by Barry Lebow
As 2006 nears an end, I can reflect back on one of the busiest years of my appraisal career. In the past twelve months I have inspected more than 130 apartment buildings representing more than 13,000 suites, from Sarnia to Cornwall and up to Ottawa. I have lost count of the apartment buildings I have inspected since I started in real estate in 1968 but they would total into the many thousands by now, from basic duplexes to major high-rise and townhouse complexes. During my 38 years in this industry (focussing on the apartment building sector only) I have been a landlord, a tenant, a Realtor, a property manager, a commercial mortgage broker and appraiser.
As an appraiser my first criterion is to establish the quality rating of a building. We rate buildings, according to a chart we have honed over the years, as A, B, C or D product. Within each of those classifications, we rate each category with a “+” or “-“ or “neutral”. In simple terms, the finest building I have ever inspected had an A+rating (Houston, Texas) and the worst building was a D- (Toronto) and should have been torn down.
Overall quality is not just a rating for an appraiser, it also helps determine the application of a capitalization (or cap) rate. It is fine to read that cap rates in Southern Ontario range from 5.5% to 8% but how do we rate a building to apply these rates? A small variable of half a percent can result in getting a mortgage or paying too much in estate tax.
First, street view is very important, not just from our perspective but from the perspective of a would-be tenant. Would we want to live in that building and call it home? We classify tenants into two groups, tenants by choice and tenants by circumstance. Normally, buildings with tenants by choice are the best buildings as these tenants want to rent, are usually more affluent and have higher demands. Tenants by circumstance just can't afford to move, are budgeted into their living spaces and, for the most part, have less pride in their surroundings. Demographics indicate that they are also more likely to be new immigrants, transient and have more children.
We note the grounds, the signage, peeling paint, rusted balconies, outdated windows, oil stained parking areas and sometimes abandoned or dilapidated cars. We always wonder why any landlord would allow a car to just rust out and detract from a building. It goes to the broken window theory. One broken window leads to more broken windows but immediate repair of a broken window discourages vandals (same with graffiti).
A pet peeve of mine is poorly viewed civic numbers and lack of basic landscaping. I find that overall, too many landlords neglect the main entrance and first impression of their buildings.
Today, it is becoming rare to find buildings without decent mailboxes and entry systems but we still enter shabby lobbies and then ride in scratched or defaced elevator cabs.
Policing the grounds is also important. Placement of garbage facilities, abundant cigarette butts near an entrance, all are noted in an appraisal report and can negatively impact the market value. We are the eyes and ears of the lender and we must report back what we see, at a minimum, in overall terms. Today, with digital photography being inexpensive, we shoot more photos and send them to the lender. In many cases we prepare a video of the inspection for the lender in addition to the written report.
We look in the vestibule, mail room or lobby to see if it is tidy. Too many times an owner is trying to get maximum mortgage financing but with minimum maintenance. Think that the flyers all over the mail room don't detract, or the piles of mail for former tenants? Vandalized mailboxes also don't enhance the impression of the building.
As we tour, we note water leaks in ceilings or underground parking. We note dirty carpeting, rusty pipes and another of my pet peeves, utility rooms filled with broken appliances and other outdated equipment. It is junk, get rid of it! Sometimes the difference between a B+ and a C+ status is just the clutter of the utility rooms and poor cleaning. Feel lucky to get anyone to be the super? Well the extra dollars to have good care of your building can add many tens of thousands of dollars to the overall value. We note that quality superintendents tend to attract quality tenants. These supers care about their homes and want only good neighbours. In an apartment building that I previously owned, the overall quality of the building improved immediately upon firing the lazy super and replacing him with someone who actually cared.
We note the windows, the balconies and the roof (structural improvements). We also note graffiti and cigarette butts at the top of the stairwells, as indications of a super that does not care about the teenagers who loiter and as a result, can drive good tenants to leave.
Overall, when we have finished our inspection (we must also rely on other professional reports on roofs, balconies, mechanicals, environment, etc.) we have determined the rating of the building and, as a result, the appropriate capitalization rate has been determined. An appraiser's research and work should be precise but emotions and subjective opinions are the norm. In many a court case I have found myself challenging another appraiser's opinion of the overall quality of a building. We can agree on everything else but I may be applying a 7% capitalization rate and the other appraiser 8%. If we are dealing with a net income of say $200,000, the variable of 1% can result in a difference of more than $357,000 in market value.
Old fridges stacked up, unkempt front entrance, lazy super? Today, professional management is the only way to keep costs down and market value up. Spending money on good care makes sense. Neglect the small stuff and the loss is yours.