As you can tell by the prior post in this series, the value of the dry lake marina is not the main issue.  The real question to be answered is whether it is financially feasible to restart the marina and if not, at what market value it would be.  Ironically, this is tied into value because there may be some price the marina could transact for (the definition of market value states that it “presumes a sale”) that would result in someone taking the risk of restarting marina operations.  This price point plays heavily into deciding on the highest and best use of the marina and in comparison to other uses that might be financially feasible.  The test here is what has the higher market value:  the price necessary to get a marina operator to restart the business and take the entrepreneurial risk or the value as vacant lakefront land (or some other use)?  For the lender that has to make this type of decision, it’s a question of how big a write down they will be forced to take.

Our Fair Weather Friend – the Income Approach

Normally when appraising a marina we rely on the income approach.  But direct capitalization will not work because neither income nor expenses are stabilized (i.e. reflective of long-term performance).  We have a “lease-up” period to consider and start up expenses such as advertising.  We may have to hire new personnel because most of the staff had left long ago for more steady gainful employment.  Cap rates for stabilized marinas are of little value for an destabilized marina.  What’s a ‘fella to do?

Time for an Out-of-the-Box Experience

Even though marina owners in the market do not use discounted cash flow (DCF), this is the only valuation method available to handle the dry lake marina.  On a high level, the incomes and expenses to restart the marina business are considered and modeled over time.  Unless this is a tax appeal appraisal, performing a DCF is the most understandable way to solve all the problems associated with restarting the marina.  More importantly, you need to do it.  Here’s why:

1. It is the best method for determining highest and best use – should the marina and the business just fold up shop or should it be restarted?  This technique is the answer.
2. Would a typical appraiser (i.e. your peers) use it?  I think so.
3. You can model “what if” scenarios.
4. You can calculate the return on investment (ROI) for various value conclusions and financing scenarios (if any); the point where it gets high enough for an investor to buy the property is most likely its market value.

Applying the DCF

Remember the last post where I mention that your research may only be able to yield a sense of pessimism, optimism or neutrality?  Another way to put it is most likely, most probable and least likely.  This is where you apply it.

One way to do so is to borrow some of the thought processes used in modeling lease-up from other property types.  Let’s say you have three sets of assumptions:  most probable, most favorable and least favorable.  You can model all three in a DCF and see what market values are derived.  Now let’s say that there’s a 20 percent chance the least favorable scenario will occur, a 70 percent chance the most likely one will prevail and 10 percent that the most favorable will come to fruition.  Multiplying these percentages times the market values gives you an indication above and beyond simply selecting the most probable scenario as your market value conclusion.  Add them together and take the average for your “most probable” weighted market value.

Weighing the Weighted Number

Notice up to this point that I haven’t said what market value conclusion is the most appropriate.‚  Also notice that we have a weighted number representing the risk and probabilities that certain assumptions will prevail.  Let’s take an example of why this is important.

Let’s say that your most probable market value conclusion is $1.5 million.  Let’s also say that the weighted market value is $1.2 million.  What does that tell you?

1. The risk of loss from the downside is greater than the upside potential scenario.  Do you think a market participant would recognize this?  I do.  Maybe not through mathematical DCF processes, but if your market research shows that a pessimistic viewpoint is necessary (as determined by boater attitudes toward the marina), then the “bottom fishing” price is the only way to make a transaction happen.  For a lender, the transaction price is critically important.  For an appraiser, it will be market value.
2. The marina has lots of stigma.
3. The absorption period may indicate that the pricing of the slip rental rates and services necessary to attract boaters to the marina needs to be set so low that it may be many years before it generates a profit sufficient for the owner…  or a profit at all.  This ties into number one above.

Let’s take this one step further.  Let’s say you’ve determined that the market value as land is $1.3 million.  If you conclude that the market value from the most probable scenarios is $1.5 million, you’ve said that the highest and best use is to restart the marina.  However, in the weighted value scenario, you say it’s less than the vacant land value because there is so much stigma and risk in the early years that the most probable market value is penalized and would not be fully recognized in the market given these risks.  Your highest and best use would be different.  Don’t you think that’s what your client wants to know?  Doing it this way, haven’t you provided support and reasoning to your opinions rather than leaving him/her in the dark and just concluding without proving it?  As I say, this type of appraisal needs to answer much more than what the market value is.

Solving The Problem

As is obvious from this and the prior post, I believe that more research is necessary and the appraisal report must prove the highest and best use to the client.  It’s not enough to say, “In my opinion, the highest and best use of the subject is as a marina.”  You can prove it.  You can give the reader multiple market value conclusions in the report that, although hypothetical, provide information for their decision processes.  You can peg that single market value conclusion the client wants with a full understanding of what is necessary for it to become reality.

Appraisal is not called a service based business for nothing.