Posted by Jonathan Miller -Wednesday, May 5, 2010, 9:19 AM
Through the process of valuing terrace space in Manhattan since the mid-1980’s we developed a logic or valuation methodology for this amenity. I am asked to explain the process several times a week and it finally dawned on me to write about it (I can be slow to the draw sometimes).
Back in the mid-1980’s when we began our company, attempts to value terrace space by the real estate community (appraisers and agents) was approached as a lump sum dollar value rather than establishing a relationship with the value of the interior space of the apartment itself (ie that particular terrace is worth $50k) which I derided as the PFA (pull from air) approach.
Outdoor area was valued quite primitively as fixed asset, with little consideration to variations in size (other than “small” and “large”) and its relationship to the apartment it was attached to (the same logic was incorrectly used with roof rights). We would see large terraces attached to one-bedroom apartments treated the same as if it were attached to a 12 room apartment. Crazy.
In fairness, this “terra logic” wouldn’t have been possible without the evolution of price per square foot as a core price metric in Manhattan. Market participants were talking and thinking about it but it wasn’t formally analyzed. We were the first appraisers to introduce price per square foot for co-ops in our appraisal reports by presenting all sales within the building to bracket the price per square foot of the subject apartment, and the first to introduce it into our market reports as a formal analysis. It was difficult because square footage is not a matter of public record and most co-op listings did not include square footage. We had amassed the information during our normal course of business.
Gotta love the completely ridiculous valuation metric “price per room” which admittedly we used in the early 1990’s in our first market reports until it morphed into price per square foot. Incredibly, price per room is still presented today. Imagine a buyer telling a broker “I won’t pay a dime over $135,000 per room.” Good grief.
Valuing Outdoor Space
We have found that a ppsf analysis on finished terrace space is generally a reliable form of valuation to determine what the terrace area contributes to the overall value of the apartment being appraised. Its a relational value – if the apartment is worth more, that carries over to the outdoor space. This logic applies to patios, garden areas and balconies. Doesn’t matter whether it is a co-op, condo, highrise, lowrise or brownstone.)
- Estimate the ppsf of the property without the terrace
- The general relationship between finished terrace space and interior space – terraces are typically valued at 25-50% of the ppsf of the interior space.
For example – if the interior space was worth $1,000 psf, without considering the terrace, the outdoor space could be worth as much as $500 psf (50% of interior ppsf). If the terrace is 500 sqft, the terrace could be worth $250k ($500/sf x 500 sq ft).
That’s the basic idea. Simple. Of course there are many other factors such as:
- depth – a 500 sq ft could be a deep terrace or a shallow 2 ft deep wrap around – same sq ft but different value.
- location – a 2nd floor terrace overlooking a busy north/south avenue has more noise and soot as well as a lower perception of security
- privacy – space that is not formally separated from the adjacent apartment terrace space has lower value
- Obstructions – such as a parapet that blocks the view from the terrace. View itself is NOT a terrace amenity since it is considered in the ppsf of the apartment. A skylight or risers are usually deducted from the square footage.
- oversized space – if the terrace is greater than 50% of the interior space, the ppsf contribution falls off considerably for the additional space over the 50% threshold. For example 700 sq ft 1-bedroom apartment with a 3,000 sqft terrace – only about 350 sq ft has any meaningful value (of course, if the maintenance charges reflect the entire terrace, any value of the terrace would be wiped out.
- primary amenity – The patio or garden in a ground floor brownstone or apartment – use the same logic as when considering a terrace in a penthouse apartment.
Comparing apartments with and without outdoor space
One of the reasons penthouse or any apartments with significant outdoor space sell for a higher price per square foot is that the sq ft denominator in the price per square foot equation only considers interior square footage. To create more parity between the two types of apartments for comparison purposes, calculate the adjusted price per square foot of the apartment. In order to do that you need to theoretically convert the outdoor space into interior space.
In the prior example, we said the terrace was worth 50% psf of the of interior space ($500 v. $1000). Use the same relationship with size and give the space full credit for interior space by taking 50% of the terrace space (500 sqft x .5 = 250 sqft) and add it to the existing interior square footage: 1,000 interior square feet + 250 interior square feet representing 500 square feet of terrace = 1,250 adjusted square feet.
This makes it easier to compare units with and without terraces and is predicated on the whether your % discount assumption for your exterior space is correct.
Disclaimer: No comments by an appraiser would be complete without a disclaimer. It is important to note that these are only rules of thumb to guide you – the value of a terrace is not formula driven – these relationships are developed from market data and can vary significantly depending on the combination of amenities and time. If you are unable to grasp this, close your eyes very tightly, think about a cool ocean breeze on a warm
breeze sandy beach, while holding a large set of perfect comps, until memories of this post fade completely away.