Is that thing a “fixer upper” or a “tear down”?

Today a friend asked me how real estate appraisers value properties that are in “below average” condition.  He wanted to know if we valued them in their “as is” condition, and whether or not repair costs were factored in.

In essence, how do you know if a property is a “fixer upper” or a “tear down”?

In a nutshell:

  1. If a property is in poor condition, an appraiser considers whether or not the value of the real estate, in its “as is” condition, exceeds the value of the underlying land.
  2. An appraiser determines this by analyzing the cost to repair the building to typical/average condition, and comparing the net value against the value of the underlying land, less demolition costs.

In detail:

It’s a relatively simple process, the appraisal buzzwords associated with this valuation method are “highest and best use” and “cost to cure”.

To demonstrate the analysis, I went on the Honolulu MLS and found a commercial property built in 1959, the same year Hawaii became a State.

Here, in all of its glory, is the poor condition (according to MLS)  office / retail property known as “1339 North School Street”:

1339 North School Street

1339 North School Street, Honolulu, Hawaii

A bunch of appraiser math/mumbo-jumbo below, skip to the chart at the end to see the answer.

For our purposes, the asking price is irrelevant, especially because the listing includes additional land parcels.  The figures used below are part of a simplistic appraisal demonstration only.

Let’s assume an appraiser determines that vacant land in the subject neighborhood is worth $100 per square foot.  Similarly, let’s assume average/typical commercial buildings are selling for $300 per square foot of building area.  The values would compare as shown below.

HYPOTHETICAL APPRAISED VALUES – 1339 N. School St.
Item Area in Square Feet Value Per Square Foot Total Value
Vacant Land 20,000 $100 $2,000,000
Less: Demolition Costs     -$100,000
Equals: Property Value   $1,900,000
       
Average Condition Building 7,500 $300 $2,250,000
    Difference $350,000

Since the value of an average condition building “as improved” is worth more than the property “assuming demolition”, we proceed to the next step: determining the value of the building in poor condition (its “as is” condition).

HYPOTHETICAL APPRAISED PROPERTY VALUE – COST TO CURE
Item Building Area
in Square Feet
Building Value
Per Square Foot
Total Value
Average Condition Building 7,500 $300 $2,250,000
Less: Cost to repair to average condition   -$500,000
Equals: Poor Condition Property Value   $1,750,000

Let’s assume a reputable contractor estimated the construction/repair cost necessary to renovate the subject building to “average” condition to be $500,000.  This amount is deducted from the “if in average condition” building value to arrive at the value of the overall property in poor condition of $1.75 million.

So, where are we at?

How does land value (assuming demolition) compare to property value (assuming renovation)?

HYPOTHETICAL APPRAISED VALUES – HIGHEST AND BEST USE
Item Total Value
Land Value Assuming Demolition $1,900,000
   
Poor Condition Property Value $1,750,000
Yep, it's a tear down.

Yep, it’s a tear down.

In this hypothetical scenario, the value of the underlying land, even after deducting demolition costs, exceeds the value of the poor condition property “as is”.  Therefore, the highest and best use of the property is demolition of the built-in-1959 (54 year old) improvements to make way for new development.

Questions, comments?  Please leave them in the comment box, I would be happy to clarify and/or expand.

Aloha, Chris

About Chris Ponsar
I'm a commercial and high-end residential real estate appraiser in Hawaii. I'm passionate about appraisal and valuation issues in the same way some folks obsess over football, shopping, or bacon. I love this stuff.

3 Responses to Is that thing a “fixer upper” or a “tear down”?

  1. Dave B says:

    I know that you established land value, but let’s assume that every other commercial building in the area of the subject property is in the same condition. Would you still subtract the $500K “Cost to Repair to Average Condition” as part of the appraisal?

    • Chris Ponsar says:

      Hi Dave, thanks for the comment, good question!

      If every other sale in the area is in similar (poor) condition, we’re done.

      In fact, we’re so done that we might not even need to consider land value if we believe that the buyers of the other poor condition properties are informed and know more about demolition costs than we do.

      So in short, no. No need to add or deduct anything for renovation if all the comps are in the same condition as the subject.

    • Chris Ponsar says:

      Dave – Just updated the post with a bar graph that (I hope) better explains the relationship between the numbers. Thanks for helping me clarify.

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