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Finance and economics generally focused on real estate

Archive for October 26th, 2020

Trophy Property

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As you all know, earlier this year I put the finishing touches on Real Estate Valuation and Strategy, published by McGraw Hill. (The link to the right takes you to the Amazon.Com page, but it is also available thru Barnes & Noble, Books-a-Million, and other regular business book retailers.) While finalizing this, I was simultaneously outlining my next two, one tentatively titled Stigma: Revisited Again and one on Trophy Property Valuation. The former is still in the outline stage, but the Trophy Property book is coming along nicely. Of course, dealing with Covid and assorted ramifications has slowed down a lot of things on my agenda, but hopefully I can move forward this winter.

The genesis of the trophy property book came from the work I did in the valuation of historic property, architecturally valuable property, and historic districts, mainly back in the 1990’s. I actually started writing Trophy Property with an eye to just those narrow niches, but came to realize that there is more of a need for a broader book, examining “preseravable” properties in the context of top-tier, collectable real estate.

My former business partner, and good friend Dr. Bill Mundy, wrote a series of articles for The Appraisal Journal some years ago on this very topic. At the time, his focus was mainly on collectable ranch lands and western “open space”, but the general paradigm holds for all manner of high-end, collectable “trophy” real estate. His definition of trophy property, broadly speaking, was the top 2.5% of any property in any given sector. Thus, one could have trophy residences, trophy forests, and even trophy commercial property. This last category is particularly fascinating — consider the top-tier office building or buildings in any major city. For example, consider Rockefeller Center or the Empire State Building or the Chrysler Building in New York City. Each of these, and many more like them, are owned not just for the direct income but also for the “halo effect” that owning such a building can have on a portfolio. Of course, the owners of such buildings expect top-tier rents and returns over time, consistent with the reputation of such properties.

Right after the 9/11 attacks, I was called in by some real estate investors to discuss the very special security needs — and thus valuation implications — of “trophy” office properties. While every major office building in the world faces heightened security today, as compared to 20 years ago, it almost goes without saying that high-amenity “trophy” buildings can be of particular concern.

Valuation of such properties is a challenge, and requires a significant level of experience, expertise, analysis, and often unusual data. Several years ago, I was asked to value an island off the coast of New Zealand. While such islands trade hands regularly, this particular island had been developed as a trophy “get-away” by a Forbes-400 family. Normal valuation metrics hardly applied, and the value of the island had to take into account the global market for such complex properties.

With that in mind, there are some generalities that transcend all sectors of trophy property investing, valuing, and curating:

  1. The market for a trophy property is often global, not just local. Valuation of any asset usually requires consideration of recent sales of comparable properties. However, what is comparable? For that matter, what is the market?
  2. Trophy properties often require care and maintenance above and beyond the norm for non-trophy properties. Again, consider just the security concerns. Consider also that “trophy” properties often have life-spans well beyond the economic norm. One great example are homes of ex-Presidents of the U.S. or other famous individuals, which are carefully maintained, at great expense, even though they are usually well beyond their economic or structural lives.
  3. Income producing trophy properties, such as offices or high-end retail establishments (think “Tiffany’s”) have very different capitalization metrics. Much like distressed properties have higher equity ROI expectations, trophy property may have much lower or even non-existent equity dividend rates, because…
  4. Value expectations are either in very-long-term growth prospects, subjective benefits, or halo effects. As a result simplistically determined market values may be very far different from more complex investment values. Indeed, more often than not, trophy properties sell at investment values rather than a more quantitatively determined market value. This point confounds professionals in the valuation field. If trophy properties trade at investment (rather than “market”) values, the don’t these investment values BECOME the market value? Indeed, this is a troublesome question, of no small concern when considering point 5…
  5. The tax implications for trophy property can be enormous. Many trophy holdings are curated to provide tax credits, and thus come burdened with easements with implications for down-stream owners. However, determinations of the bases for such credits requires a stylized measure of “market value” and defending this can be a challenge when similar properties are sold for complex purposes.

Point 5 gets even more complicated when dealing with a pure tax credit as opposed to a sale (or swap) of property to the Federal government. As it turns out, different valuation rules apply, and so even “market value” may be two different numbers, depending on the intended users of the valuation.

I know this is a scattershot of information about trophy property holdings, the implications for valuation, and the potential benefits. Acquisition, management, and value optimization are all dynamic elements. Real Estate Valuation and Strategy dealt with these topics in the context of overall real estate investment, and hopefully I’ll have the chance to drill down on these issues more closely in the next book. In the meantime, and as always, if you have any questions, I invite you to reach out.

John A. Kilpatrick, Ph.D., MAI —

Written by johnkilpatrick

October 26, 2020 at 10:30 am

Posted in Uncategorized

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