German Property Portfolio Valuation

 

Four story commercial property in downtown Hannover 

The actual valuation assignment was to appraise a one-half ownership interest in four rental properties in the cities of Hannover and Kiel in Germany. These were multifamily, mixed use and one retail property. 

These interests were inherited by a U.S. citizen, but the other half owner is German. 

To value a partial interest, one has to discount for an owner’s lack of liquidity, lack of control, lack of marketability and lack of mortgage financing. 

Finding comparable sales is extremely difficult, especially in a country of such strict privacy laws as Germany, and because only about one out of about every 500 property sales in western capitalist societies are of fractional interests. 

The ultimate intended user of the appraisal was the Internal Revenue Service, so the appraisal report had to be an English language report done by an IRS “qualified appraiser” who prepares an appraisal report compliant with USPAP, the Uniform Standards of Professional Appraisal Practice. Much of my international work is this kind – inheritances, gifts and the increase in tax basis to spouses of decedents. 

I used a technique known as “factor-based fractional discounting”, a technique developed by the Appraisal Institute, in which individual value factors are quantified and discounted, such as asset risk, profitability, condition, liquidity, diversification, size of interest, lack of control, quality of management and growth potential. I also had to do this method in my last jobs in Korea and Mexico as well as one of the French properties I handled in 2017.

The trip to Germany took place during the New Year Holiday, and it rained every day I was there.  I bought a raincoat of the German fashion name "Camp David", no relationship to the U.S. President's weekend white house. Here I am displaying it.

 

I finished the trip in the charming city of Hamburg. Perhaps John F. Kennedy would have said "Ich bin ein Hamburger!"

"Today is the Day, Club Wyndham!" Why Timeshares, Fractional Vacation Home Ownerships and Condotels are a Bad Deal

 

        Condotel unit in Waikiki

By now there are millions of disappointed investors in these types of properties. The most important investment lesson learned is that these buildings are deteriorating assets that have ever increasing maintenance needs.

When timeshares and other forms of fractional vacation ownership became popular in the 1970s, the U.S. economy was experiencing a high rate of price inflation. Real estate was known to provide protection from inflation, because property values were increasing at a similar rate of return, and leveraged rates of return were even higher. In the early 1980s, condotels had also become the rage in Miami Beach.

My mother was a realtor in the 1980s, and she and her fellow agents were all directed by their broker to buy timeshare units at a resort in western North Carolina. They were told that they were fixing their vacation costs at 1980s prices while their investments would continue to appreciate in value as vacation travel would become more expensive in the future. 

By 2007, my mother was retired and living on a limited fixed income. The maintenance fees on the timeshare had increased to $40 per month and she asked me to take over the deed and use the unit as I wanted. I never visited the actual unit, but since it was part of Club Wyndham, I exchanged my week for other places each year – Hawaii, San Francisco, New York, San Antonio and Mexico. My week only counted for 3 days, though, for a stay in Honolulu, San Francisco or New York.

Now the maintenance fees have increased to $139 per month, meaning that I would be paying $1668, or $556 per day, for annual 3-day stays in Honolulu, San Francisco or New York, which I could get for a lesser cost without any sort of vacation club ownership. Since 2007, these maintenance fees have increased at an 8.66% rate of annual inflation in a period in which the U.S. CPI has increased at only a 2.4% rate of annual inflation.  But this is not fraud, it is the simple arithmetic of property depreciation.

Why are timeshares and  condotels a bad deal?

It's the maintenance fees, Stupid!

This leads me to an important concept that gets forgotten in the real estate investment world, that buildings are deteriorating assets. Over time, income for a real estate asset will increase approximately at the rate of inflation, while expenses increase at the rate of inflation plus the rate of depreciation. Anyone who tells you differently, including Wall Street, is selling something, paid to sell something, and paid to deny arithmetic.

Hospitality assets deteriorate even faster than most other real estate assets because of the exacting standards of the hospitality industry, under constant pressure to renovate. This is why maintenance fees are always rising so much faster than consumer price inflation for timeshares and condotels and other fractional vacation interests. And you, the investor, will be contractually obligated to pay these increasing maintenance fees for the rest of your life and the lives of your heirs! Thanks, Mom.

Meanwhile, an excess of vacation properties was built between 2005 and 2008, and values plummeted after the Global Financial Crisis of 2008 and some have not yet recovered due to the oversupply. 

As for condotels, I first witnessed them in the early 1980s, spurred by the 15-year Accelerated Cost Recovery System enacted by the Economic Recovery Tax Act of 1981, but the Tax Reform Act of 1986 took away these benefits, and the burgeoning oversupply of vacation units killed the condotel industry, a historical fact that keeps getting forgotten after each time this industry collapses.

Constant problems with condotel investments include 1) high maintenance fees, many more than $10 per square foot per year, 2) having to share 35 to 50% of revenue with management without any guarantee of occupancy, 3) having to compete for occupancy with other owners, 4) having to frequently buy new furniture packages to comply with the hotel franchise rules, 5) HOA dues, 6) housekeeping fees, 7) special assessments, and 8) elevated insurance costs. On top of that, this is an investment type that rarely experiences capital appreciation. If capital appreciation was reasonably expected, the developer would never have wanted to sell units prematurely, right?

Condotels continue to re-emerge as a brilliant new concept before crashing in flames yet again and then forgotten. Some friends of mine were just pitched by WorldMark this week for a condotel investment in the California Wine Country.

Industrywide failure to consider buildings as deteriorating assets

The real estate industry in the 1980s newly embraced a valuation method called “Discounted Cash Flow Analysis”, in which valuations were based on 10-year cash flow projections. The only problem was that most of the DCF practitioners inflated income and expense projections at the same identical rate of inflation, not acknowledging that buildings were deteriorating assets in which operating expenses increase faster than income over long term. Every DCF valuation thus became inflated, and hundreds of millions of dollars were lost in the collapse of the commercial real estate and savings and loan industries in the late 1980s and early 1990s.

As for Club Wyndham, I was satisfied with the exchange possibilities, but displeased with the high-pressure sales tactics used on me whenever I showed up to peacefully use my reserved unit. 

Twice when I stayed in Manhattan, for instance, the unit was not ready on time, even if I arrived at 8:30 pm, and then I would be handed off to a high-pressure salesperson trying to convince me to buy more points or I would never be able to stay in New York City again. 

There were also the mandatory Information Breakfast Meetings I was supposedly required to attend during every stay at any Club Wyndham property. The first time, in Hawaii in 2007, I showed up and was denied admission because I did not bring identification, which was fine with me. They must have thought I was a cheap tourist attempting to steal their orange juice and plastic-wrapped muffins.

In San Antonio, Texas, I attended their Information Meeting on a Sunday morning, to which I was bussed several blocks away to assure that I would not escape during the brutal Texas summer heat. The speaker casually chatted with me before the Meeting started, mentioning that he had been a flight attendant before entering the esteemed career of timeshare sales. I had orange juice and muffins and scrambled eggs. 

When he started the Information presentation, the only information he provided for the first 15 minutes was about himself, in which he had elevated himself to the status of being a former airline pilot. Then he asked all of us to chant the phrase “Today is the Day!” I felt like I was trapped in an Amway sales rally and quietly left, walking several blocks back to a very nice unit on the San Antonio Riverwalk. 

When I returned to my building, the doorman had already been alerted in advance of my escape. He asked me if there was a reason why I left the Information Meeting so suddenly. I just said, “Today is not the day.”

PS: See the film Glengarry Glen Ross. Watch this film about desperate timeshare salesmen even if only for the outstanding acting performances of the late Jack Lemmon, Al Pacino, Alec Baldwin, Alan Arkin, Kevin Spacey, Ed Harris, etc.

Appraisal in Panama

Looks like rice cultivation

This was a litigation situation in Panama in which 3 different Panamanian appraisers had already appraised a group of agrarian properties which were near each other, with the highest appraised value more than 5 times the lowest appraised value. I was asked to make an independent appraisal.

Two appraisals had been done for the respective litigants, and one had been done by the Panamanian government. One of the litigant’s appraisals and the government appraisal quickly became suspect when it became obvious that these appraisers had not visited the properties. One property was actually a revenue-producing rice farm, and another was a residential property, but two of the three appraisers did not know this, casting doubt upon their inspections of the properties. If they had just consulted Google Earth, they would have seen the rice cultivation and the residence.

My appraised value came in second highest because I was only one of the two appraisers to notice a rice farm instead of a vacant agricultural parcel. I elected to use local comps (from the same “corregimiento” which translates as “township”) rather than use superior locations outside of town.

The International Appraiser completes expert witness testimony in a divorce case in Costa Rica

 

A recent marital dissolution trial had me establishing value for proposed luxury lodges near the beach in Puntarenas, Costa Rica, in the Santa Teresa area where famous rich people have also been recently seen vacationing or buying houses, such as Tom and Giselle Brady, Mel Gibson and Matt Damon and family. These types of properties consist of several luxury villas on site renting at $400 or $500 each night, and development restrictions in Costa Rica make these types of properties easier to develop. 

I represented the developer’s wife in the trial. The American husband chose an appraiser from a Costa Rican appraisal firm, although the trial was in Massachusetts. 

Sometimes hiring the local Costa Rican appraiser does not help, if the appraiser uses demonstrably inferior methods (such as not adjusting land prices for differences in zoning), or the appraiser cannot effectively testify in English. 

One point of contention in the trial was that a work stoppage during the COVID crisis signified the failure of the project, particularly since the construction permit expired. 

I pointed out that tourists were coming back to Costa Rica as early as November 2020, and that the architect/builder, Benjamin Saxe, is one of the most famous architects in Costa Rica. A very short distance from this property is Saxe’s famous “Floating House”, a group of three tree houses situated at the top of the jungle canopy near by beach, presenting the illusion of floating in air. Surely he could get a permit renewed. 

Even more surprising, every local lodge near the beach was 100% booked over the next three months.

Appraisal of Coastal Land on a Pacific Island

Notice the proximity of the cliffs and the calm, reef-protected waters. 

Some of my appraisal assignments call for “second opinions”. This one called for a third opinion, as appraisal reports had been respectively submitted by two MAIs who resided on the island. The estimates of value were more than $50 million apart. Who was right? Who was wrong? 

A survey measuring more than 250 acres had been done 8 years previously after an assemblage of smaller lots had been rezoned to hotel use. This survey was officially accepted by the local government, but the survey had a strangely unprofessional appearance. The survey was two-dimensional except for a central portion of the site which was described as “cliff face area” and drawn 3-dimensionally, including ravines within the cliffs, and this area was given a significant amount of site area, 63.5 acres, even though the cliffs appeared to be almost vertical. Had “vertical” become the “new horizontal” on this quaint island? Upland area had been measured at 110 acres and beachfront area had been measured as 105 acres.

Survey  

These cliffs are mislocated on the survey

Google Earth now gives us tools in measuring land, and the differences between the satellite view and the survey were quite apparent. The survey showed the cliffs by the shore at only the northernmost part of the property, whereas they seemed to be touching the shore in 3 different places from south to north in the satellite photo. 

Measuring all site area below 50 feet in elevation, I found only 36 acres of beach land, not 105 acres. 

Surveys of tropical beaches often have to be redone every few years due to beach erosion or accretion as a result of tropical storms, and this island experiences plenty of storms, but the loss of 70 acres of beach land seemed to be too much to be believable for a coral reef-protected beach like this one. 

I had to conclude that the survey was inaccurate to begin with, due to its strange measuring conventions, seemed almost to exaggerate this site's beach land and overall site area. 

In addition, as I have constantly maintained on this blog, the most accurate technique for valuing beach land is the use of “price per lineal meter” or “price per lineal foot” as the unit of comparison. The use of price per square foot or price per square meter yields less precise results, as the value on the beach side of the property is so much more than the value of inland area. Every statistical analysis I have done indicates that price per lineal measure provides the least variance among possible beach land valuation results. 

Nevertheless, the appraisers were both using price per square meter as their metric. I asked one why, and the response was that there was no public data on beachfront or waterfront length on this island, so price per square meter is what they felt that they were limited to.

For certain comparable sales and listings, though, there were satellite photos, some of which were sufficient to make estimates of the beach length. Some times using the right metric requires some extra effort.  The comps for raw beach land were in a range of $1650 to $2500 per lineal foot of beachfront.

That's enough of today's lesson, but I want to discuss the politics I sometimes have to contend with on foreign assignments such as this. The politics typically comes from loan salesmen and/or jealous, mediocre appraisers.

1. "These are the acknowledged appraisal experts for this island! They are MAIs! How dare you challenge their expertise in their own land. You are geographically incompetent!"

First of all, these grand poobahs did not even agree on value. One estimate was almost three times as high as the other one.  They did not even measure the length of the beach, the most important part of the property. They used outdated sales from prior to the pandemic, and did not notice beach property listings at much lower prices than yesterday's sales. I have always wondered why The Appraisal of Real Estate, the most comprehensive real estate appraisal textbook in the U.S today, spends less than one paragraph explaining how listings can be used to estimate market value in declining markets.

I have had no prior experience with this island, but I have spent the last 15 years appraising beach properties in Fiji, Hawaii, Brazil, Barbados, Puerto Rico, the Dominican Republic, Costa Rica, Mexico, U.S. and Canada.  So that is my statement of geographic competency.

Where do U.S. retirees really emigrate to? It’s not what international real estate purveyors would have you believe.

  Harrison Hot Springs, British Columbia. Canada is the preferred destination of U.S. retirees.

While I have addressed International Living and Real Estate Trend Alert before, there are many other vendors of foreign real estate fantasies and get-rich-quick-schemes with their hyperbole about Costa Rica, Panama, Ecuador, Vietnam, etc. 

Every year, though, the U.S. Social Security Administration summarizes the number of Americans in other countries receiving social security benefits, and it paints a much different picture. These are retirees, spouses and those who are on disability. In 2019 the Social Security Administration was mailing checks to 682,888 Americans outside the U.S., an impressive number, but most of the destinations don’t seem to be the ones constantly promoted by Katherine Peddicord or International Living. 

Where in the Western Hemisphere have the most U.S. retirees moved to? Canada. There were 110,626 retirees receiving social security and SDI checks there, although some of these retirees may have already been Canadian, and were returning home with U.S. social security benefits. 

What about the Latin American hot spots constantly featured in the real estate fantasy magazines? Costa Rica – 2551, Panama --2799, and Ecuador – 3879 U.S. retirees. One exception is Mexico, with about 60,000 retirees, but some of these may also be Mexican citizens returning home after a career in the U.S. 

Thailand and Vietnam are mentioned as the hottest retirement hot spots in Asia. The number of retirees is 7262 in Thailand and just 556 in Vietnam. Where in Asia are the most U.S. retirees? Japan, with more than 90,000. 

Portugal and Spain get mentioned as the hottest European retirement hot spots, but Portugal has just 12,910 U.S. retirees and Spain has 12,732. The leading European nations in attracting Americans are Germany (40,000) and the United Kingdom (37,500).

Another appraisal in Seoul, Gangnam-style

 

The subject is a 14-story office tower in Seoul, built in 2006, with a height of 182 feet. Gross building area is 70,310 square feet (6532.81 square meters), covering most of the site.

This was yet another valuation assignment done for inheritance purposes as wealthy Korean immigrants to the U.S. pass on valuable real estate assets to their children. This particular building is situated in Gangnam-gu, one of the three major business districts in Seoul, and the most modern one. Most office buildings in Gangnam were built after 1990.

As luck would have it in this very active Seoul office market, two very comparable sales were found to have occurred in the last month within 2 blocks of the subject, and a third comparable sale was found about one mile west, having occurred three months ago. All were very similar office buildings less than 15 stories in height.

The last measured office vacancy rate in Gangnam was 4.2%, office building sales are amazingly active, and Seoul is a surprisingly easy place to appraise office buildings.

A Recent Appraisal in Costa Rica's Zona Maritima

Most of the real estate in Costa Rica consists of "freehold" or "fee simple" interests in real property, or in other words, properties with titles, estimated to cover about 85% of the country.

The remaining 15% is leasehold land known as “concession properties”. Concession properties are considered desirable because they are at the beachfront, where titled land is not available.

All Costa Rican beach properties are located in what is known as the Maritime Zone, a 200 meter strip starting from the average ocean high tide line. The ZMT (Zona Maritima) is divided into a 50 meter strip closest to the shore known as the public zone, which cannot be privately occupied, and the remaining 150 meters can be applied for “concession” in the corresponding Municipality. 

Think of “concession land” as a “concession stand” at a ball park or a fair. All Concession land is leasehold land, with lease payments going to the municipality; it cannot be privately owned, but real estate developers and wealthy homeowners can lease and develop these properties profitably.

The subject property was zoned as a “Hotel and Touristic Zone”, which is a valuable zoning classification to have, and the owners wanted to develop it with a hotel, but the key to maximizing the value of the land is to have an already-approved hotel development plan in place, as it can take years to get a hotel project approved. Otherwise the concession is only worth half as much

PS: Next stop, Greece, or maybe not so, with the Greek nation on Coronavirus lockdown. Non-EU citizens are not allowed to visit until after April 18 and I could not negotiate a later appraisal deadline.

Another Misleading Rental Property Offering From Global Investments Incorporated Through Mondinion (Global Investments)

My name is on many “real-estate-for-suckers” spam lists, and some it comes out of Britain from Mondinion, Global Investments Incorporated, PropertyO, NuBricks or whatever name they change to again. This is a group of British real estate salesmen internationally hawking rental properties in some of America’s most troubled urban residential markets, such as Detroit and St. Louis. The central problem with these cities is depopulation, and in 2017 CBS News declared St. Louis to be the fastest depopulating major city in the nation, with population declining by more than 1% per year.

One may wonder why they would go to such trouble to find and market properties in bad neighborhoods of America’s fastest depopulating major cities. It is because they can claim high initial rates of return on investment (“capitalization rates”) without disclosing such recurring problems as vacancy, low income areas, foreclosures, depopulation and crime in the neighborhood, instead describing these neighborhoods as “stable” and “safe”. These properties can be acquired quite cheaply and be flipped to naïve British pensioners and foreign investors.

High capitalization rates, such as return on investment > 10%, indicate properties with uncertain futures and high risk; thus the investor wants to get his return on investment much sooner before conditions deteriorate. There is also the possibility that the numbers are false.

I commented previously about them in 2017 (https://www.internationalappraiser.com/2017/11/lately-i-have-been-receiving-e-mails.html) when they were selling residences in the Detroit area, which they continue to do. They described the Inkster, Michigan neighborhood as safe although it ranked 93 percentile for crime in the state of Michigan.

This time Global Investments contacted me with a list of 6 homes in St. Louis. I chose to analyze one at random, 5752 Astra Avenue, an 1107 square foot, two bedroom, 1 1/2 bathroom home built in 1927 which they listed for $43,900 (about $45 per square foot) and described as “fantastic” and tenanted at a rental rate of $750 per month.

Checking the local Multiple Listing Service I found that the home was still vacant and listed for sale, but a sale was pending, maybe to Global Investments, the company that is marketing these homes. The brochure begins by describing the house as a 3-bedroom house  (not 2 bedrooms as actual) and already tenanted. The brochure itself shows the house to be vacant, with the only furniture being a dining table. They also neglected to disclose that the home is next to a mosque.

These groups have the habit of marketing their properties as rented, but the photos they show are of empty properties. If they do have a tenant waiting, why would a tenant wait when there are other vacant homes ready to move into?

From an appraiser’s point of view I searched for the 3 most proximate sales to the property this year and found two similar but larger homes at 5980 and 5984 Astra which sold for $10,000 and $20,000, respectively. The next closest sale was on a cross street, 5756 Vivian Avenue, a 2504 square foot duplex that sold for $52,000. The prices ranged from $6.86 per square foot to $20.52 per square foot.

As for the neighborhood, the Census Bureau’s information for this census tract as of 2015 was that it had a median annual household income of only $24,519 and a housing vacancy rate of 19.2%. This is about as bad as urban neighborhoods get.

The property was represented as tenanted, although vacant, so it is hard to say whether it would earn $750 per month, but more importantly, neighborhoods like this have poor tenant quality, so the new owner would have to scramble around to rent the home again before too long. When there is depopulation, filling homes can sometimes be like a game of musical chairs. This home is also adjacent to a mosque, which may be considered an adverse influence.

I was later telephoned by Global Investment’s sales director, who also advised me that they also charge a fee of $4000 in addition to the purchase price, to compensate their efforts in turning around the property. Had they actually been to St. Louis?

I have seen other rental home opportunities marketed by Global Investments Incorporated for cities such as Chicago, Cleveland and Memphis. These are all depopulating cities. CBS News, for instance, compiled a list in 2017 of the 12 major U.S. cities fastest losing population:

1. St. Louis

2. Baltimore

3. Milwaukee

4. Buffalo

5. Detroit

6. Cleveland

7. Hartford

8. Rochester

9. Chicago

10. Memphis

Here’s the reason to avoid such investments:  Depopulating cities experience decreasing property values and rents. Investing in older buildings in depopulating areas is a prescription for failure.  The Rust Belt, for instance, has many cities that have lost half their population in the last 50 years, including Detroit, Cleveland, Youngstown and Dayton.  This usually means increasing vacancies, despite gallant leasing efforts.  Rents are so low that only the lowest cost renovations make any sense, too.  Even then, other new space gets built, hastening the demise of the older buildings. 

So beware of rental properties being offered at high returns; these returns might not be long lasting.

Update Dec. 5, 2019:

A list published on AOL today indicated that the 6 fastest depopulating U.S. cities, in absolute numbers, are:

1. Chicago
2. Los Angeles
3. Detroit
4. St. Louis
5. Cleveland
6. Memphis

Tropical American Tree Farms Update, 2019: A Guest Post

One of the new homes being built on former TATF properties

 I encourage guest bloggers offering topical content on issues that concern my readers.  I have received this guest post written by an anonymous source who lives in the vicinity of some of the many teak farms owned by Tropical American Tree Farms. I have received more e-mails and comments from TATF investors than on any other post on this blog. This anonymous writer is telling the story of a sibling in Costa Rica who has witnessed the destruction of Tropical American Tree Farms. For the many of you who write to me on how to tell your IRA administrator that your investment in TATF is a total loss, perhaps this blog post may help.

"My sister lives in Costa Rica and for the last 3 years has been trying to protect the trees and land , of several farms of TATF. In her efforts to stop the illegal invasión and stealing of the land and trees she was viciously assaulted, as a retaliation for seeking legal means through MINAE 

(ministry of Environment), to prevent the environmental damages and unlawful activity.

Cear-cutting of part of the teak farm

 

Squatter home built from TATF timber

"She does not or did not, know the Brunners and cannot speculate if TATF was a fraud. The Brunners certainly did benefit from the money of the investors over the many years. But to her knowledge, the Brunners never received any money from the harvesting of the teak wood. 

The majority of the teak has been harvested- but not by the Brunners. 

The government of Costa Rica has turned a completely blind eye to the illegal invasión and stealing of this wood and land - bought and paid for by foreign investors dollars. Many of the locals, who worked and benefited for years from TATF money are the same ones now stealing the trees and the land. Please be assured that these are not needy people. Sadly the locals are also invading the primary forests and destroying land the Brunners had left in conservation.

This is in complete violation of environmental laws in Costa Rica."