Click here to download a PDF of Valuation Viewpoint Fall 2009
By Christopher J. Stockness
On August 1, 2007 the Interstate 35W bridge spanning the Mississippi River collapsed during rush hour. As a result of the catastrophic collapse and subsequent reconstruction of the bridge, the State of Minnesota and the Minnesota Department of Transportation invoked the power of eminent domain to acquire several adjacent land parcels to facilitate the reconstruction of the bridge and surrounding area. The project was completed ahead of schedule and the new bridge opened on September 18, 2008. However, a number of business concerns and land parcels were adversely affected as a result of this taking.
One of the acquisitions was a 1.35-acre vacant land parcel located at the southeast corner of University Avenue and Interstate 35W. At the time of the taking, the landowners were in the advanced stages of implementing plans for a proposed retail development, Varsity Crossings, and anticipated breaking ground in the fall of 2007. Shenehon Company was hired to determine damages to the Varsity Crossings development project. To accurately identify damages, the appraiser first determined an appropriate market value for the subject interest before-the-taking. A second analysis was performed to establish an after-the-taking value.
As part of the new bridge design, the southeast off-ramp at the Interstate 35W/University Avenue and 4th Street exit were reconfigured. The new design resulted in the taking of a 2,807 square foot parcel of land from the subject property. As part of the same taking, the entire site was encumbered with a 40-month temporary easement. Determining just compensation for Varsity Crossings was somewhat atypical because the owners were entitled not only to compensation for the land taken, but also for damages resulting from the temporary easement which delayed the project for several years.
Specific to this taking, the appraisers identified key points to address in order to determine the fair market value of the subject interest:
In the ordinary taking of vacant land, the appraiser would apply the sales comparison approach to analyze the subject’s before and after values to arrive at the fee simple loss in value as well as a ground lease analysis on the temporary easement to determine the total damages due to the taking. In this case, however, the landowners were actively developing the site for the proposed Varsity Crossings retail development. To fully capture the losses, the appraiser employed an additional approach to value: the development cost approach. By using two methods, the appraiser fully quantified not only the damages to the subject land but also captured the damages to the proposed development.
An appraiser is required to consider three important validity tests to determine if the development approach is applicable:
The subject land was one of very few vacant land parcels in the area. The area is densely populated and benefits from being adjacent to the University of Minnesota East Bank Campus. The owners were actively working on developing the subject property. They planned to break ground for a retail development project in the fall of 2007. The developer’s plans were in full compliance with zoning ordinances and were in the final stages of receiving approval. The owners had already secured a broker who was actively marketing the development. Thus, the subject property met the three conditions for using the development cost approach.
To make certain that the appraisers fully understood all aspects of the project, several meetings and discussions involving the developers, planners, architects, engineers, contractors, and brokers took place. Because the planning was well underway, most of the information necessary to complete a before-the-taking analysis of the project was readily available. Next, the appraisers had to focus on identifying how the taking would affect the value of the development for the after-the-taking analysis.
In the appraisal analysis for the before condition, it was assumed that: development would start, as planned, in the fall of 2007; be completed in the spring of 2008; and be fully leased by the end of the year. In the after condition, the development would be reduced in size due to the loss of land and the project would be delayed 40 months due to the temporary easement that encumbered the entire property. Not until December 1, 2010, would the developer be in a position to continue with plans to develop the property.
Basically, there were two damage issues: (1) damages resulting from a reduced developable area and its impact on the development; and (2) damages due to delaying the development for 40 plus months over the term of the temporary easement. It should be noted that the property owners will receive ground rent from the condemning agencies. Rent paid to the owners will partially offset the burden of delaying the development and is reflected as an adjustment to the total damages in the final appraisal report.
VARSITY CROSSINGS - BEFORE
In the before condition, Varsity Crossings was designed as a 17,214 square foot multi-tenant retail center with tenant spaces ranging in size from approximately 500 square feet to 2,400 square feet. The plans submitted for approval maximized the site for the retail development and required no zoning variances. Clearly, any reduction in site size would impact the entire development from the size of the building to the number of parking spaces the site could accommodate.
Given its location, a highly visible intersection in a heavily populated area of Minneapolis, a retail use was determined to be the highest and best use (HBU) of the site. Therefore, the development project represented a financially feasible and maximally productive use of the site and met the conditions for HBU. Additional uses, such as residential were also analyzed but were considered to be either speculative or not maximally productive uses of the subject property.
As mentioned previously, the appraisers reviewed site information for the proposed development and interviewed the developers, planners, contractors and brokers involved. Following that, they completed independent research to verify and validate the components of the development. Conformance with zoning was verified and the owner’s estimated construction costs were supported by cost information found in Marshall & Swift Valuation Service. Discussions with the owner’s retail brokers provided the necessary insight to make assumptions on the leasing of the subject.
Based on reliable market information and independent analyses, we derived market-supported assumptions and completed a Discounted Cash Flow (DCF) analysis for the subject based on a ten year holding period. We included the construction and development costs anticipated for the development in Year 1 in the DCF analysis and began to absorb lease space during the last six months of the first year of analysis. Development costs, as of the date of taking, were applied and a market rent of $28 per square foot was concluded. Additionally, we applied market operating expenses, a vacancy rate of 5%, and anticipated an annual increase for rental rates and operating expenses of 3% annually.
After applying an appropriate discount rate, we determined that the subject land as vacant had a market value of approximately $2,600,000, roughly $44.00 per square foot. As a check on our value, we also completed a comparable sales analysis that indicated the subject’s value fell within the range of the few available comparable sales.
REVIEW OF THE TAKING
As a result of the I-35 W bridge taking, the subject development was impacted not only by the fee simple loss in land area, but also by the temporary easement encumbering the entire property. The Varsity Crossings site no longer accommodated the retail development plans or the projected development timeline. Additionally, revised site plans could not be submitted for review and approval until the temporary easement expired.
As a result of the 40-month temporary easement encumbering the property until December 1, 2010, development of the subject would be delayed until at least spring of 2011. Table 1 summarizes the Before and After conditions.
| TABLE 1 | Before | After |
| Site Area | 58,863 sq. ft. | 56,056 sq.ft. |
| Gross Building Area | 17,214 sq. ft. | 16,078 sq. ft. |
| Parking Stalls | 71 stalls | 64 stalls |
| Anticipated Groundbreaking | Fall 2007 | Spring 2011 |
MARKET INFORMATION
When valuing a taking, it is important to remember that market information used in the value analysis should be consistent with the market expectations as of the date of valuation, not predicated on information available subsequent to the date of the taking. In this case, one might argue that if we were appraising the subject property today, the proposed development would not be considered a prudent investment. It is quite likely that the recent economic recession would have adversely affected the performance of the subject retail center. In fact, it is possible that the owners actually benefited from the taking. One could also argue that, due to the recession, construction costs did not increase from 2007 to 2011 as anticipated. Nevertheless, damages are determined as of the date of the taking. The appraiser must rely on the market conditions most representative of what an investor would anticipate as of the date of the taking.
In the case of the subject, although the general retail market had shown signs of softening, given the subject’s desirable location (a high profile intersection, a highly populated area, near a major university, and on-site parking), demand for the subject was expected to remain strong. Additionally, the developer had already identified a broker who was actively marketing the development for a spring 2008 construction start. Market conditions clearly indicated that there was a demand for this type of retail development prior to breaking ground on the project.
AFTER CONDITION
To determine the subject’s value in the after condition, one must first determine whether or not the taking altered the HBU of the site. The taking resulted in a small loss in the development’s size and the number of parking spaces. However, we concluded that the subject’s proposed use still represented the HBU of the subject in the after condition. It was the 40-month temporary easement that posed the greatest impediment to this retail development project. The most difficult task was to value the damages (risks) associated with developing in the future versus developing in the near term.
As was the case in the before condition, we completed a DCF analysis factoring in the reduced building area and the 40-month delay. The assumptions used in the before condition were also applied in the after condition. For example, rental and operating expenses increased at approximately 3% annually throughout the holding period including the period when the site was vacant and encumbered by the temporary easement, and the vacancy rate remained at 5%.
The DCF analysis in the after condition again utilized a 10-year holding period, but with the first 40 months capturing our estimated ground rent. Once the temporary easement expired, development and construction costs were estimated and applied in Years 4 and 5 with leasing taking place in Year 5. Absorption of the development, in the after condition, is estimated at a rate similar to that used in the before condition. However, we extended the development period slightly, in the after condition, to reflect the additional time necessary to revise the plans, submit them and receive approvals.
Ultimately, our value conclusion for the after condition reflects what a buyer would pay for the site which had the ability to collect ground rent for 40 months and delivered the right to develop a slightly smaller shopping center at the end of the easement period. We reflected the additional risk of developing the site four years into the future by adding 50 additional basis points to the applied discount rate and estimated a market value of $1,900,000 in the after condition. When all the consequences of the taking were considered, the DCF analysis indicated an estimated value of $34 per square foot.
SUMMARY
With a value in the before condition of $2,600,000 and a value in the after condition of $1,900,000, we estimated the fee simple damage loss of the subject at approximately $700,000. Additionally, our analysis of the temporary easement indicated that the present value of leasing the subject for 40 months was $725,000. Therefore, total damages were estimated at $1,425,000. Ultimately, the Commissioners relied on Shenehon Company’s valuation. The hearing resulted in an award to the property owners of $1,200,000 and reimbursement of reasonable appraisal fees. The issue of whether a retaining wall was damaged as a result of the taking is undecided at this time. Additional compensation may be appropriate in the future unless the site work is actually underway. The Commissioners’ decision assumes that additional work will not be necessary. If this is not the case, the owner’s may submit the additional costs to MnDot for reimbursement.
