Adapting Old Theories for New Applications: A New Approach to Church Valuation
By: John T. Schmick
Religious facilities are typically classified as special purpose properties or limited market properties. Their unique design is intended to meet the needs of a specific group or purpose and they lack adaptability to other, more conventional uses. The most common reasons for churches to change ownership are that the congregation has outgrown the facility or has declined in membership/financial capability and can no longer support the facility. Since there is no recognized income approach for valuing church property, most appraisals of religious facilities incorporate only the traditional cost approach to value and the sales comparison approach to value. Given the limited market sales data and the declining reliability of estimating depreciation as the property age increases, the overall range of value estimated by professional appraisers on a specific church property tends to be broad, creating a question concerning the reliability of the value estimate process.
In general, the appraiser's role is to research, interpret, and report on the available evidence that supports a value estimate equivalent to the future benefits potential from a specific property. As a result of an eminent domain case, Shenehon Company has developed a new approach to value for church property that can be used in conjunction with the traditional approaches to value in order to increase the reliability of the appraiser's estimate of property value. In that case, our assignment was to determine the impact of a 30% loss of land area to an existing church property where the city indicated they would enforce all zoning code requirements.
How does church property function?
Church property operations are, in effect, a reflection of the religious group that occupies the property and the environment needed to attract visitors and membership to the property. The relevant physical components are the seating capacity of the sanctuary and the related parking requirements. 'Sanctuary' is used herein as a generic term for the seating area for worshipers/ members/visitors during worship services.
Most municipal zoning codes require a minimum parking relationship to the number of fixed seats in the main place of worship. Typically this is one parking space for every three to four seats. In facilities that have no fixed seating, or a significant number of movable seats, the focus becomes the maximum room capacity permitted by the local fire marshal. Where seating capacity is unknown, a local church architect can provide an estimate of seating capacity. Typically, one seat is defined as between 20 to 24 inches wide. Thus, an eight foot long pew would provide between four to five seats.
Adequate parking is necessary for a church property because if parking is too inconvenient or difficult to use, church leaders will acknowledge that people will leave the congregation and go to another church property and congregation of the same faith but with more accessible facilities. In downtown areas where churches seldom own enough land to support their parking needs, church groups are more dependent on neighboring businesses and street parking to meet their parking needs. Parking is also important to a church property because it is often the first impression of the church that a visitor has. Architects emphasize the need to give a friendly and inviting impression. Therefore, all parking must be easily identified and accessible to building entrances. This sends the message to visitors that there is room for them to attend services and that they are welcome.
Economic Profiles
The economic profile of church property is often overlooked by appraisers because few people consider church property to be 'income producing'. However, it is important for the appraiser to understand that churches tend to be community based facilities and they do have an economic profile; both for the current occupant and as it relates to the local community. On the church level, this relates to membership and revenue while on the community level, this relates to median community income.
Church membership generally does not have a consistent definition across the different religious groups. Different religious groups may define a member as one family unit, only the adults in a family unit, or each person in the family unit. Therefore, the first task for the appraiser is to define the church membership in a manner that is comparable to other churches (ie. a common unit of measurement). From that point, the appraiser can study the growth in membership over time.
After membership data, the church budget/revenue is reviewed on both a macro level (total revenue) and a micro level (per member). If the church body is growing in membership, we should expect to find this growth reflected in a growing budget or revenue. Conversely, if the church body is declining in membership, there should be a corresponding decline in the budget or revenue. In one respect, the budget/revenue profile is a reflection of how well the facility is meeting both the individual member's need and the more general community needs.
For example, if the community is growing with many new families moving to the area but church membership is stagnant or declining, it may be an indication that the church facility may not be consistent with community needs for building size, design, location, condition or other features. These are all issues that can affect value. Inconsistency between the total revenue growth and per member revenue growth may indicate either success or problems in meeting individual needs as well as market penetration the church has achieved when compared to the median income in the area. Our research of church sales over four years and nine communities indicated a range of per member giving as a percentage of community medium income of between 0.45% to 3.96% with an average of 2.07%. An individual church's ability to achieve per member giving relative to community median income can be a reflection of the segment of the community the church attracts and/or its ability to capture market share or penetrate the market of potential members up to its capacity to service those new members.
Revenue Capitalization Theory
The appraisal process has been described as the research, interpretation, and reporting of the available evidence that supports a value estimate equivalent to the future benefits potential from a specific property. A broader description of the appraisal process is simply the study of relationships. In comparable sales we study the relationship of sale prices in terms of location, size, topography, access , economic rents, etc.. We then express this relationship as a value per some common unit of measurement. For income producing property, we study the relationship of some type of cash flow to a market based investor/buyer required rate of return and express the results mathematically in the form of a value estimate. It follows that if appraisers study relationships, then we can the identify relationships which exist for church property.
There does not appear to be consistency in the reporting of financial statements of churches in terms of categories of expenses and priority of expenses. One church may be more focused on mission work and have large expenditures to support that function. Another church may have a strong emphasis on music and education but engage in little mission work. Affiliation with national organizations may require more or less in the way of contributions to the parent affiliate from the local religious group. Each may have a different clergy and staff structure and more or less volunteer support. The result is an inability to separate the cash flow attributed to the operation of the property only. Thus, a true income approach, as commonly understood by appraisers, has yet to be developed for church property.
In the course of our research, we theorized that there were economic characteristics in church property that were similar to other real property situations whereby we could draw on other techniques, methods or theories to develop an economic approach to the problem of church valuation. Two areas that seemed relevant were the profile of church property buyers/sellers and the gross revenue concept.
In the case of buyers of church property, there are similarities between an ordinary home buyer and congregations that buy church property. Lenders for churches approach the issue from a cash-flow viewpoint similar to that of the home buyer. They look at the ability of the congregation to make payments on a loan and the size of the down payment. If their budgets do not have room for the loan payment, the congregation needs to re-prioritize it's spending to support the loan request. Similarly, a home buyer bases his/her purchase of property on the ability to provide a down payment and to make loan payments. Loans to home buyers are also evaluated on the basis of borrower's gross reported income (gross revenue or revenue from all sources).
More importantly, the appraisal industry already recognizes the relationship between gross income/rent and sale price as it is applied to apartment buildings in the form of the Gross Rent/Income Multiplier (GRM or GIM). It is an easy step in apartment valuation to expand the GIM or GRM to include all revenue and measure the Gross Revenue Multiplier. This is nothing more than the mathematical expression of the relationship between sale price and gross revenue. It follows then, that if this relationship already exists, it can be applied to other property types, such as church property.
Our research into this revenue/price relationship started with the development of a database of sale properties. In the Minneapolis/St. Paul metropolitan market we found approximately twenty-seven sales of church properties over ten years, or an average of 2.7 sales per year. Within this database, we found that sale activity ranged from one to five church properties per year. Further analysis on location and size identified distinct patterns.
From this database, were we able to confirm financial and membership data on a number of buyers and sellers.
The hypothesis in the revenue/price relationship is that church property sellers should have a high revenue to price relationship while buyers should have a lower revenue to price relationship. Typically sellers have outgrown the facility and are at, or above, ninety percent seating capacity during peak service time. A buyer, on the other hand, is purchasing a facility to grow into over time and can be expected to be at or below forty percent seating capacity at peak service times. This relationship is expressed mathematically as a percentage of gross revenue/budget divided by property sale price, equaling a gross revenue capitalization rate.
Average seller revenue capitalization rate 59.47%
Average buyer revenue capitalization rate 22.39%
Within our database, we include a number of sellers and buyers. In some cases, we obtained financial data on both the seller and buyer in the same transaction. On the seller's side of the relationship, the indicated seller revenue capitalization rate ranged from 55.8% to 64.1% with an average of 59.47% On the buyer's side of the relationship, the indicated buyer revenue capitalization rate ranged from 13.9% to 32.1%, with an average of 22.39%
Clearly the range for both buyer and seller revenue capitalization rates is wider than appraisers normally expect to find. Capitalization rates for other, more common types of property are the results of thousands of transactions and national publications of data. In contrast, church sale data is limited and, until now, not followed by any analyst or publication reporting on revenue capitalization rates. In addition, market participants for this type of property have not yet been educated to the potential for economic analysis to evaluate (in conjunction with other approaches to value) the market value of church property. In many respects, religious groups that purchase existing church property are similar to the typical home buyer in that they do not know how to value a property, but unlike the home buyer in that there are few comparable church properties on the market at a given time for comparison pricing. Those that are available for sale may not be geographically acceptable to a given buyer. Professional appraisers should be capable of comparing the suggested economic profiles related to comparable church property sales data and making a reasonable judgment as to the appropriate revenue capitalization rate for the subject property.
Relationship to Other Approaches
The revenue capitalization approach for church property is not intended to be the sole determinant of value. It should be used in conjunction with the cost approach and the sales comparison approach to value as a third approach or methodology for estimating market value. As with all appraisal assignments, the three approaches to value are interrelated.
The relationship of the a church property's revenue/ budget to the cost approach focuses on accrued depreciation. A larger budget (more revenue) increases a property owner's ability to maintain his/her property while a smaller budget (less revenue) makes maintenance more difficult. Many smaller churches receive some portion of their property maintenance from congregation volunteers. Therefore, we can anticipate less deferred maintenance, and perhaps more modernization, as the economic profile of the church increases. This, in turn, can reduce the deductions for both physical and functional obsolescence.
The relationship of the a church property's revenue/budget to the sales comparison approach to value is one of confirmation of value within the broad range of market sale prices. Keeping in mind that the revenue capitalization rate for churches is the mathematical express of the gross revenue, or budget, to sale price relationship, the appraiser can use economic profiling to better understand how the church functions in the community and its potential for growth or further market penetration. An economic analysis of the church provides the appraiser with the basis for reasoned judgment to know where within the range of reported sale prices the subject property's value estimate is most likely to be found.
Conclusions
Shenehon Company has proposed a new use for an existing methodology to explain the relationship of a church's economic profile to its expected market value. By understanding that a church body/congregation is similar to a combination of home buyer and apartment buyer, a Gross Revenue Multiplier can be converted to a revenue capitalization rate that mathematically expresses the relationship of a church's revenue/budget to expected value. In terms of problem solving analysis, the revenue capitalization approach becomes a useful tool for quantifying changes in a church property. In this case, a church property was impacted by the loss of parking. This parking loss can be followed through occupancy level and its impact on the economic profile of the church, which can then be converted into a dollar estimate of impact.
The test of any new methodology or new technique is whether or not it can be repeated in other markets with similar results. Shenehon Company will be presenting this approach at a professional conference in late March to encourage appraisers in other metropolitan markets to research church property sales to determine if similar results are evident in their data. 
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