Real Estate Valuation - New Castle Sheraton

Posted on: 18th June 2023

Question

Please read the article and focus on the following elements:

1) as you all have learned about “highest and best use”, how would you analyze highest and best use of this property based on the story?

2) if the property was not granted a “certificate of occupancy” after being completed, what would the value of the property be?

3) what are other valuation issues that arise from understanding this situation?

here is the link to the article.
https://delawaretoday.com/life-style/that-hotel/

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Solution

Real Estate Valuation - New Castle Sheraton

Question 1

The highest and best use of this property would be as a hotel. The property is located near several corporate markets, has good highway access, and features a ballroom, conference rooms, and an indoor heated pool. While the hotel industry is competitive, the property has the potential to attract business from travelers going between Philadelphia and Baltimore. For example, the hotel could market itself as a convenient stopover for business travelers or a destination for weddings and other social events.

As the hotel industry is slowly recovering from the recession, this property could help attract business to the area that might not have otherwise come. Therefore, while adding another hotel in the area may somewhat dilute the market, this particular property has a good chance of being successful. For example, there is a new hotel near I-95. This place will attract travelers who want to stop in the city. There are 8 conference rooms, including a ballroom. It will have an indoor heated pool and a wedding planner on-site. The area has had trouble recovering from the recession, so this hotel may help to bring jobs and make money for the city. The hotel will have an annual payroll of $2.5 million and 90 employees.

Question 2

If the property were not granted a certificate of occupancy after being completed, the property’s value would be greatly reduced (Kucharska-Stasiak & Źróbek, 2015). Without a certificate of occupancy, the property cannot be used for its intended purpose as a hotel. This would make the property much less attractive to potential buyers and significantly reduce its market value. For example, a potential buyer might be willing to pay $10 million for a hotel with a certificate of occupancy but only $5 million for the same property without a certificate of occupancy. In other words, the property’s value without a certificate of occupancy would be cut in half.

Without a certificate of occupancy, the property would likely have difficulty getting financing (Kucharska-Stasiak & Źróbek, 2015). Lenders would be unwilling to lend money for a property that cannot be used for its intended purpose. This would further reduce the property’s value and make it even less attractive to potential buyers (Leskinen, Vimpari, & Junnila, 2020). For example, a property with a value of $10 million and a loan for $5 million would have a loan-to-value ratio of 50%. However, if the property did not have a certificate of occupancy, the loan-to-value ratio would increase to 100%, making the property much riskier for lenders.

Question 3

Some other valuation issues that arise from this situation are the potential for environmental contamination and the risks associated with financing. The property is located near several former coal mines, which raises the possibility of environmental contamination. If the property is contaminated, it would likely be worth less than a similar property that is not contaminated. For example, a clean property might be worth $10 million, but a contaminated property might only be worth $5 million.

The property also has a high loan-to-value ratio, which is riskier for lenders. If the hotel is not successful, the lender could foreclose on the property and end up with a loss. Therefore, the lender might be unwilling to lend money for the property or might only be willing to lend at a higher interest rate, which would reduce the property’s value (Leskinen, Vimpari, & Junnila, 2020). For example, if a lender is willing to lend at a 6% interest rate for a clean property, they might only be willing to lend at an 8% interest rate for a contaminated property. This would increase the monthly payment and make the property less attractive to potential buyers.

References

Kucharska-Stasiak, E., & Źróbek, S. (2015). An attempt to exemplify the economic principles in real property valuation. Real Estate Management and Valuation, 23(3), 5-13.

Leskinen, N., Vimpari, J., & Junnila, S. (2020). A review of the impact of green building certification on the cash flows and values of commercial properties. Sustainability, 12(7), 2729.

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