What’s going to happen with Boston real estate? In the coming weeks, months, and years, is it going to go up, down, or sideways? Is it time to buy or sell?

One thing’s for sure: No one knows. No one has a crystal ball, and there are countless factors that can affect property values.

However, in this article we’ll summarize the most salient points that most economists are talking about, and discuss what we think might happen with the Boston real estate market.

Boston, MA Real Estate Market Values over the Past Ten Years

• 2011: $400k
• 2012: $400k (+/-0%)
• 2013: $410k (+2%)
• 2014: $440k (+7.5%)
• 2015: $480k (+9%)
• 2016: $515k (+7.5%)
• 2017: $550k (6.7%)
• 2018: $610k (10.9%)
• 2019: $615k (+1%)
• 2020: $625k (+2%)
• 2021: $660k (+5.6%)

There’s a popular maxim that reads “the best predictor of future performance is past performance.”

When it comes to certain investment classes, this idea has been thoroughly debunked — but it largely holds true for certain areas in the real estate market. After all, the three biggest rules for real estate are location, location, location — and Boston still regularly ranks as one of the best cities to live in in the United States, and the world:

• Boston comes in at #13 according to BestCities.org
• The US News and World Report puts Boston at #18 in Best Places to Live in the US.
• Deutsche Bank ranks Boston as #1 in terms of “Quality of Life” in the US, and #8 in the world.

That doesn’t mean Boston will grow at the same rate as previous years. In fact, we think there’s some reason to believe that the days of fast growth are behind us — and there’s even the possibility of a looming crash.

All-Time Low Interest Rates Are Driving Up Prices — But Boston’s Growth Lags Behind the Average

To anyone even remotely involved in real estate, this shouldn’t come as a shock.

Interest rates are at decade-lows. According to Freddie Mac, one of the nation’s largest federally-backed mortgage companies, the rate for a 30-year fixed mortgage is at 2.8-3.0%. The average over the past 30 years has fluctuated anywhere from 3.5-6%.

However, the median sales price for all homes in the United States is up 14.3% year-over-year, while the picture in Boston looks a bit more bleak: only up 2.9% year-over-year. Personally, at Boston Appraisal Group, we’ve noticed a significant price decline in the downtown market, which could possibly signal an incoming crash.

Why might this be?

Great Migration Spurred by the Work-at-Home Movement

Some people have predicted that, due to the pandemic, work-at-home might just become the new normal. Two-Thirds of Massachusetts office workers said they would prefer to keep working at home even after the pandemic. With more people working at home, that might drive less business toward the city center.

After all, if you could buy a house for $200k in the suburbs 45 minutes away from Boston and the same house would cost you $800k to live in the city, if you’re working from home, it simply doesn’t make sense to shell out another $600k (unless you really want to lock in a big loan on a low interest rate).

A Lack of Migration into Big Cities

But even more importantly, while small numbers of residents might be moving out of Boston to the less-expensive suburbs, there’s another problem: more people aren’t moving in to take their place. Policy Economist Stephen D. Whitaker asked the question, “Did the COVID-19 Pandemic Cause an Urban Exodus?” in a recent research study. He tracked migration patterns using an anonymous survey that tracks Americans with a credit file (which includes 9 out of 10 Americans).

In and around the Boston area in particular, there’s a 15% change in outflow, meaning that 15% more people are moving out of Boston than they usually would, but also a 20% decrease in inflow (so 20% fewer people are moving into Boston than normal). The result? A 36% total decrease.

Many big cities, including Boston, have relied on a steady inflow of migrants to drive growth. But with lockdowns forcing many people at home and a workforce that’s gotten used to the idea of working from home, it might mean that the Boston real estate market isn’t poised for the same growth that it’s seen over the past ten years.

Conclusion: Boston, Massachusetts Real Estate Market Analysis

Over the past ten years, Boston market values have only gone up. If you bought a house in Boston in 2010, it’s increased by nearly 60% in value YTD. That’s one great investment.

But past performance is no indication of future success.

With interest rates at decade-lows, housing across the United States has been having its best year in a long time, but Boston real estate isn’t quite seeing the same level of gains, and that could be due to a number of factors.

At Boston Appraisal Group, we’ve noticed a downtrend in some of the sale prices in the downtown market, and we think it could — in part — be attributed to the overall migration patterns of the city in general: some people are moving out, but, even more importantly, fewer people are moving in, causing a 36% decrease in total migration.

Whether or not that indicates a coming crash is anyone’s guess. It’s also entirely possible that, as people become vaccinated, they start pouring back into big cities, eager to spend their savings on all of the world-class restaurants and cafes that an award-winning city like Boston has to offer.

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Appraisals express value as the monetary relationship between properties and those who buy, sell or use those properties, as defined by the Uniform Standards of Professional Practice(USPAP). Fundamental to appraisal practice is the idea of comparing the subject of an assignment to other properties. The Sales Comparison Approach is the foundation of appraisal analysis: appraisers apply its techniques not only in that approach but also in the Cost Approach and Income Approach. Competent appraisers recognize the components by which buyers and sellers judge properties and then measure those components relative to a subject property.

Units and Elements of Comparison

After an appraiser collects information about sales of properties similar to the subject, they usually express the sale prices as dollars paid per a specific measurement. Units of comparison are traditionally related to the size or composition of a property. (Occasionally, properties will be compared on a whole-to-whole basis. This practice is only applicable when sale properties are very similar in size, as houses in a newly-constructed subdivision or vacant lots within such a development.)

The appraiser applies the comparison unit that is most often used in the market for the type of property. Typical units are by square foot, acre, square foot of usable area, and square foot of leasable area. Specialized properties are often compared by units depending on their use: a room, theater seat, marina slip, or garage bay. Comparison units may also vary according to local measurement custom, as in per square foot in the United States vs. per square meter in Europe.

When a sale property is composed of a collection of units that are used or leased separately, an appraiser often expresses a unit sale price that recognizes the property’s range of units. For example, the total square footage of an apartment might be divided by the number of apartment units, to describe the apartment’s price per average unit. Another method might be to apply weights or factors to the various units, based on market data.

Before analyzing the sales relative to subject, the appraiser identifies the property elements that influence sale prices, such as location, permitted uses, physical features (overall size, leasable unit size, building components, and condition), real property rights, financing terms, market demand, and income production capability. The appraiser must thoroughly assess subject property’s market to understand which factors will be significant.

Quantitative vs. Qualitative Analysis

To reach a value conclusion for the subject property, the appraiser considers the effect each variable of comparison had relative to the subject property. This analysis can result in the appraiser making adjustments to the comparable sales’ unit prices to suggest a probable range of value for subject. The price modifications can be expressed in monetary terms or by percentage difference. The best basis for each adjustment is by ‘paired sale analysis,’ where the appraiser compares sales that are alike in all but a single feature.

Ideally, adjustment factors are derived from the data an appraiser has collected for a specific appraisal assignment. However, sales data is often not extensive enough to develop multiple reliable adjustment factors. The appraiser may then use adjustment factors developed in other similar tasks. Many appraisers keep files of these proven adjustment factors for such instances. Competent appraisers must be confident that factors developed in other appraisals are relevant to a current assignment.

Sometimes there just isn’t enough comparable sale data—either in a current assignment or from other appraisals—to develop reliable adjustment factors. In those situations, appraisers may rate the comparison elements on a qualitative base, such as ‘better than’ or ‘inferior to.’ This approach can be more credible than applying unsupported numeric adjustment factors. In all cases, though, analysis of comparison elements reflects fact rather than an appraiser’s opinion.

When Sales Data is Limited

Experienced appraisers often work in markets where comparable data are scarce or nonexistent. This data insufficiency can occur when the subject property is rare or constructed for a single, unique purpose. It also arises when market activity has been suppressed for economic reasons: recession, extremely high interest rates, or a minimal number of market participants. In these situations, appraisers may expand their search for comparable data by looking in other physical locations, searching further back in time, or including sale properties that are considerably different from the subject. Therefore, it is imperative that the appraisal report clearly describes both the data limitations and the means taken to obtain adequate data.

Credible Assignment Results

Professional appraisers are obliged to provide appraisals that are complete enough to provide reliable results and reported in sufficient detail for intended users to understand. Appraisers also must recognize intended users’ additional appraisal development and reporting rules. The bottom line in every appraisal assignment is that the appraisal results must be credible and understandable. The professional appraisal analyzes comparable sales by justifiable methods and clearly reports those methods and how they are applied.

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The demand for all types of real estate in New England reflects region-wide economic factors. While the national economy influences geographical real estate values, some 2019 trends unique to New England are especially important to buyers and investors. These trends include labor characteristics, financial considerations, and population behavior.

Employment

Unemployment in New England is currently 3.7%, a significant drop since the post-recession level of 8.7%. New England’s job gain rate over the last year was 1.5%, compared to a national rate of 1.7%. Massachusetts and New Hampshire experienced the highest job growth in 2018, while Rhode Island’s and Maine’s employment numbers were virtually unchanged, and Vermont’s jobs shrank slightly.

Average wages throughout New England increased in the last year at an average rate of 2.6%. This increment was marginally lower than the national average of 4.7% but still positive for each of the region’s seven states. Wage growth in both Massachusetts and New Hampshire surpasses the national average.

New England, particularly the Cambridge area of Massachusetts, is seen as an excellent source of skilled labor. The technology industry has traditionally benefitted most from a wealth of well-educated workers. In recent years, major growth witnessed in the life sciences industries (including pharma and biotech) has made these sectors the strongest segments of New England’s economy.

Cost of Living

A downside to this regional employment growth is an elevation in living costs. Specifically in the Boston area, the cost of living increased by 2.5% in 2018. Housing represented the greatest portion of that increase: shelter costs rose by 4.7%. Market prices for natural gas and dairy products also grew sharply.

Recent interest rate increases have also hiked the cost of living in the New England area. The Federal Reserve increased its short-term lending rate by a quarter-point, to 2.5%, in December 2018. At its January 2019 meeting, the Federal Reserve suggested that rates would stay level for the coming year.

The current rate for a fixed 30-year mortgage in New England ranges from 4.40% to 4.50%, according to bankrate.com. This is slightly below the U.S. average of 4.54%. However, uncertainty about the near future of the American economy leads experts to conclude that residential mortgage rates will increase in 2019. Also, the recent federal government shut-down hampered consumers’ confidence. Economists expect the U.S. economy to slow in the coming months in response to tariffs’ damaging effects on some trade markets. Great Britain’s imminent exit from the European Union (the infamous Brexit) has also reduced investors’ expectations for 2019.

Consumption, Work, and Commuting

Lifestyle changes are affecting real estate demand. U.S. online retail shopping increased by nearly 13% between 2017 and 2018. Online purchases represented 9.8% of all retail sales at the end of 2018; this is more than 200% of what was attributed to online shopping in 2010.

Furthermore, labor models are rapidly changing. While unemployment continues to be low, the rate of new hires is also low. Statistics for the number of independent contractors and gig workers in the U.S. economy are scattered and inconsistent. But by many measures, non-employees are increasingly becoming a crucial part of the workforce. The most recent Bureau of Labor Statistics (BLS) analyses suggest that some 7.5% of the U.S. labor force are independent contractors, and another 6.4% are on-call, temporary, or gig workers.

Unfortunately, the BLS has not standardized its collection methods for this segment of the labor force; the Federal Reserve estimates that as many as 75,000,000 Americans, or 46% of the workforce, work in ‘non-traditional’ arrangements. Independent contractors and gig workers often escape the burden of commuting. In New England, that burden is noteworthy: Boston ranked first in 2018 for hours lost and cost per driver, due to traffic congestion.

Trends’ Effects on Real Estate Markets

All the economic trends mentioned influence demand for New England real estate. Increases in mortgage rates and relatively high prices will likely slow single-family home sales. These same forces are further intensifying demand for residential rental property.

Congestion, high office rental rates, and constantly improving telecommunications are driving large employers out of city centers, increasing demand for suburban office spaces. The ongoing growth in technology and life science industries is escalating businesses’ need for campus office properties that include laboratories and storage spaces. The proliferation of independent contractors and remote workers is also heightening demand for co-working offices near residential and retail developments.

The growth of online retail commerce is causing substantial changes in the commercial real estate market. Demand for traditional bricks-and-mortar stores of all kinds is declining. Consumers expect ever faster delivery of retail goods and services; this trend has increased demand for dispersed distribution hubs to speed up last-mile delivery. Thus, opportunities abound for investors who are looking for the ‘next new thing.’
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Many residential appraisals don’t require the application of the cost approach, but there are situations where separate value opinions for land and improvements are necessary. In certain circumstances, the sales comparison approach is hampered by a shortage of sale properties that are truly comparable to the subject. Experienced appraisers recognize that a peculiar improved property sale may wholly reflect land value. They also know how to analyze outlier sales to support both vacant and improved property value opinions.

When Land Value Is Needed

An appraisal of a newly constructed property, or one where construction is proposed or in progress, usually includes a separate value for the land exclusively. Land value is also a necessary component of highest and best use analysis: when it appears that the subject property’s current use is not its highest and best use, the highest land value among possible uses can be used to determine the subject property’s highest and best use. Special-purpose properties (such as museums, schools, and libraries) rarely sell in an open market; their appraisal typically requires land value opinions.

An appraisal’s intended use may also be a separate land value estimate. When an appraiser is estimating just compensation for a partial taking, land value is a central component of the appraisal conclusion. Some intended users, including clients and regulatory agencies, mandate the use of a combination of the cost approach and land value opinion.

Clues to Identify a Land Sale

An experienced appraiser recognizes comparable sales that seem to be outside the normal range of unit prices. When an improved property’s price per square foot of building is oddly low, it is possible that the sale of that property is based primarily on land value with no (or negligible) contributory amount paid for improvements. If an improved sale property is surrounded by properties under different use, its sale price alone may be enough to indicate land value. Or if a neighborhood is likely to change significantly in the near future, improved property sales may anticipate the demolition of existing improvements and redevelopment.

Sometimes, an appraiser can expand a comparable sales search into a broader market area or past transactions. The presence of a new building indicates the underlying land was either vacant or redeveloped before new construction commenced. Research may reveal the purchase of that land or the improved property that preceded the new building.

Analysis to Derive Land Value

An extensive review of comparable sales can sometimes seem like ‘appraising the comparables.’ However, this kind of study is often the only way to derive the contribution of a land/building in a sale transaction or develop adjustment factors for paired sale analysis.

Appraisers use several methods to estimate the value that should be attributed to land in an improved sale. One of the simplest of these processes is allocation. The appraiser assumes land and building value ratios based on ratios applied by experienced developers or percentages derived by mass appraisals of similar properties. This method works satisfactorily when sufficient development data are available or when the local assessor uses well-supported assessment models.

Extraction—another of the appraising methods mentioned above—can also separate land and improvements value. In this approach, the appraiser estimates a sale property’s depreciated costs and deducts them from the total sale price. This practice is most effective when the improvements are easily quantifiable.

Two variations of the income approach may indicate land value. In residual land capitalization, the appraiser estimates a sale property’s net operating income and subtracts from that the income due that building. The remaining net income to land reveals land value through the application of a market-derived capitalization rate. Furthermore, Ground rent capitalization requires that the appraiser research both land rental costs for similar vacant tracts and the capitalization rates suggested by those tracts’ sale.

Matching Sales Analysis to the Circumstances

A land value opinion can be required in a variety of assignments. Vacant site sales are often scarce in fully developed neighborhoods or in locations where vacant land rarely changes hands. In such instances, sales of improved properties can be used as the sole indication of land value. Some improved sales may even grant little to no value to existing improvements. The experienced appraiser knows how to identify sales that primarily indicate land value and determine such sales comparability to the subject property. Appraisers’ skill and judgment are crucial when either the assignment requirements or available comparable sales data do not fall within the demands of a simple sales comparison approach.

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What is the process when private real estate is needed for public projects? ‘Eminent domain’ is the label frequently used to describe that process, and its basis lies in the U.S. Constitution. All U.S. states, including Massachusetts, have their respective statutes regarding the state taking private real property. Although eminent domain’s application has expanded in recent decades, it is now a contentious issue in many regions. This latest controversy means appraisers currently have a critical role in the eminent domain field, working for private property owners and public entities. When eminent domain plays a part in an appraisal assignment, both the appraiser and client need to be aware of the unique requirements of this kind of practice.

What Is Eminent Domain?

‘Eminent domain’ is the legal term for a government’s legal authority to take private property and convert it to public use. The process of eminent domain is also called condemnation. This power is granted to American governments by the Fifth Amendment of the U.S. Constitution, which also requires that a government that takes private property must offer the property owner equitable indemnity. Courts have traditionally considered just compensation as fair market value for the property taken. The U.S. Supreme Court has defined fair market value as “… the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.”

Dissecting Massachusetts’ Property Condemnation Laws

Massachusetts law further regulates eminent domain within the state. That law does not limit the kinds of uses for which governments can employ eminent domain. In 2005, the U.S. Supreme Court upheld a government’s right to condemn real estate for private development. The decision sparked debate about appropriate uses for eminent domain. Contested uses include those for private redevelopment, sports stadiums, and recreational trails. The issue often revolves around whether the term ‘public use’ includes public improvement or public benefit. Since 2005, 44 states have enacted laws that limit their uses of eminent domain. Massachusetts is not one of those states.

Redevelopment funded by government is sometimes called ‘urban renewal.’ Areas targeted for urban renewal are often described as decayed or blighted. Massachusetts, Vermont, and Maine have specific laws regulating the urban-renewal process. Massachusetts’ Department of Housing and Community Development administers an urban renewal program to help municipalities establish redevelopment authorities.

Similarly, local governments often constitute specific boards or authorities to oversee redevelopment projects in their areas. The Boston Redevelopment Authority directs urban renewal in defined areas of a city, totaling about 3,000 acres. There are similar authorities throughout New England, including in Bangor, Lewiston, and Springfield.

Eminent Domain Expertise

An appraiser can provide a value estimate either for an eminent domain authority or a property owner. When working for the condemning authority, the appraiser may have a role in estimating project costs, preparing appraisals to establish just compensation offers, or serving as an expert witness in court proceedings. Likewise, the appraiser might be retained by the owner or the owner’s attorney after the appraiser has estimated value for a property owner. If the property owner and condemning authority can’t negotiate just compensation agreeable to both parties, they usually proceed to court. In that situation, the appraiser is often seen as an expert witness, and he is almost always hired by the owner’s attorney.

Appraisal assignments for eminent domain require special training and experience. The appraiser must be familiar with valuing partial property rights, such as easements and rights-of-way. He should also be well-informed about the applicable laws of where the taking occurs: these may affect both the market value definition and the admissibility of comparable sales. In an eminent domain court case, the appraiser acting as an expert witness may be asked to provide court testimony. This service demands the appraiser possess excellent public presentation skills and thorough knowledge of court procedure.

Advice for Consumers and Practitioners

Eminent domain has a specific and complex history. The U.S. and Massachusetts both have laws governing the taking of private property for public use. The traditional application of eminent domain is for building highways, utility lines, and public safety projects. Eminent domain also has a role in urban renewal, where a local government seeks community improvement by acquiring and redeveloping a property. Expanded use of eminent domain—for individual developers, sports facilities and trail corridors—has gained public scrutiny. Appraisers serve the eminent domain process by providing estimates of fair recompense, for public entities and private property owners. This service is a specialized area of appraisal practice. Appraisers need extra training to be competent in eminent domain issues and public testimony. Sometimes, an appraiser’s most crucial role is advising a prospective client to seek legal help before ordering an appraisal for just compensation.

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Most improved real properties and many vacant tracts can only be sold subject to existing easements. Appraisers identify existing easements and consider their effect on value whenever a market value definition is part of an assignment. Easements and rights-of-way often influence how real property can be used and may even affect a property’s ownership cost.

Identifying Existing Easements

When an owner has exclusive rights to a building, the property is said to be owned in “fee simple.” But when any part or use of the property is held by another, that part is a “fractional interest.” The interests can be physical, in title, financial, by specific use, or over time. Easements are a type of fractional interest that grants an entity the right to use a specific part of a property separate from the rest of the property.

Physical easements—often used for utilities, roadways, and open spaces—can apply to a site’s surface, its underground, and the space above it. Rights-of-way provide access across a geographic area. They usually are composed of easements over many properties. Whole property easements limit the owner’s right to develop, improve, or alter the property. This type of property easements includes conservation, façade, and historical designation easements.

Appraisers can identify a property’s easements in several ways: recorded documents, such as deeds and mortgages, contain detailed legal descriptions that describe existing easements; a title search will reveal all recorded documents relevant to a property over time; development plats, site surveys, and site plans usually show surface easements.

How Existing Easements Can Affect Property Usage and Value

Utility easements are assigned for gas, electricity, water, sewage, and communication lines. In order to provide uninterrupted delivery of those services, their easements usually don’t allow buildings or surface disturbance. Some kinds of site improvements, such as landscaping, might be allowed. Access easements (for roads, sidewalks, emergency corridors, etc.) prohibit any uses that would block or interfere with passage across a property. These physical easements can reduce a site’s usable area, therefore, the size of potential building improvements. The presence of easements may also dictate improvement layout, such as building height, the placement of driveways, or secondary structures. At the same time, while usable site area is diminished, the property owner is often responsible for maintaining and paying taxes on easement areas.

Whole property easements determine the use of an entire site. Conservation easements forbid improvement of land beyond its current use. Historic preservation easements limit the demolition of existing improvements. Façade easements require that existing improvements be maintained within a specific set of guidelines such as paint colors, materials, and architectural style; all of these restrict a property’s prospective alternate uses.

Value Estimates of Proposed Easements

The value of an easement is most often estimated through a “before and after” analysis. The appraiser develops two value opinions: one assuming no easement and the other reckoning the easement is available. The difference between these two opinions describes the easement’s value. When the intended use of the easement appraisal is to determine just compensation for eminent domain, the appraiser generally identifies which portion of the easement value results from damage done to the property in the “after” condition.

Some appraisers and easement purchasers use alternative methods to estimate easement value. The across-the-fence method compares actual prices paid for other nearby easements. Typically, this method is unreliable because an easement across a specific property affects each property’s use differently. The corridor method assumes a specific property’s easement value as a part of the acquisition cost of an entire right-of-way. Again, this method is unsound because it doesn’t consider the unique attributes of each easement within the right-of-way. Corridor valuation also sometimes ascribes added value to a group of easements over multiple properties.

Easement valuation is a specialized kind of real estate appraisal. Appraisers gain that special expertise through additional education, experience and, often, participation in professional organizations such as the International Right of Way Association.

Conclusion

A competent appraiser identifies existing easements, their limitations on usability and their effect on value for every subject property. Easements may reduce usable area of a site, the extent of improvements to the site, and future uses of the entire property. Careful review of sale documents, title insurance reports, site surveys, and development plats help the appraiser identify easements that are in effect on the date of appraisal. If quantifying the value of easement is part of an appraisal’s intended use, the most usual approach is “before and after” method. Easement and right-of-way valuation are an appraisal specialty. Appraisers and clients should ensure that competency requirements are met in this kind of assignment.

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It’s standard procedure for most commercial lenders to request all three approaches to value—sales comparison approach, income approach, and cost approach—be undertaken during an appraisal. Usually, there is a stipulation that an approach may be excluded from the valuation if such an approach is deemed dispensable. This omission can be a point of conflict between lenders and appraisers, as the necessity of one or more approaches is debatable in certain situations. This post attempts to clarify the instances where the cost approach is either relevant or extraneous to a property’s valuation. Being able to prudently determine the importance (or otherwise) of the cost approach to valuation increases efficiency and fosters understanding between lenders and appraisers.

What Is this Method all About

Per Investopedia, “The cost approach is a real estate valuation method that surmises that the price a buyer should pay for a piece of property should equal the cost to build an equivalent building.” Essentially, in the cost approach the market value of a property is equal to the cost of the underlying land plus the cost of new construction, minus depreciation. To assist with the cost approach, most appraisers turn to cost manuals, such as the Marshall & Swift Valuation Service, that provide pertinent information on building expenditures associated with different building types, locations, and dates of construction. The following section breaks down the ideal scenarios that require this approach to valuation in commercial appraisals.

When to Use the Cost Approach

The ideal stage to utilize the cost approach is when constructing or proposing a new property. Given that construction expenses associated with erecting a new building should be readily available to the appraiser, these costs are often the best indicator to determine a property’s value. While some buildings may be improved beyond market standards, generally, the most compelling reflection of the cost approach is when the actual price to construct a property is known. The over-improvement issue would likely be adjusted for in an associated sale comparison approach, which would then be reconciled with the cost approach to reach an appraiser’s value conclusion.

The valuation of special-use properties (such as churches, schools, libraries, or other non-income-producing buildings) usually requires the use of the cost approach. Since most of these buildings neither yield an income (and if they do, it’s often at non-market rates) nor frequently transact in some markets, the cost approach can be either the primary or the sole approach for valuation. Although calculating appropriate depreciation can be challenging in these instances, most cost manuals include reference charts to help appraisers determine the right amount of depreciation.

Often when an appraisal is ordered for insurance purposes, a cost-based valuation is required. An example of this is when an insurance company needs to know the exact amount to insure a building, which requires separating the underlying land value from the building’s worth. In this case, the cost method would be the most relevant approach to valuation.

The Cost Approach Is Not Always Relevant

For older properties, the cost approach is generally not as useful. While there are some exceptions, such as found in special-use properties, the high degree of depreciation in older buildings makes it difficult to accurately apply depreciation in the valuation. Considering this reality, buyers normally won’t consider this approach during their buying process, making it not only an unreliable approach to valuation, but also irrelevant in the market.

In some cases, the income approach and the sale comparison approach are enough to determine a property’s value without the use of a cost approach. This cost-approach exclusion tends to be especially true for income-generating properties. For example, unless it was very recently constructed, an appraisal of a multi-tenant retail building would likely exclude the cost approach. In this scenario, given the reliable data derived from the subject property’s income and expenses and the high probability that there are good supporting rent and capitalization rate comparisons in the market area, the income approach would provide the best indication of the subject’s value.

The second-best indication of the property’s value would then be determined by the sales comparison approach (also called the substitution method), again, assuming there are ample sales comparisons within the subject’s market. If there is an active market for the multi-tenant retail building mentioned above, and vacancy rates are relatively low, it is likely that there would be a large pool of buyers interested in purchasing the property. As with the case in older properties, a potential buyer for this multi-tenant retail building most likely wouldn’t consider the cost to construct a similar building in the area, unless the buyer had more specific needs. Their main concerns are the property’s income potential and the cost to acquire the property, compared to other similar properties in the area. Therefore, the cost approach would be irrelevant in the market in this situation and, thus, should be excluded from the appraisal.

Efficient Appraisals

Now that we’ve addressed some examples of when a cost approach is necessary, you’ll have a better understanding of when it’s proper to request a cost approach and when this valuation method is redundant. Identifying instances where the cost approach is not needed can ultimately increase an appraiser’s efficiency and speed up the appraisal process. The necessity of this approach should be discussed in your initial conversation with an appraiser when determining the appropriate scope of work.

The post The Cost Approach: Examining an Important yet Sometimes Irrelevant Appraisal Method appeared first on Boston Appraisal Services.

The Market Analysis section in an appraisal report contains precious information that directly influences the value of a property and also provides priceless insight into a myriad of data relating to the financial feasibility of a property. It is common for many prospective users of an appraisal report to ignore various sections of the report and focus solely on segments that indicate property value. The downside of this approach to valuations is that the reader, therefore, misses key insights into the subject market that can benefit the owner, buyer, seller, or lender.

Highest and Best Use Application

The impact of the marketability studies in the Highest and Best Use section is perhaps the most meaningful—highest and best use refers to the utilization of a real estate in a way that such property will yield the greatest economic benefit for the owner or operator of the property. These studies provide valuable information for the highest and best use decision. While it would be easier to read only the Highest and Best Use section of an appraisal, the hard data that support the financial feasibility element of the highest and best use conclusion is found in the market analysis. In the Market Analysis segment, you can expect to find the ‘what’ and ‘why’ of a property’s marketability and feasibility.

Typically, the best use is consistent with the usage of surrounding properties and complies with existing and emerging zoning policies. Also, the Market Analysis section provides the figures required to identify the use that could lead to a higher profit potential (relative to that derived from the existing use) and making purchase or finance offers that leverage this potential.

Business/Tenant/Occupant Insight

One of the more overlooked aspects within a commercial appraisal market analysis is a review of the primary business(es) or tenant(s) occupying a property. Beyond surface-level information, many reports will address a business’s history at the subject, as well as their competitive market and long-term potential at the site. Businesses, schools, churches and other special-use properties can have some of the more interesting and insightful analyses into their operations. Understanding not only the property, but the use and functionality for the current occupants help to provide a more holistic comprehension of the subject and make investment decisions that are guided by extensive research and objective statistics.

Local and National Economic Information in the Market Analysis

Being well informed on the inner workings of the market influencing subject value is always a good idea, regardless of the locality or economy. A well-rounded report serves to cover market trends and economic obsolescence of the location more thoroughly. Fortunately, nearly all Market Analysis sections will (to varying degrees) assess the local and national economic factors that are directly affecting both the subject property and the economy as a whole. The best reports will further include an array of compelling charts and graphs to pair with the data presented in the text. Experienced local appraisal firms strive to provide the most recent and accurate data on these topics; these companies can be reliable sources for important economic and market information, as well as assisting in interpreting the results generated.

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If you’re planning your next development, considering strategies for an upcoming renovation, or managing an existing build, how can you maximize the returns from the project and do something good for human health and the environment?

There are an array of strategies and methods to reduce environmental impact, limit energy and water consumption, increase demand and resale value, and improve your bottom line.

Reduced Operational Costs

The most pragmatic reason to pursue green strategies is to save money. If the methods you implement don’t contribute to a positive cash flow, it’ll be difficult to justify the measures to stakeholders in the project. Fortunately, it’s relatively easy and inexpensive to make short-term modifications and improvements that limit wasted energy and increase margins.

A simple measure is energy efficient lighting in the form of CFL and LED lamps that cut energy consumption by 76.7% and 88.3% respectively. This is a fairly obvious and common example, but it can save you a tremendous about on electricity when applied to the scale of a commercial building and all the interior and exterior spaces that require relatively intense lighting. Lighting is critical to the user experience and can have a very real impact on tenant comfort and appeal. According to the U.S. Energy Information Administration (EIA), lighting accounts for 10% percent of energy use in commercial buildings.

The greatest costs are attributable to space heating and cooling at 33% of typical energy expense as reported by the EIA. Low cost methods to cut costs are as simple as replacing air filters with the highest MERV value available. Restriction in airflow reduces HVAC system efficiency drastically. In the planning phases, give extra consideration to installing dual or triple-pane coated windows that have very low heat transfer and help keep indoor temperatures consistent regardless of outside weather. High R-value insulation is also crucial to maintain a thermal barrier that keeps funds in your account.

Improved Tenant Demand and Resale Value

While reducing energy costs is important, what’s even more crucial is creating a structure that meets the needs of the people that occupy it. No matter how efficient your structure is, if it doesn’t provide an environment that fosters good health and promotes greater productivity, it’s not likely to command a high rent or maintain a low vacancy rate. Tenants and buyers value comfort, ergonomics, functionality and a pleasant psychological environment.

A couple things to consider are thermal comfort, daylighting, and natural views (all of which will earn you LEED credits). Thermal comfort includes providing solar control (window coverings), zoned HVAC, and user controls in occupied spaces. Daylighting reduces artificial lighting requirements and also brightens the interior with natural light that lifts moods and inspires creativity. Another aspect of occupant comfort is proper ventilation, both during and after construction. Indoor air quality (IAQ) in an important factor in sustainability and has ramifications for human health, comfort, and the likely resale or lease value of your project.

There is so much to cover on the topic of commercial real estate value and sustainability, that we’ll have to break it down into more future posts. If you have any questions or comments, please feel free to leave them below. If you’d like to know how specific features can affect value from an appraiser’s perspective, please reach out and we’ll share all our knowledge and resources with you.

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