Methodology Guide- Valuing Office Buildings in Ontario · METHODOLOGY GUIDE VALUING OFFICE...

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

©MunicipalPropertyAssessmentCorporation2016Allrightsreserved 4

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.


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


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.


1.5ConsultationandDisclosure

MPACiscommittedtoprovidingmunicipalities,taxpayersandallitsstakeholderswiththebestpossibleservicethroughtransparency,predictabilityandaccuracy.Insupportofthiscommitment,MPAChasdefinedthreelevelsofdisclosureaspartofitsdeliveryofthe2016province-wideAssessmentUpdate.

• Level1–MethodologyGuidesexplaininghowMPACapproachedthevaluationofparticulartypesofproperty

• Level2–MarketValuationReportsexplaininghowthemethodologyoutlinedinLevel1hasbeenappliedatthesectorlevelforthepurposesofeachassessment

• Level3–PropertySpecificValuationInformationavailabletopropertytaxpayers,theirrepresentativesandmunicipalities


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.


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.


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.”


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.


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.


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.

© Municipal Property Assessment Corporation 2016 All rights reserved 14

• ThevacancyandcollectionlossisanallowanceforreductionsinPGIattributabletovacancies,tenantturnoverandnon-paymentofrent.


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.


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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cipalPropertyAssessmentCorporation2016Allrightsreserved

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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.


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.

Methodology Guide- Valuing Office Buildings in Ontario · METHODOLOGY GUIDE VALUING OFFICE...

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