Casualty Loss Valuation Patrick OConnor, MAI OConnor & Associates.

Casualty Loss Casualty Loss ValuationValuationPatrick O’Connor, MAIPatrick O’Connor, MAI

O’Connor & AssociatesO’Connor & Associates

MythMyth

““I was insured, so there is no casualty I was insured, so there is no casualty loss.”loss.”

Perception of most ownersPerception of most owners Perception of many tax professionalsPerception of many tax professionals

Casualty LossCasualty Loss

Similar to bonus depreciationSimilar to bonus depreciation Can be 10 – 20%+ of market value prior Can be 10 – 20%+ of market value prior

to the casualtyto the casualty Likely applies even if you are fully Likely applies even if you are fully

insuredinsured

Casualty Loss DeductionCasualty Loss Deduction

Market value immediately before the Market value immediately before the casualty,casualty,

Less the market value immediately after,Less the market value immediately after, Less insurance proceedsLess insurance proceeds

ExampleExample

Market value beforeMarket value before $5,000,000$5,000,000 Market value afterMarket value after 3,000,000 3,000,000 DifferenceDifference 2,000,000 2,000,000 Less insurance proceedsLess insurance proceeds 1,200,000 1,200,000 Net casualty lossNet casualty loss 800,000 800,000 Tax savings at 35%Tax savings at 35% $ 280,000 $ 280,000

MV before CasualtyMV before Casualty

Routine valuation assignmentRoutine valuation assignment

MV after CasualtyMV after Casualty

ComplexComplex Limited dataLimited data Many issues to considerMany issues to consider More subjective than many assignmentsMore subjective than many assignments

MV after Casualty IssuesMV after Casualty Issues

Physical damagePhysical damage Obligations to tenantsObligations to tenants Litigation with tenantsLitigation with tenants Tenant options to cancelTenant options to cancel Market value of leaseholdsMarket value of leaseholds Outlook for metro area (ie population and Outlook for metro area (ie population and

employment on Galveston in 1 – 3 years)employment on Galveston in 1 – 3 years)

MV after Casualty IssuesMV after Casualty Issues

Time to settle insurance claimTime to settle insurance claim Time to rebuildTime to rebuild Time to releaseTime to release Tenant improvements to leaseTenant improvements to lease Leasing commissionsLeasing commissions Reduced level of revenue until stabilized Reduced level of revenue until stabilized

income is reachedincome is reached


Is market rent higher or lower? (Lower Is market rent higher or lower? (Lower population / employment?)population / employment?)

Has stabilized occupancy changedHas stabilized occupancy changed Are expenses different? Insurance?Are expenses different? Insurance? Entrepreneurial profit to induce a buyerEntrepreneurial profit to induce a buyer Different cap rate due to changes in Different cap rate due to changes in

population / employment?population / employment?

New Orleans after New Orleans after KatrinaKatrina

City of New Orleans at 72% of pre-City of New Orleans at 72% of pre-Katrina populationKatrina population

New Orleans metro area at 87% of pre-New Orleans metro area at 87% of pre-Katrina populationKatrina population

Source: Greater New Orleans Source: Greater New Orleans Community Data Center, July 2008Community Data Center, July 2008

Valuation ExampleValuation Example

Before AfterBefore After

Gross potential rentGross potential rent $16$16 $15$15 Stabilized occupancyStabilized occupancy 90%90% 85%85% Other income PSFOther income PSF $4$4

$3.3$3.3 Operating expensesOperating expenses PSFPSF $8$8 $8$8 100,000 SF retail center100,000 SF retail center 90% occupied before90% occupied before


Lower rent and stabilized occupancy less Lower rent and stabilized occupancy less likely as distance from Galveston likely as distance from Galveston increasesincreases

I.e. long term impact on revenue and I.e. long term impact on revenue and expenses diminishes as distance from expenses diminishes as distance from area affected catastrophically increasesarea affected catastrophically increases


PGIPGI $1,600,000$1,600,000 $1,500,000 $1,500,000 Less vacLess vac 160,000 160,000 225,000 225,000 Plus other inc 400,000 380,000Plus other inc 400,000 380,000 EGIEGI 1,840,000 1,840,000 1,655,000 1,655,000 Expenses 800,000Expenses 800,000 800,000 800,000 NOINOI 1,040,000 1,040,000 855,000 855,000 MV (9%) $11,555,556 9,500,000MV (9%) $11,555,556 9,500,000


Casualty loss of over $2 MM without Casualty loss of over $2 MM without considering lost rents, leasing considering lost rents, leasing commissions and entrepreneurial profitcommissions and entrepreneurial profit


Remaining issues:Remaining issues: Lost rentsLost rents Leasing commissionsLeasing commissions Entrepreneurial profitEntrepreneurial profit

Lost RentsLost Rents

1 year to negotiate insurance claim and 1 year to negotiate insurance claim and rebuild; 15% occupancyrebuild; 15% occupancy

Reach 85% occupancy 1 year later (24 Reach 85% occupancy 1 year later (24 months after casualty)months after casualty)

$1,575,000$1,575,000

Leasing CommissionsLeasing Commissions

Lease 70% of space at $15 PSF for 5 Lease 70% of space at $15 PSF for 5 year term; 5% commissionyear term; 5% commission

Leasing commissions $262,500Leasing commissions $262,500

Entrepreneurial ProfitEntrepreneurial Profit

How much profit (% of value after rehab at How much profit (% of value after rehab at stabilized occupancy) would you want?stabilized occupancy) would you want?

Guarantee construction loanGuarantee construction loan Lease up riskLease up risk Assemble capitalAssemble capital Supervise constructionSupervise construction Supervise leasingSupervise leasing 5% or 10% or 15% ($475,000 or $950,000 or 5% or 10% or 15% ($475,000 or $950,000 or

$1,425,000)$1,425,000)


Entrepreneurial profitEntrepreneurial profit 5% = $475,000 5% = $475,000 10% = $950,00010% = $950,000 15% = $1,425,00015% = $1,425,000


Stabilized valueStabilized value $9,500,000$9,500,000 Less lost rentsLess lost rents 1,575,000 1,575,000 Less leasing commissionsLess leasing commissions 262,500 262,500 Less entrepreneurial profitLess entrepreneurial profit 475,000 475,000 Net value after casualty $7,187,500Net value after casualty $7,187,500

Casualty Loss DeductionCasualty Loss Deduction

MV before casualtyMV before casualty $11,555,556$11,555,556 Net MV after casualtyNet MV after casualty

7,187,5007,187,500 Casualty lossCasualty loss 4,368,056 4,368,056 Tax savings at 35% Tax savings at 35%

$1,528,820$1,528,820

ProcessProcess

Request a preliminary review of whether Request a preliminary review of whether you qualifyyou qualify

No value, but can determine whether it is No value, but can determine whether it is worthwhileworthwhile

No cost for preliminary analysisNo cost for preliminary analysis Review with your CPA / tax return Review with your CPA / tax return

preparerpreparer

ProcessProcess

Obtain appraisal (before and after)Obtain appraisal (before and after) Tax return preparer claims casualty lossTax return preparer claims casualty loss

ConclusionsConclusions

LegitimateLegitimate Assumptions are reasonableAssumptions are reasonable Valuation would withstand peer reviewValuation would withstand peer review

Casualty Loss Valuation Patrick OConnor, MAI OConnor & Associates.

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