In real estate, value isn’t measured by what you spent

AACI | Vice President, The Regional Group of Companies Inc.
  • Oct. 1, 2014

John ClarkIt may seem clear enough: a good or service is only worth what someone is willing to pay for it.

But things can quickly become murky when it comes to real estate. I recently gave a talk at the Canadian Property Tax Association National Workshop, in which I outlined how some properties have no market value because of government restrictions on their usage.

In these instances, an assessment must reflect the market reality – if no one wants to purchase the property because of onerous restrictions, it has little or no value. It doesn’t matter how the property could be used, or what its value could be based on its local market, in the absence of those restrictions. If use is restricted, the property’s assessed value, and its property taxes levied against it, needs to reflect this.

Let’s start with a basic appraisal

An appraisal begins by looking at a property from the point of view that the owner has absolute control of what can be done with the property, unencumbered by any other interest or estate, subject only to the limitations imposed by the four powers of government that I will outline below.

In this scenario, the owner has a bundle of rights that includes the right to sell, to lease, to mortgage or to give away an interest, as well as the right to occupy the property. These rights are not unrestricted. Any restrictions must be reflected in the valuation of property, along with the probability that any intended use of the land could become a reality.

Where is the line drawn on that last point? There must be better than a 50 per cent chance that an intended use is likely to happen. If not, the assessment of the property’s value shouldn’t reflect that intended use.

Take, for example, a prime piece of downtown real estate, which just happens to be an old gas station site with soil contamination, or an old office building full of asbestos. Consider, too, an industrial property in a flood plain that’s annually under threat.

If these issues mean the property has less than a 50 per cent chance of being redeveloped or occupied in a manner that allows it to command the prevailing market rates, this should be reflected in a lower assessed value.

Perhaps like Sherlock Holmes, once you have eliminated improbable uses, what remains is that probable use to which value is to be assigned.

Government restrictions come in four flavours

But a property’s inherent flaws are only one factor that should be reflected in the assessment. Government-imposed restrictions on use typically have the most impact. These fall into four categories:

1. Taxation

2. Expropriation

3. Police power

4. Escheat (the transfer of the property to the Crown or state when the owner dies without heirs)

Of these, police power is the one that most affects the use of property. The Appraisal of Real Estate, Third Canadian Edition, defines police power as:

“The right of government through which property is regulated to protect public safety, health, morals and general welfare. Examples of police power include zoning ordinances, use restrictions, building codes, air and land traffic regulations, public health codes, and environmental regulations.”

Which of course includes, but is not limited to, municipal bylaws and zoning. These restrictions are largely a product of the 20th century, as government came to impose greater and greater restrictions on land use. Gone are the old days, when the only restraints imposed related to the law of public and private nuisance.

What’s left?

Once you have taken that initial assessment based on the owner’s unencumbered use of the property, adjusted to account for the uses of the property that are probable or not, and considered any and all restrictions imposed by the four powers of government, what’s left?

In some cases, not much.

It all comes back to market value – what is an informed buyer willing to pay for the property in a competitive and open market?

Costs incurred in relation to current ownership of the property, and money that has been invested into the property, are moot. If there is no buyer for a property, little prospect for profit and poor odds of collecting any rent from it, there is no market value. “Value,” therefore, is a measure of use and utility.

This of course can be a painful pill to swallow for stakeholders. I have been at meetings where people who should have known better have asserted “it’s big and expensive, everyone knows it’s valuable.”

While it may be poor consolation, there’s at least one upside. If the property is a lame duck and can be proven to be so, at least the assessment should reflect that and result in a much lower property tax bill.

To discuss this or any other valuation or real estate topic, please contact me at [email protected]. I am also interested in your feedback and suggestions for future articles.

John Clark is Vice President with The Regional Group of Companies Inc. He has more than 33 years of experience in the real estate appraisal field, is a fully accredited…

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John Clark is Vice President with The Regional Group of Companies Inc. He has more than 33 years of experience in the real estate appraisal field, is a fully accredited…

Read more

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