USPAP for hypothetical conditions
In this specific scenario it’s not the fact that there is no tenant occupancy in the subject’s condominium project that prevents the hypothetical condition from being imposed and the approach developed. In this scenario the Condominium Regime has declared and recorded that ownership of the condo unit includes the agreement such ownership foregoes the right to lease. If it is illegal to lease then the Income Approach is not applicable; it lacks the legal opportunity to enjoy an income stream on that effective date.
When determining whether an approach is applicable and appropriate it must also have a legal allowance. Research into possibilities and consideration of those privileges of ownership must also be legal. When the legal right has been dissolved the fact, there are competing properties of similar lifestyle can’t be considered an alternative substitute if they don’t have the same legal allowances.
The same reasoning comes into play when properties being appraised are located in gated communities and sales are lacking. Going to properties located in close proximity that have sold but are not located in a gated community will generally not have the same rights of use or limitations of use. Apples with Apples is where our focus needs to be when we choose comparable transactions. The development of our Scope of Work plan must consider the rights of ownership, the limitations or defeasance on the property interest being appraised. Although it may now be obvious to the appraiser why the Income Approach is not applicable in the scenario discussed, the challenge is whether or not the lack of the development was explained sufficiently in the Appraisal Report. Keep in mind, what drives the amount of information necessary for sufficient understanding is the client and other identified intended users. A simple sentence can be written, “Tenant occupancy is not an ownership right to offer in the subject’s condominium project. For this reason, the Income Approach is not applicable and was not developed in this appraisal.”
This is Diana Jacob and you just had a tip from ABC-the Appraiser’s Business Companion.
 Excerpt from the 2018-2019 edition of USPAP