The Granular Approach
Covid-19 has significantly impacted real estate valuations. For example, under the comparable sales approach to valuation, valuators look at sales prices of similar properties in recent transactions, making adjustments for differences between those properties and the subject property. As stated by Lisa Loychik of Cohen & Co. in a paper dated August 20, 2020, “It’s debatable whether pre-Covid-19 sales can be considered comparable with post-pandemic sales, though. Valuators are looking beyond comparable sales and considering individual circumstances on a more granular level. This approach acknowledges that generalities are of limited value when Covid-19 may have different effects on different properties in the same neighborhood.”
Ms. Loychik also noted, businesses that were healthy months earlier have boarded up, threatening the continued vitality of neighborhoods and increasing expected vacancy rates. Struggling tenants may have fallen behind on monthly payments. Governments are mandating rent relief but also providing financial support to prop up troubled companies. Plus, operating costs may be higher to comply with health and safety concerns, as well as to adapt property use and features for changes in demand.
In an article published by Co-Star on September 9, 2020, written by Kenny Kim, “Commercial Reals Estate Valuation in the Age of Coronavirus,” Mr. Kim wrote: “When evaluating comparable market transactions, it is important to examine not only the market condition and sales price, but also the condition of sale. As opposed to market price, market value should consider market exposure in an open market, marketing time, “motivated buyer” and “motivated seller” conditions and typical market financing – in times of crisis or uncertainty, property sale conditions can vary widely based on some of these factors. Accordingly, it is vital to distinguish between market and distressed sales.”
The Appraisal Institute has issued guidance to its members on the Coronavirus Pandemic. The statement provides:
- An important part of any appraisal is analysis of market conditions. The Coronavirus threat may be impacting market conditions. However, in most markets it is not yet clear to what extent, if any, market conditions are affected. Related, complicating factors include fluctuations in the stock market and changes in mortgage interest rates.
- Market analysis includes observing market reactions. This analysis becomes more complicated when market participants themselves are facing uncertainty.
- Appraisal reports should include a discussion of market conditions, and so mention the Coronavirus outbreak and its possible impact. However, it is not appropriate to include a disclaimer or extraordinary assumption that suggests the appraiser is not taking responsibility for analysis of market conditions.
Consider, you and your partners have been assembling a development site for seven years. You purchased adjoining properties, one-by-one. Bought out and relocated the tenants. Demolished the buildings.
During this time period, you managed the property and paid real estate taxes. Architect’s plans were prepared, filed and building permits obtained.
Just as you are about to commence construction, an historic pandemic occurs. As a result of the deadly virus, Covid-19, a national quarantine is put into effect. New York City was particularly hard it.
There were virtually no large real estate sales in the last year. People literally deserted the City taking up residence in the suburbs. The vacancy rate for apartments in the City was so high that there is no measurable historic benchmark.
People still in the City did not leave their apartments. Retail stores and restaurants closed, some permanently. Offices closed and some employees worked from home if they could. Many tenants without employment could not pay rent. Homeowners could not pay their mortgages. The State imposed eviction and foreclosure moratoriums. Nevertheless, property owners still had to pay taxes and maintain their properties.
Then after all of this calamity with property values at their lowest, the Metropolitan Transportation Authority schedules a public hearing as required to condemn property for the Second Avenue Subway Phase II.
Should the property the MTA acquires be valued at its distress value? Bear in mind that there is really no market. No one is selling. Investors will continue to hold their properties until such time as the real estate market comes back to normal.
The power of eminent domain is an awesome governmental power. It is a forced sale. There is no willing seller. The classic definition of fair market value provides that it is the price that a willing seller under no compulsion to sell and a buyer under on compulsion to buy agree to as the sales price. Keator v State of New York, 23 NY2d 337 (1968). This is the reason that appraisers, in most instances, will use the market data or comparable sales approach to finding a value.
I submit the comparable sales approach cannot be valid now because there are no fair market sales. Not only are there very few sales, but the ones that do occur are distress sales, deeds in lieu of foreclosure and other transactions made because of dire straights properties sold because of loss of financial ability to carry the property. The capitalization approach is also invalid with a loss of income paying tenants, vacancies and no prospects in the near future.
In these circumstances, traditional approaches to valuation will fail to assure that the constitutional right to just compensation will be recovered. Properties, particularly those in the course of development, must be valued, as previously mentioned, on a more granular level.
Cases Dealing with the Pandemic
Although there are no eminent domain cases discussing Covid-19 in litigation, courts have taken the pandemic into consideration. In SEC v Champion-Cain, 2020 U.S. Dist. LEXIS 152226 (US Dist. Ct. South. Cal. 2020), the Court approved the sale of property much reduced in value because of the pandemic. In Berg v Velocity Fin., Inc., 2021 U.S. Dist. LEXIS 179333 (US Dist. Cen. Cal. 2021), the Court refused to find a violation under the securities law for an increase in non-preforming loan in an investment trust’s portfolio which plaintiffs premised on a failure to adequately disclose Covid-19 risks.
In Barnes v Barnes, 2020 Bakr. LEXIS 991 (US Bank Ct. Conn., 2020), the Court upheld the sale of a luxury home at a price far lower than originally valued. The Bankruptcy Court held that despite the poor market due to Covid-19, in the face of the lockdowns, the subsequent financial volatility of the stock market and uncertain depths of the resultant national financial crisis, a remarketing and resale of the property logically and foreseeably is merely an invitation to assure a lost sale.
In my opinion, these decisions indicate a judicial acknowledgement that the real estate market has been dramatically affected by Covid-19.
Valuation of real estate during contemporary times is challenged and will continue to be so for several years. In a forced sale, a court should only consider pre-Covid-19 data whether it be comparable sales from 2018-2019, or financial data from the same period.