Appraisal in Lima, Peru

An interesting cityscape resulting from upzoning approved in the 1990s. Many of the office buildings erected then have a lack of windows.

This was a one-acre site, improved with an old mansion from decades ago, situated in Lima’s main financial district, San Isidro. Per JLL (Jones Lang LaSalle), the office vacancy rate in San Isidro was measured at the end of 2013 at just 1%, so a site such as this one would have great value to commercial real estate developers.

Many Latin American cities are divided into municipios, or municipalities, which are similar in concept to the boroughs of New York City. During the 1990s, the municipio of San Isidro, a sort distance south of Lima’s central business district, was upzoned to building heights ranging from 4 to 32 stories, and most of the banks relocated to this district, making San Isidro Lima’s de facto financial district, but also home to many embassies, too. This is one of the nicest areas of Lima.

Lima and Peru have in recent years undergone rapid economic expansion, averaging 7% per year and predicted to be 6% this year, and the supply of office and residential space has been unable to keep up with rapidly increasing demand from redevelopment ventures. This has resulted in urban land values spiraling upward, quadrupling since 2006.

In places like Manhattan, New York, such land is often appraised on a “value per square foot of allowable building area”, which is based on land prices divided by site area divided by FAR (Floor Area Ratio). Such a method does not work quite so well here in Lima because many lots are so small that high density construction is not efficient, partially because of required setbacks. There are many lots of less than 400 square meters (4280 square feet) zoned for 7 stories of construction, and perhaps their main value is to serve as part of an assemblage of a larger site, which is being done all over the financial district in San Isidro.

The Lima office of Colliers International, which seems to be the most active global broker in Latin America (based on seeing their signs), was generous in providing comps. However, I found that price per square foot of FAR was not working as a unit of comparison; it was seriously undervaluing many sites with allowable building heights of 7 stories, which are selling for more than $3000 per square meter.

Because of the number of available comps, I performed a regression analysis on the data in order to isolate possible adjustments to comparable sales for both building height and for site area. Because of low sample sizes in commercial real estate markets, such regressions cannot meet the high standards of the scientific community, yet they are better than pulling adjustments out of thin air, the last resort of many appraisers. The regression suggested an adjustment of $170 per square meter of site area for extra floor allowed to be built. The adjustment for site area was more understated, a premium of $60 per square meter for every extra 1000 square meters of site area.

This assignment reminded me of a similar assignment in San Jose, Costa Rica last summer. The shortage of land within the central cities of prospering Latin American cities is resulting in a profound amount of redevelopment, and it must be an exciting time to be a real estate developer in many Latin American cities.

Appraisals of "View Land" in Costa Rica

Much of my work involves flying to faraway places and then being driven in a 4-wheel drive vehicle into the countryside, up winding dirt roads, to a parcel of land with sweeping vistas featuring bodies of water, and then being told “Just look at this view. It’s priceless.”

I often encounter misconceptions of what constitutes the value of a “view parcel”. There is no argument that a finished lot with a view commands a premium over lots with no views. I emphasize the word “finished”, as “raw” mountainside or mountaintop land with views is usually priced and valued less than flat land at lower elevations.

Why? Because of the extra costs to develop land in rugged terrain or higher elevations.

Let’s indulge in a reductio ad absurdum to make my point.

The top of Mount Everest offers spectacular views, but I offered to sell you a lot up there, you would say “How ridiculous! How could I get my Range Rover up there? How and when could I get utilities connected? Where would I buy groceries?” I would attract no buyers, despite the magnificent view.

Suppose that I had already graded the lot and just completed a 4-lane road to the top of Mount Everest, installed all utilities, including digital cable, and even supplied extra amenities such as a golf course, supermarket, and gourmet restaurant? Now that might be something somebody is willing to pay a lot of money for, and the value would be enhanced by the unequaled views from the top of the world.

The extra costs of land development at such a high altitude would probably not be compensated for by the view premium for the finished lot, so this hypothetical unfinished lot on top of Mount Everest would be comparatively worthless.

View Land for Rich Gringos
Developers all over the world have spent the last few years acquiring “view land” for subdivision and sale to rich foreigners, whether they are North Americans, Europeans or Australians. Costa Rica is crowded with numerous proposed “5-star developments” as developers compete to attract rich gringos. Most of the developers are foreigners, too. Many of the projects have impressive artists’ renderings and obligatory photos of female backsides in infinity pools, beautiful women getting massages, Caucasian families frolicking on the beach, and exotic fauna and flora.

 

The result in Costa Rica, as I’ve also seen in Mexico, Fiji, the Dominican Republic, Brazil, Canada, and Barbados, is a surplus of unstarted or unfinished (see previous post on Barbados) 5-star projects and declining values for raw land.

Such was the case with two land parcels I recently appraised in different parts of Costa Rica. The dome-shaped parcel below looks very difficult to develop because of steep slopes, but there are views at the top of the scenic Orosi Valley. Also limiting value was the lack of approved entitlements and a well report indicating a water flow rate (10.8 liters per second) which can only support about 16 households.

The Orosi Valley


The other subdivision had distant ocean views and was farther along in the entitlement process, still not having local approval, and the “will serve” letter from the municipal water utility read more like “we might serve in the distant future”, as was their commitment to waste collection. This project had pre-sold 9 out of 94 lots in the last 20 months, at prices ranging from $100,000 to $270,000, but pre-sales stopped in 2011, and once pre-selling stops, it is very difficult to get it going again, as foreign buyers fear that the project won’t get completed and they may lose their deposits. When existing buyers see land prices falling, moreover, they may be willing to forfeit their $5000 deposits.

The foreign subdivision projects I actually see succeeding, on the other hand, are the ones aimed at the local nation's burgeoning professional class, offering lots and residences at lower prices within reach of the upper middle class and within commuting distance of major employment centers.  In the Dominican Republic, for instance, when a new highway improved accessibility to the beach towns east of Santo Domingo, such as Juan Dolio, Grupo Metro made a lot of money building condos and villas for sale to professionals working in Santo Domingo.  Similarly, I've seen the Palm Springs community north of Natal,  Brazil, achieve enviable pre-sales as new roads and a bridge to downtown Natal are enabling Palm Springs to become an oceanside bedroom community for Natal commuters, with lot prices starting at $30,000, certainly within reach of the middle class.

One stigma that is currently complicating lot sales in Costa Rica to foreign buyers are some spectacular development project failures, such as Hacienda Matapalo and Wyndham Jade, which are alleged to have been fraudulent schemes all along. There have been development scams, teak farm scams (see my post entitled “Costa Rican teak farms for gringo investors), and squatter scams (see my post entitled “Latin American land grabs from absentee owners”) going on in Costa Rica, many of which are being perpetrated by foreigners, too, such as Americans, Canadians, British and Dutch. That does not mean that local developers are any more trustworthy, and the inherent problem spoiling confidence in the real estate market in Costa Rica is its slow, ineffectual justice system.

Meeting a Costa Rican appraiser

In this valuation assignment, the developer asked me to meet “the independent appraiser” to discuss his recent valuation of the two properties together for a combined value of $12.4 million. Finding the “independent appraiser” sitting across from me at the lunch table made me doubt his independence, and his valuation reports were addressed to the developer.

The developer invited me to ask the appraiser questions. My first question was “¿Qué es lo que utiliza para las ventas comparables?” (What did you use for comparable sales?) His answer was quite unexpected but interesting. There is some institution, perhaps governmental, which has mapped out real estate values, and a Costa Rican appraiser consults the map and then makes adjustments much as any appraiser would. This is not the same thing as researching comparable sales, though, although the map is probably based on previous sales; I just don’t know how long ago they occurred.

Incidentally, all professional appraisers in Costa Rica, as in Mexico, are either architects or engineers, and are expected to have a more rigorous education in quantitative methods than in the U.S., where one can major in Psychology or Religion and still meet the academic standards needed to get certified or designated.

I am not an architect or an engineer, but as an appraiser I am a traditionalist. I like to use recent comps and listings (if the listing prices are below previous closed sales prices, and there is no shortage of failed subdivisions for sale in Costa Rica). Unfortunately, my estimate of value came in lower.

Appraisal in Costa Rica

The property consisted of three parcels of raw land totaling 92 acres adjacent to a remote beach in Guanacaste, a northwestern province of Costa Rica. The owner wished to finance construction of a 5-star hotel, tourist hospital and wellness center. The owner had signed a management agreement one year ago with Barcelo Hotels, a Spanish-owned luxury hotel group with many existing hotels in Mexico and the Dominican Republic. There were Costa Rican appraisals estimating the combined property to be worth about $26 million “as is”.

Although written in Spanish, the Costa Rican appraisals seemed to contain too much hyperbole to be considered objective. For instance, what were described as 360 degree panoramic views were largely obscured by hills and protected mangroves. The appraisers also assumed that 25 kilometers of unpaved road leading to the project would soon be paved and they valued “protected” (unbuildable) land at 80% of the value of buildable land. (Twenty percent would be a more reasonable number, since nature preserves do add some incremental value to adjacent development land.)

The owners claimed to have full entitlements to build the project, but the submitted documents only indicated approval to build 12 seven-story condominium towers on one of the three parcels, and these approvals were from 2007. The owner had decided to turn the condo towers into hotel rooms, without creating architectural drawings or plans, and there was no documentation that a development plan for a hospital and wellness center was even under consideration by local authorities. There were no drawings, plans or specifications for the revised development plan, other than a generalizd aerial view of the proposed project. The only site work had been to drill two authorized wells.

There were factors that caused great doubts about feasibility, the first of which was the lack of paved road access. The closest paved roads were in Santa Cruz, 25 km away, and the 6-month rainy season and rugged topography of this region can make road travel difficult, as roads are occasionally flooded during the rainy season. Four wheel drive vehicles are needed for half of the year. This is not a good setting for a 5-star hotel, but for a hospital, the setting was particularly doubtful. Successful tourist hospitals are typically located near airports, indicating that accessibility is a strong selection criterion of a hospital. The notable tourist hospitals in Costa Rica are CIMA, Clinica Biblica and La Catolica, located in the capital of San Jose, and the first two are already developing similar facilities near the Daniel Oduber airport in Guanacaste, with La Catolica also considering a branch there.

The idea for this project is that the hospitals would specialize in cosmetic procedures and that patients had the choice of convalescing in a time-share wellness center or else in a room in a 5-star hotel. Get a face-lift, for instance, and spend a month recuperating while gazing at the ocean. Still, the concept of a hospital so far removed from paved roads seemed to be far-fetched. Imagine being sore from a tummy-tuck operation and then having to return to the airport over bumpy, gullied roads.

The other factors that made me believe that this was not a serious project were:

1. The property is listed for sale for $8,500,000, entitlements included.

2. The property was previously listed for sale in 2008 for $5,500,000 and marked sold.

3. The construction cost estimates were quite incomplete, as were designs, drawings, plans, and specifications.

4. The lack of housing in the area for hospital or hotel support staff.

Considering that the owner had originally conceived of condo towers and townhouses on his property, the change to hotel and hospital seemed like an afterthought. This was a parcel of land in search of a profitable use, not a hospital enterprise in search of an ideal location.

As in Mexico, comparable sales are hard to come by in Costa Rica. There is no rule that the sales price recorded has to be accurate, and there are other circumstances that induce sellers to record false prices. I turned to listings of entitled land and unentitled land to set a ceiling of value for the property, and there are getting to be more fully entitled projects put on the market today just as in U.S. beach communities, too. I found entitled projects priced as low as $20,000 per developable unit, and unentitled ocean-adjacent land in Guanacaste priced as low as $10,000 per acre. I valued the hotel parcel as entitled land and the other two parcels, with no proven entitlements, as unentitled land.

Unfortunately, when looking at lending opportunities in Latin America, I see too many deals like this one, with the property listed for sale at a fraction of the value estimated by local appraisers, with the owner meanwhile spinning a fanciful story of a world-class development project. Lender beware!

My observations about international real estate deals are essentially this:

The least desirable properties must travel the furthest to find buyers or lenders. Good real estate opportunities tend to get picked off by local investors and lenders.