Fractured Condo Projects:              Highest and Best Use Determines Valuation Approach                                 ...
Feature Articleunits are rented be valued the same               I am unaware of a provision in the law     value a condom...
most significant for fractured condo         the highest and best use and the cor-         In essence, the proper valuatio...
Feature Articlehave rejected this approach, as illus-         Arbitrary adjustments to sales were ad-        the highest a...
Fractured condos
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Fractured condos


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In the current real estate market,
owners of condo conversion properties
are unable to sell their units at
prices they previously enjoyed and
thus are renting their unsold units.
These residential condo projects are
called fractured condos and present a
challenge to conventional valuation

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Fractured condos

  1. 1. Fractured Condo Projects: Highest and Best Use Determines Valuation Approach Tim WilmathThe statements made or opinions expressed by authors in Fair & Equitable do not necessarily represent a policy position of theInternational Association of Assessing Officers.T he trend of converting apartment properties into projects, on the other hand, are typically assessed (and condominiums began in Florida in 2004. The moti- appraised) on the basis of the income approach and/or vation was to maximize profit—an individual condo sales of entire apartment projects. Typically, in apartmentunit generates a higher value than a rental apartment. projects units have a lower value than individual condoThis trend quickly became a very popular mechanism to units. For this reason, many fractured condo owners re-generate cash flow, and hundreds of apartment projects quest their properties be assessed as Florida were converted to condos. Since late 2006, however, the overall residential real es- Residential condominium projects in which a significanttate market has declined significantly. As a result of thisdecline and the oversupply of individual condo units, many portion of the units remain unsold and are being rentedcondo conversion property owners (typically developers)have been unable to sell units at the prices they had previ- are often referred to as fractured condos; that is, they areously enjoyed. Renting the units became a more appealing partially owner-occupied and partially rented.option than selling them at significantly reduced prices. Residential condominium projects in which a significantportion of the units remain unsold and are being rented As these fractured condos became more prevalent andare often referred to as fractured condos; that is, they are the number of tax appeals rose, the Hillsborough Countypartially owner-occupied and partially rented. Tradition- (Tampa, Florida) Property Appraiser’s office was increas-ally, individual condo units are assessed (and appraised) ingly challenged about the proper way to value theseon the basis of sales of individual condo units. Apartment properties. Should condo projects in which most of the Fair & Equitable • July 2012  3
  2. 2. Feature Articleunits are rented be valued the same I am unaware of a provision in the law value a condominium unit as a time-way as traditional apartment complex- which would permit unequal assessed share until the condominium unites? If there is a market, even a weak values for identical residential units becomes a legal timeshare under themarket, for condo units, should sales such as condominiums or subdivision law. It seems that it would be equallyof individual condo units be used to properties based solely on whether the improper for the property appraiserdetermine the value? If the developer owner chooses to live in the property or to value unsold/rented condominiumof a fractured condo project seeks to rent it out. (Jeff Kielbasa 1993) units (in a project in which some unitspurchase back sold units in an attempt In some cases, unsold units far out- have been sold) as if the property wereto dissolve the condominium, should number sold units in a condo proj- one rental apartment project, priorthe facility be valued as an apartment ect, particularly condo-conversions to the termination or the imminentcomplex? These were the questions that were converted well into the real termination of the declaration of con-facing the Hillsborough County Prop- estate boom and at the beginning of dominium.erty Appraiser’s office when it was try- the downturn. Owners of these prop-ing to forge a policy for valuing these Highest and Best Use erties often assert that the propertyproperties. In reviewing all the issues related to appraiser’s office should value the fractured condos, the property ap- property utilizing the income ap-Precedents Set by Court praiser’s office realized that the real proach, because the vast majority ofDecisions the units are being rented and most issue in the selection of the valuationUnderstandably, many condo con- approach is highest and best use. of the property is being operated asversion property owners believe the Typically, the actions of the market an apartment complex.assessment of the unsold units must indicate highest and best use. Whenbe based on the income approach, be- a developer converts apartments tocause the units are being rented and The determination of highest individual condo units and sells allnot marketed for sale. The courts have of them, clearly the highest and bestruled that the method of assessment and best use is accomplished use is individual condo ownership andis at the discretion of the property through the traditional four-step the appropriate valuation approachappraiser. In Bystrom v. Bal Harbour would be based on sales of individual(1987), the court stated, process: physically possible, legally units. When a developer converts apartments to condos and is unable to The mere fact that that the taxpayer permissible, financially feasible, sell any units, the market is reflecting disagrees with either the weight to be and maximally productive. Of those that the highest and best use is prob- accorded each factor or the method to ably apartments. For apartments, the be utilized in arriving at the valuation of the property is not a sufficient reason four steps, the most significant for appropriate valuation method would be the income approach or sales of to overturn the appraiser’s valuation. fractured condo projects is the last whole apartment projects. Although the owner of a condo-minium unit may choose to rent it, one: maximally productive. However, many projects have toothat action alone does not dictate that many sold units to be consideredit should be valued via the income ap- apartment projects. This point of no In Schultz v. Lurie (1987), the courtproach. As the Florida Supreme Court return prevents the developer from actually held that a condominiumnoted in Bystrom v. Whitman (1986), dissolving the condo documents and project should be valued as an apart- resuming the original arrangement. The core issue in any action challeng- ment project utilizing the income There are too many sold units to go ing a tax assessment is the amount of approach. However, in that case, the back in time, yet a significant inven- the assessment, not the methodology taxpayer owned all the units within the tory of unsold/rented units remains. utilized in arriving at the valuation.” project and could terminate the con- These are the properties that chal- Clearly, it would be improper to dominium at any time. Unfortunately, lenge conventional valuation think-value some units in a project with one in most condominium projects, a num- ing. The determination of highest andapproach (sales) while valuing iden- ber of units have been sold and are best use is accomplished through thetical units with a different approach outside the control of the developer. traditional four-step process: physi-(income). The Florida Department of In Gilreath v. Westgate Daytona, Inc. cally possible, legally permissible, fi-Revenue echoed this point in a June (2004), the court held that the prop- nancially feasible, and maximally23, 1993 opinion, stating, erty appraiser is not permitted to productive. Of those four steps, the4  Fair & Equitable • July 2012
  3. 3. most significant for fractured condo the highest and best use and the cor- In essence, the proper valuationprojects is the last one: maximally responding approach appropriate for approach hinges on the determina-productive. Which use would produce fractured condos, as follows: tion of highest and best use. Thesethe highest value—apartment rental five guidelines assist the assessor in 1. If a developer owns every unitor sales to individual owners? making that determination. If the in the condo project and is op- When sales of condo units slow highest and best use is deemed to be erating the property as a rentaldown, many developers choose to rent individual condo ownership, then apartment property, then the in-the units because the price at which the valuation approach is the sales come approach should be usedthey would sell is unacceptable. Often comparison approach using sales of with sales of apartment projectsthese properties have a mortgage bal- individual units. If the highest and as the basis for valuation.ance greater than the current market best use is deemed to be apartments, 2. If a developer has sold only then the valuation approach is thevalue; this is often referred to as being a very few units but is trying to income approach using sales of apart-upside down on a property. Rather than reverse the condo conversion ment projects.sell the unit at a loss, in the interim by buying back sold units, thenmany owners choose to rent, wait- Method of Valuation the highest and best use is prob-ing until the market improves. Many Once the highest and best use has ably apartments and the incomeeven discontinue sales and marketing been established, the appropriate approach should be used withefforts during this interim period. valuation approach is determined. sales of apartment projects asAlthough the prices at which units Although the property appraiser’s the basis for valuation.could sell are below the debt amount, office may be confident about thethey are above the values per unit as 3. If the developer has reached valuation approach, the propertyan apartment property. This indicates the point of no return, that is, owner is often still convinced thethat the highest and best use remains there are too many sold units property should be treated as ancondos—with an interim use as rent- to make repurchase feasible, apartment complex. In seeking anals until the market provides a price then the highest and best use is assessment reduction, the owner oracceptable to the owner and above the probably condo ownership, not the owner’s representative sometimesdebt amount. rental, and the sales comparison utilizes methods inappropriate for approach should be used with assessment purposes. individual units as the basis forThe determination of highest and valuation. Many appraisals for financing pur- poses utilize the discounted cash flowbest use ultimately dictates the 4. If the project is still marketing approach. Financial institutions are units for sale, then the highestvaluation approach to be used. typically interested in the discounted and best use is likely individual value of the unsold units with con- condo ownership, not rental, sideration of an absorption period, and the sales comparison ap- selling expenses, and holding period. Sometimes developers convert proach should be used with However, this approach has beenapartments to condos and are unable individual units as the basis for rejected for assessment sell them at price typical for simi- valuation. In Palm Beach Development v. Walkerlarly sized condo units. This clearly 5. If a developer has temporarily (1985), the court stated,indicates that the highest and best use discontinued marketing unitsis reversion to apartment use. Often because of the declining market Implementation of the owners’ dis-this is accomplished through dissolu- but sales in competing projects count sellout theory would result intion of the condominium documents. indicate units would sell for more lower valuations on owners’ property than they would as a rental prop- than exist on adjacent similar propertyDetermining the Valuation erty, then the highest and best owned by others.Approach use is probably condo ownership, Another technique used by apprais-The determination of highest and best use not rental, and the sales com- ers in valuing condo conversions isultimately dictates the valuation approach parison approach should be used sales of entire apartment projectsto be used. In that light, the prop- with individual units as the basis instead of individual condominiumerty appraiser’s office has developed for valuation (with consideration units. In essence, they are valuing theguidelines to assist in determining for the declining market). sale of the units in bulk. The courts Fair & Equitable • July 2012  5
  4. 4. Feature Articlehave rejected this approach, as illus- Arbitrary adjustments to sales were ad- the highest and best use is deemed to betrated in Edward Rose Building Company dressed in Walters v. State Road Depart- apartments, then the income approachv. Independence Township (1990), in ment (1970), in which the court said, coupled with sales of apartment projectswhich the court opined, One of the basic rules of evidence in should be used for valuation. It was not appropriate to apply a ‘whole- this state and other jurisdictions is that References sale discount’ to reflect the difference testimony that is essentially speculative Bystrom v. Bal Harbour 101 Condo- between the prices the developer would and conjectural is inadmissible to minium Association, Inc., 502 So. 2d have received if it sold the lots on an prove the value of property. 1312 (Fla. 3d DCA 1987). individual basis [versus selling them] Summary Bystrom v. Whitman, 488 So. 2d 520 ‘en masse.’ Use of a wholesale discount In the current real estate market, (Fla. 1986). would violate the constitutional require- owners of condo conversion proper- ment of uniformity of taxation. Edward Rose Building Company v. In- ties are unable to sell their units at dependence Township, 462 N.W.2d 325Assessment Appeals prices they previously enjoyed and (Mich 1990).In some appeals of condo conversion thus are renting their unsold units.valuations, property owners point to These residential condo projects are Gilreath v. Westgate Daytona, Inc., 871certain expenses in closing statements, called fractured condos and present a So.2d 961 (Fla. 5th DCA 2004).asserting that discounts to the buyer challenge to conventional valuation Jeff Kielbasa, Assistant General Coun-at closing were not reflected in the re- thinking. Typically, units in apartment sel, State of Florida Department ofcorded sale price. Adjusting sale prices projects have a lower value than those Revenue to John C. Dent, Jr., Dent,based on closing fees is inappropriate. in condo projects; thus condo conver- Cook & Weber, June 23, 1993, Talla-In Southern Bell Telephone and Telegraph sion property owners request their hassee, Florida.Company v. Dade County (1973), the properties be assessed as apartments.court said, Palm Beach Development v. Walker, 478 With a variety of court rulings on this So. 2d 1122 (Fla 1985). Therefore, in this context the price at issue and questions about the valuation which property is sold as indicated approach most suitable for fractured Schultz v. Lurie, 512 So.2d 1003 (Fla. by the documentary stamps on the condos, the Hillsborough County Prop- 2d DCA 1987). instrument is prima facie evidence of erty Appraiser’s office recognized that Southern Bell Telephone and Telegraph its value. determination of the highest and best Company v. Dade County 275 So. 2d 4 Tax appeals for some condo con- use ultimately dictates the appropriate (Fla. 1973).versions are based on analyses that valuation approach. If the highest and Turner v. Tokai Financial Services, Inc.,included extraordinary cost-of-sale ad- best use is deemed to be individual con- 767 So. 2d 494 (Fla. 2d DCA 2000).justments. It is improper to apply a cost- do ownership, then the sales compari- son approach with sales of individual Walters v. State Road Department, 239 So.of-sale adjustment outside of the mass units should be used for valuation. If 2d 878 (Fla. 1970).appraisal approach. The court com-mented on the cost of sale in Turnerv. Tokai Financial Services, Inc. (2000): Tim Wilmath, MAI, is the Director of Valua- tion for the Hillsborough County Property Ap- To allow a blanket deduction for costs praiser’s Office in Tampa, Florida. He has been of sale gives a windfall to the seller who involved in appraising for over 25 years and ad has already accounted for them in his valorem assessments for 15 years.   Tim oversees sales price. Property appraisers can the valuation for all property types in Hillsbor- make a cost of sale adjustment when ough County, a jurisdiction of 500,000 parcels. the circumstances warrant it, but no Tim earned a Bachelor of Science Degree in such deduction is required by 193.011. Business Administration from the University of Some tax appeals for condo conver- South Florida and currently holds the MAI andsion valuations propose significant SRA Designations from the Appraisal Institute. downward adjustments to recent Tim was the recipient of the IAAO Bernard L. Barnard Outstanding Tech-sales. Often these adjustments are nical Essay Award for “Mass Appraisal of Hotels” in 2006.not supported by any empirical data.6  Fair & Equitable • July 2012