December 12, 2023 • 25 mins
Embark on a journey into the intricate world of property valuation with our seasoned experts, John Penner and Marcus Espinoza. Not only will you hear from the creator of the Penner Expense Guide himself, but you'll also gain insights into the complex concepts that drive this industry. What's the significance of MAI, SRA, ASA, and CCIM designations? How do they impact the property appraisal process? We'll explore these answers together as Marcus breaks down the critical role of the Penner expense guide in ensuring accurate valuations.
Prepare for a deep dive into the often controversial aspects of real estate taxes, insurance, and property expenses. We'll discuss the rise in insurance premiums and introduce you to the anticipation theory used by appraisers. Our debate over Prop 13 and the dilemma of whether to use the purchase price or the lowest value conclusion in calculations promises to be both insightful and thought-provoking. Plus, John and Marcus are eager to share money-saving tips aimed at property owners with multiple buildings. And don't think we forgot about the Penner expense guide! Stay tuned until the end for details on where to find this invaluable resource online. Remember, knowledge is power in the realm of real estate investments, and we're here to empower you. Join us for an enriching discussion at the Real Estate Shop.
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Transcript
Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Ari Petronelli (00:03):
Hi, hello everyone, and thank you for
tuning in to the Real EstateShop educational platform, the
go-to destination for expertinsights into the dynamic world
of real estate.
I'm Ari Petronelli and a realestate agent based in sunny
Southern California.
Whether you're a seasonedinvestor or a first time home
buyer, or simply just curiousabout the intricacies of
property appraisal, you are infor a treat today.
(00:26):
Our experts are here to answeryour burning questions and share
invaluable insights.
So sit back, relax and let'sembark on a journey of real
estate wisdom with the RealEstate Shop.
Today, we are going to delveinto the intricate realm of
property valuation.
Joining us are two highlyesteemed appraisers with a
wealth of knowledge andexperience.
(00:47):
Please welcome John Penner andMarcus Espinoza, whose expertise
spans the diverse landscapes ofthe ins and outs of appraisals.
Thank you, guys, for being here.
John D. Penner (00:57):
Yeah, hi Ari.
Ari Petronelli (00:58):
Hi, thanks, hi.
So John Penner has over 40years of experience in appraisal
and consulting services for alltypes of properties,
specializing in medical office,industrial, retail, development,
fractional interests andeminent domain.
In addition, he publishes thewidely cited Penner expense
guide, which uses actual expensedata from properties throughout
(01:19):
Southern California.
Mr Penner has qualified as anexpert witness in bankruptcy in
Superior Court for Orange, laand San Diego counties.
He is a member of the appraisalinstitute with an MAI
designation and certificate inlitigation.
John, again, thank you forbeing here.
John D. Penner (01:36):
Hey, great, that was a great introduction.
Sound more experienced than Iam, maybe.
Ari Petronelli (01:42):
No, sounds pretty impressive.
John D. Penner (01:44):
But I have been in for a long time and I
consider myself really fortunateto be in a field that I really
enjoy for this long and I hopeto be in it longer, so for
another 10, 15 years.
So your question was about theMAI designation.
Ari Petronelli (02:00):
Yes, what is an MAI?
John D. Penner (02:02):
MAI stands for the member of the appraisal
institute, which is the largestorganization in the country for
appraisal, and it's the longeststanding.
It goes back to the 1930s andit was created after the banking
crisis that created GreatDepression.
So it's a very rigorouseducational thing that we have
(02:25):
to take a number of classes andshow our experience and pass a
demonstration report and also acomprehensive exam to get this
after having a four-year degree.
So it's pretty extensive andusually it takes at least 10
years in your career before youreach that point.
Ari Petronelli (02:41):
So it's almost like having a master's or PhD.
John D. Penner (02:43):
Yes, very much so.
Ari Petronelli (02:44):
And appraisals.
That's really interesting.
So Marcus Espinosa is acertified real estate appraiser
who holds an MAI, sri, asa andCCIM designations with his own
company, accurate Appraisers,with over 23 years of real
estate appraisal and consultingexperience.
Marcus, what exactly is a SRA,asa and CCIM?
Marcus Espinoza (03:10):
Thank you.
Thank you, ari, just like JohnPenner just mentioned, the SRA
is also another designation thatyou obtain by the Appraisal
Institute.
Like John Penner just mentioned, the Institute has been around
for several 1930s and it standsfor Senior Residential Appraiser
and the Senior ResidentialAppraiser RSRA I would say the
(03:40):
last I check about, maybe 1% ofall appraisers holds that
designation.
The ASA is another Institutethat has been around for a long
time as well and that stands foraccredited senior appraiser,
and the ASA is more of amulti-discipline organization
(04:02):
where they focus on businessvaluation.
They focus on personal propertyvaluation, real estate
valuation, and the reason why Ipicked that one up was because
of the going concern valuationsthat we do in our field.
And the CCIM is more gearedtowards brokers and that stands
(04:22):
for certified commercialinvestment member.
And, just like John said, youhave to.
You know rigorous, you knowprogram, you know you have to do
a lot to get it, so you know.
So, yeah, it's like gettingyour master's or your PhD.
You know those designations, sothey're not easy to get,
they're hard to get, but youknow we do it because we want
(04:44):
our clients to feel comfortableand who they're selecting as
their next appraiser, and soit's very important to them, so
it's very important to us.
Ari Petronelli (04:51):
I think that's really incredible that you guys
have done that.
John D. Penner (04:55):
Yeah, I wish I would have done some things
Marcus did.
Ari Petronelli (04:59):
John, I was curious about your expense guide
and why you created the expenseguide for other real estate
professionals or investors.
I've had the privilege ofreading it and it is.
It's incredible.
It's really interesting withthe amount of information that
you have in there.
John D. Penner (05:16):
Yeah, thanks, when I was starting out
appraising and I'm also a brokeryou start to look into
investment properties and youknow you have a rent.
You know, let's say, theproperty is fully leased, you
have a rent.
You have a pretty good idea ofwhat the rent is because you
have a rent for your property.
If it's fully leased, then youpretty much know what your
(05:36):
vacancy is.
You probably have an idea of acap rate.
These are all the things thatgo into coming up with an income
approach, analysis of yourproperty and come up with a
value.
The real question is theexpenses.
It's hard to know what they areand if you don't itemize them
especially here in Californiawith Proposition 13, then you're
just never really going to.
(05:56):
You're not going to be able tojust say, oh well, it's $10 a
square foot or it's eight orit's this percentage or
something.
That is just isn't going towork.
So you have to really itemizethem.
And so I began to look at that.
And you know, when you look atexpenses and you itemize them,
sometimes you don't get thatgood information.
And so if you don't have anexpense guide or something to
(06:19):
look at, what is the marketreally doing here?
All you have is what the ownerprovides to you, and you may not
get it right if you assumethat's correct.
Ari Petronelli (06:29):
No, that information is, I mean, so
valuable to potential investorsor buyers.
So Marcus, in one case may be aproperty owner Would say that
they don't want to provide,maybe, their 2019 financials, as
they received a Substantialincome that year and don't want
to show that.
How would you handle that?
Marcus Espinoza (06:51):
That's actually a real life question and that
happens in real life is what Imean.
So, so they don't want toprovide their 2019.
So I mean, if they're providingtheir 18, their night, they
don't want to provide their 19,20, 21, 22.
Then it kind of lookssuspicious.
It looks like why are you notincluding that inside of your
(07:12):
appraisal report?
Now, can I not include itbecause there was an anomaly
Income stream that year?
Yes, I mean, I could.
It doesn't.
It doesn't help our valuationbecause it might not have any
weight to what our conclusionwould be, because it was not an
anomaly year.
But we actually see it theother way.
(07:32):
Where there's not a lot ofincome, I see it more when
there's not a lot of income in2019.
2019 was before COVID, so IWouldn't, that wouldn't be a
reason to not include it, but Iwould encourage the client, I
would encourage the propertycontact to include it and we can
just, you know, we would justsay that you know this was an
(07:54):
anomaly year.
Yeah, maybe, maybe it doesn'treflect what this, what the
subject property is, performance.
So we would, we would, we justit all.
It all depends on on where thatnumber is at.
I mean, if it's double 2018, ifit's double 2020, 2021-22, then
(08:16):
we might elect to give it lessweight and we'll take any
consideration, but we'llprobably like elect to give it
less weight.
John D. Penner (08:21):
Yeah, yeah, you hate to say it, but you know
Property owners are biasedtowards what they want and they
usually want to hire Valley.
Sometimes they want lower value, but that's not our job and Our
job is to come up with what areasonable buyer Would pay for a
property and a usually sellerwould sell it for.
So you know, if you're gonnalook at expenses, this is where
(08:44):
they tend to buffalo you.
Yeah, this is where they, youknow you and you got to think
that and know that, going in,you got to really kind of have
an idea of what's going on, orthey may be able to pull the
wool over your eyes, right?
Ari Petronelli (08:57):
Right, because usually appraisers request maybe
three to five years offinancials and you know a lot of
property owners don't want tonecessarily divulge that
information.
John D. Penner (09:07):
Yeah, sometimes they think it's kind of
ridiculous or just too much orwhatever, but they're really
kind of holding back and well,and sometimes they don't keep
very good records.
Ari Petronelli (09:16):
You know mom and pop and so yeah, so also
expenses in rank and, I'm sorry,expenses in RSO.
And rank Expenses haveincreased over the past several
years, both due to inflation andhigher usage from residents,
whether they're working fromhome or just being home in
general.
(09:37):
Conversely, rents have notreally increased the last few
years.
So how does that operatingResults?
You know, should a return tonormal expense ratios before a
cast?
Marcus Espinoza (09:49):
Right.
So what, it should be normal.
And when I say normal, I meanit should be normal with your
data set.
Your data set.
If you're appraising an RSOproperty with the restrictions,
with rent controls and a rentcontrol area, your data that you
extract, you want to get yourrent comparables, you want to
(10:10):
get your sales comparables, yourexpense comparables.
You want to generate all thatinformation from a rent
controlled environment.
Otherwise, you're not analyzingthe correct data.
So it should be normal.
Yes, expenses, historically,have gone up.
Trash has gone up, water hasgone up, insurance has gone up
(10:32):
and rent has not gone up.
And rent hasn't gone up, notbecause of the market, it just
hasn't gone up because of theRSO restrictions.
Covid-19 put a freeze onincreasing rents.
We're supposed to allow ourlandlords to increase their
rents this February at 7%, whichis a very high number.
John D. Penner (10:52):
You're talking about apartments.
Marcus Espinoza (10:53):
Apartments, yes .
So yeah, rent control is a bigissue.
Rso properties are easy toappraise, as long as you know
what that is, as long as you'rebringing the correct data to the
table.
So the expense restrictionsshould be normal.
Ari Petronelli (11:16):
All right.
So, John, reserves andreplacements are another expense
that I see appraisers use andothers don't use.
What is the correct way ofanalyzing reserves and
replacements?
John D. Penner (11:26):
Well, you have to have the Pinner Expense Guide
.
Ari Petronelli (11:28):
I mean number one.
John D. Penner (11:32):
I think that we're talking about.
You've got some expenses thatare related to long life items
that the building has that areyour structure.
That's not going to, that'sgoing to depreciate over time
when it's done, your building'sdone.
But there's short-lived itemsalso and that's really what
we're talking about the roof,the floor covering the parking
(11:56):
lot, things like that.
If you're doing an apartment,we're talking about all the
appliances and things of thatnature your air conditioner,
your oven, your refrigerator,your washer dryer.
So we're looking at those andwe're looking at the life
they're going to be, which isshorter than the life of the
building, and so we're trying tocome up with what would that
maintenance be?
So it's kind of an add-on tothe repairs and maintenance
(12:18):
expense, but it needs to bereflected because sometimes your
repairs and maintenance thatare normally happening aren't
reflecting that, because maybeyour building's 10 years old but
these things are going to last10, 15, 20 years, and so you
don't really have a number forthat.
But you have to factor it inbecause it's going to happen
over time and your income streamestimate, when you're all said
and done, is going to reflectthe value of your property into
(12:42):
perpetuity, for the life of thatbuilding for the life of that
investment, and so it needs toreflect those expenses.
Ari Petronelli (12:49):
Another big topic these days is insurance,
and insurance is a big issuewith property owners.
Since insurance has increasedmore than historical norms in
the recent years, do you use ahigher conclusion than the
current insurance premium?
Marcus Espinoza (13:06):
So our conclusions are based on the
theory of anticipation.
That means that we'reprojecting how the property's
going to perform that next year.
And so if we have historicalsaying that they're at 20 cents
a square foot and it's 25 centsa square foot, 30 cents a square
(13:29):
foot, or let's say all of themwere 30, I have seen insurance
go up as much as 30% compared tolast year.
So that right there would haveto be taken in consideration for
your projected expense lineitem.
(13:50):
And us, as appraisers, we takethat in consideration.
We look at their history.
We look at something like theexpense guy line from John
Penner.
We also look at expensecomparables and so we group all
that information together and wesay, ok, well, what makes sense
and what's going on in themarket today?
If the market today, if all ourdata, is saying it's all 30
(14:12):
cents a square foot, but we knowthat the next year will be
there's an increase in 30%because we've seen it, then we
would take that in consideration.
John D. Penner (14:23):
Marcus, what do you think about earthquake
insurance?
How do you handle that?
Marcus Espinoza (14:27):
We tend to leave that out because it's not
a required expense.
Some landlords elect to pick upthat expense.
But the reason why we don'tinclude it include it because
it's not underwritten that waywith other properties.
It's not underwritten.
If you don't underwrite it,investors don't underwrite it.
(14:48):
So if investors are notunderwriting in the sale, number
one and two don't underwrite it, then it just mixes.
John D. Penner (14:55):
Yeah, and the expense can be doubled.
Marcus Espinoza (14:57):
Right and the expense which of all?
John D. Penner (14:58):
your expenses are, it's kind of crazy high
here in California.
Yeah, that's true.
Oh, yeah, yeah flood insuranceis another, but if the property
is required to have floodinsurance, then we'll include
that Right.
Ari Petronelli (15:11):
John, I wanted to talk about Prop 13.
I've noticed that someappraisers use Prop 13 for the
real estate tax conclusion,using the value conclusion.
In other cases I see appraisersnot deduct taxes and add the
tax rate to the cap rate.
What is the correct way inhandling this expense line item?
John D. Penner (15:30):
Well, I think it's the first way, but I did
have an attorney just this lastweek argue with me a lot because
I'm doing a tax appeal andstate law has a different
definition of market value fortax appeal.
So the assessors are looking forus to load the cap rate with
the tax rate.
However, it does result in alower value, which is what the
(15:52):
client wants, but that's statelaw also.
So I'm including and I'mloading the cap rate, but other
than tax appeal, I never usethat method.
I always use just using the caprate times the value.
Ari Petronelli (16:06):
So, marcus, if using Prop 13, which value
should be used, the finalconclusion, the purchase
contract price or the lowestvalue conclusion by the approach
is used?
Marcus Espinoza (16:16):
That's interesting.
I see that done in differentways, but if you're asking me, I
would be using the purchaseprice.
However the purchase price canbe, there could be a big delta
between purchase price, becausethat's an market value.
I mean, I actually myselfpersonally bought a property
(16:40):
back in 2020, and on paper webought it for 600,000.
But the property was neverworth 600,000.
It was clear that it wasn'tworth 600,000.
So the assessor turned on theradar for the assessor.
The assessor said, hey, thisproperty is not worth 600,000.
We're gonna do our ownassessment.
So they did their ownassessment.
So when they did their ownassessment, they came out at 950
(17:02):
.
Now, was it worth 950?
That's the question.
Well, what does the assessor use?
They use market rents, they useaverage condition, and that's
what they did.
And so when doing that, they'renot considering the other
things.
They don't know what the actualrent is, they don't know what
the condition of the property is.
(17:23):
So, was it worth 950?
No, it wasn't worth 950.
It was worth something south ofthat number.
But then that's when you have togo do a tax appeal and say, hey
, listen, it's not worth 950,and here's why.
And so then here's why it comesup.
And then the assessor appraiserlays low on it.
(17:43):
But in most cases we use thepurchase price because if our
valuation is off, say 5% or 10%,the assessor is still going to
use purchase price.
So that's what they would use.
That's what I would use.
I do see it used where they saythat the income approaches are
(18:06):
self-contained approach, solet's use that number.
I also see other people use thesales comparison approach
because that's going to be thefinal conclusion of the report.
So I see it done different ways, but I tend to veer on the
purchase price.
John D. Penner (18:24):
Yeah, I think I like to look at how court really
looks at things, becauseultimately if something is in
dispute it ends up there notthat often, but that's really
the arbitrator of what, reallythe final arbitrator?
And so you have to get back tobasics and what they're really
looking for is sales.
It's really hard to disagreewith the sale because, like Mark
(18:45):
Roos was saying, the purchaseprice is the purchase price.
Somebody actually agreed to buyit for that and sell it for
that, and so as long as thatsale goes along with other sales
in the market, it's really hardto disagree with that.
So I think the other approachesare strong also in certain
instances.
But that's probably thestrongest indication.
Ari Petronelli (19:03):
I was always curious about this, but do you
find that there are significantcost savings if a property owner
has more than one building, forexample, lower repairs and
maintenance, and what otherexpenses could have cost savings
?
Marcus Espinoza (19:17):
That's actually a good question.
And the reason why that isbecause when you're doing, when
we're doing, portfolioassignments, we do see a lax
amount for repairs andmaintenance.
And the reason why is becauseif you own a portfolio of
property say 25 buildings, andthey're multi-tenant then you're
(19:37):
gonna have ongoing repairs andmaintenance, like it's just
gonna be reoccurring like on adaily.
So you can actually hire ahandyman and just hire him for
40 hours a week and you justinclude him in your payroll and
it might.
It turns out that it could beless expensive than hiring the
(19:59):
subcontractor coming out andvetting him and it just yeah,
and then they're charging youfor that one-time appearance.
If you have a subcontractorcoming out and they're coming
out 15 times a month, thenthey're gonna be more relaxed on
what they charge you.
Also, a property management.
(20:19):
If I went to you and said, hey,ari, I got a four-unit retail
building that I would like foryou to manage and you'll be like
, okay, cool, I'll manage it.
And then if I bring 15 of thoseto you, you might be, okay,
well, I'm gonna, I'm bringingmore revenue to your business
and you might cut me some slackon the percentage.
So, yeah, so that's what I seewhen I'm working with portfolio.
Ari Petronelli (20:45):
I also see that a lot of buildings are managed
by the property owner.
John, why would you deduct amanagement expense when
analyzing a property?
John D. Penner (20:54):
Well, you're gonna have to manage it, no
matter what.
So you are doing something Now,whether you want to.
If you don't charge amanagement fee, then that means
you make more income.
Okay, so you're gonna pay a taxon that.
If you are the manager and youmake money, that well, then
you're gonna pay that as incometo you and you're gonna pay
taxes on that also.
So it's just a matter of whatthey're gonna do.
But basically, you know,everybody's gonna have to have
(21:15):
management for a property and ifyou're a buyer, then you're
gonna have to assume that that'sgonna be a cost, absolutely.
So you have to account for that.
Somebody has to do the work,yeah.
Ari Petronelli (21:25):
So how should owners handle capital repairs
and improvements, John, Likewater heaters, roof replacement
you know painting and when canthey deduct them?
In the year incurred, versusamortizing them?
John D. Penner (21:38):
Yeah, that's a good question.
Just to kind of go back alittle deeper, sometimes there's
capital expenses and maybethat's a major tenant
improvement for the property orsomething, and that's not
something that's going to bededucted as an everyday
operating expense.
So we do not include that inour everyday expenses.
That's going to be dealt withseparately down below the NOI
(22:02):
line, the net operating incomeline.
So but aside from that thenwe're just kind of looking at
the expenses and some ownersdeduct them every year all the
time, and then others you knowaccount form over a time period.
We're not really looking asappraisers, we're not looking,
we're not an accountant, we'renot going to, we're not going to
utilize depreciation and thingsof that nature.
(22:25):
We're going to try to accountfor what is typical for this
property and arrive at a numberat that and probably prepares a
maintenance Probably the hardestnumber to come up with in your
appraisal as far as expenses go.
Ari Petronelli (22:37):
So where do you see expenses in the next year
then?
John D. Penner (22:41):
You know I think that Mark has touched on
insurance that's got to be thebiggest rising one, whether it's
worried about fires or allsorts of different liability, so
that's probably the biggest onethat's really jumping right now
.
There's no question, when Icome up with my numbers next
year I know that's going to behigher utilities.
Utilities are just crazy rightnow.
(23:01):
I mean whether it's water orelectric, and they're putting
all this infrastructure in inCalifornia for climate change.
Well, we're going to end upfooting the bill, so the
utilities are really probablygoing to go up too.
I think maintenance actually iskind of staying stable because
the supply chain problems we hadduring COVID are not there
(23:22):
anymore.
There's not as muchconstruction going on right now,
so the cost of different itemsisn't as high.
I think that is kind of leveledoff.
But the insurance and utilitiesare probably the biggest area.
Ari Petronelli (23:33):
Yeah, I feel it Absolutely.
Marcus Espinoza (23:36):
With repairs and maintenance.
I've seen contractors thatwould contact me and they would
actually, you know, hey, youknow.
I mean, can I do some work?
When they're calling youbecause they need work, that's
when you know that there's goingto be some relaxed numbers.
So, yeah, stable, stable, even,probably even decrease with
repairs Possibly.
John D. Penner (23:54):
Yeah, because I hate to say that.
Marcus Espinoza (23:56):
Because labor is available, insurance, you
know, like gosh, you know StateFarm just left California, yeah,
yeah.
So I mean it's just the onlyone.
Yeah, they're not the only one.
So I mean, if you have a policywith State Farm, they're not
renewing you.
So it's a very interesting timefor a lot of you.
John D. Penner (24:16):
Try to get car insurance.
Crazy yeah.
Ari Petronelli (24:20):
Also, what are the hardest expenses to analyze?
John D. Penner (24:23):
Yeah, I'd have to go back to repairs and
maintenance.
Yeah, really the most difficult, because you're really kind of
having to assess the quality ofthe building, the age of the
building, the components of it,what's going on.
Have they really done anymaintenance in the past?
You know what condition is thebuilding in, so you're going in
there and you're looking at thatand if we're going back to, you
know management, professionalmanagement is on it.
(24:45):
They're looking at it all thetime.
They're maintaining theirproperties and then all of a
sudden there's one owner that'smom and pop, that only own one
property and they kind of tendto let things go and then all of
a sudden they you know theywonder why their property is
being hit with some extra costand losses in the value,
deferred maintenance.
But there can be a lot ofdeferred maintenance that creeps
up.
Ari Petronelli (25:05):
Well, before I wrap this up, I just want to
know, John, where can we findthe Penner expense guide?
John D. Penner (25:10):
Well, it's on the internet.
Just a quick.
Ari Petronelli (25:12):
Google search of .
John D. Penner (25:14):
At penner-associatescom.
Ari Petronelli (25:17):
Okay, awesome.
Well, thank you so much to ourguests, john and Marcus, who
have certainly added a new layerof understanding for myself and
, I'm sure, our listeners aswell.
Until next time, remember thatknowledge is power and the real
estate shop is here to empoweryou in the real estate world.
Marcus Espinoza (25:33):
Thank you.
John D. Penner (25:33):
Great, thank you .
Hi, hello everyone, and thank you for
tuning in to the Real EstateShop educational platform, the
go-to destination for expertinsights into the dynamic world
of real estate.
I'm Ari Petronelli and a realestate agent based in sunny
Southern California.
Whether you're a seasonedinvestor or a first time home
buyer, or simply just curiousabout the intricacies of
property appraisal, you are infor a treat today.
(00:26):
Our experts are here to answeryour burning questions and share
invaluable insights.
So sit back, relax and let'sembark on a journey of real
estate wisdom with the RealEstate Shop.
Today, we are going to delveinto the intricate realm of
property valuation.
Joining us are two highlyesteemed appraisers with a
wealth of knowledge andexperience.
(00:47):
Please welcome John Penner andMarcus Espinoza, whose expertise
spans the diverse landscapes ofthe ins and outs of appraisals.
Thank you, guys, for being here.
John D. Penner (00:57):
Yeah, hi Ari.
Ari Petronelli (00:58):
Hi, thanks, hi.
So John Penner has over 40years of experience in appraisal
and consulting services for alltypes of properties,
specializing in medical office,industrial, retail, development,
fractional interests andeminent domain.
In addition, he publishes thewidely cited Penner expense
guide, which uses actual expensedata from properties throughout
(01:19):
Southern California.
Mr Penner has qualified as anexpert witness in bankruptcy in
Superior Court for Orange, laand San Diego counties.
He is a member of the appraisalinstitute with an MAI
designation and certificate inlitigation.
John, again, thank you forbeing here.
John D. Penner (01:36):
Hey, great, that was a great introduction.
Sound more experienced than Iam, maybe.
Ari Petronelli (01:42):
No, sounds pretty impressive.
John D. Penner (01:44):
But I have been in for a long time and I
consider myself really fortunateto be in a field that I really
enjoy for this long and I hopeto be in it longer, so for
another 10, 15 years.
So your question was about theMAI designation.
Ari Petronelli (02:00):
Yes, what is an MAI?
John D. Penner (02:02):
MAI stands for the member of the appraisal
institute, which is the largestorganization in the country for
appraisal, and it's the longeststanding.
It goes back to the 1930s andit was created after the banking
crisis that created GreatDepression.
So it's a very rigorouseducational thing that we have
(02:25):
to take a number of classes andshow our experience and pass a
demonstration report and also acomprehensive exam to get this
after having a four-year degree.
So it's pretty extensive andusually it takes at least 10
years in your career before youreach that point.
Ari Petronelli (02:41):
So it's almost like having a master's or PhD.
John D. Penner (02:43):
Yes, very much so.
Ari Petronelli (02:44):
And appraisals.
That's really interesting.
So Marcus Espinosa is acertified real estate appraiser
who holds an MAI, sri, asa andCCIM designations with his own
company, accurate Appraisers,with over 23 years of real
estate appraisal and consultingexperience.
Marcus, what exactly is a SRA,asa and CCIM?
Marcus Espinoza (03:10):
Thank you.
Thank you, ari, just like JohnPenner just mentioned, the SRA
is also another designation thatyou obtain by the Appraisal
Institute.
Like John Penner just mentioned, the Institute has been around
for several 1930s and it standsfor Senior Residential Appraiser
and the Senior ResidentialAppraiser RSRA I would say the
(03:40):
last I check about, maybe 1% ofall appraisers holds that
designation.
The ASA is another Institutethat has been around for a long
time as well and that stands foraccredited senior appraiser,
and the ASA is more of amulti-discipline organization
(04:02):
where they focus on businessvaluation.
They focus on personal propertyvaluation, real estate
valuation, and the reason why Ipicked that one up was because
of the going concern valuationsthat we do in our field.
And the CCIM is more gearedtowards brokers and that stands
(04:22):
for certified commercialinvestment member.
And, just like John said, youhave to.
You know rigorous, you knowprogram, you know you have to do
a lot to get it, so you know.
So, yeah, it's like gettingyour master's or your PhD.
You know those designations, sothey're not easy to get,
they're hard to get, but youknow we do it because we want
(04:44):
our clients to feel comfortableand who they're selecting as
their next appraiser, and soit's very important to them, so
it's very important to us.
Ari Petronelli (04:51):
I think that's really incredible that you guys
have done that.
John D. Penner (04:55):
Yeah, I wish I would have done some things
Marcus did.
Ari Petronelli (04:59):
John, I was curious about your expense guide
and why you created the expenseguide for other real estate
professionals or investors.
I've had the privilege ofreading it and it is.
It's incredible.
It's really interesting withthe amount of information that
you have in there.
John D. Penner (05:16):
Yeah, thanks, when I was starting out
appraising and I'm also a brokeryou start to look into
investment properties and youknow you have a rent.
You know, let's say, theproperty is fully leased, you
have a rent.
You have a pretty good idea ofwhat the rent is because you
have a rent for your property.
If it's fully leased, then youpretty much know what your
(05:36):
vacancy is.
You probably have an idea of acap rate.
These are all the things thatgo into coming up with an income
approach, analysis of yourproperty and come up with a
value.
The real question is theexpenses.
It's hard to know what they areand if you don't itemize them
especially here in Californiawith Proposition 13, then you're
just never really going to.
(05:56):
You're not going to be able tojust say, oh well, it's $10 a
square foot or it's eight orit's this percentage or
something.
That is just isn't going towork.
So you have to really itemizethem.
And so I began to look at that.
And you know, when you look atexpenses and you itemize them,
sometimes you don't get thatgood information.
And so if you don't have anexpense guide or something to
(06:19):
look at, what is the marketreally doing here?
All you have is what the ownerprovides to you, and you may not
get it right if you assumethat's correct.
Ari Petronelli (06:29):
No, that information is, I mean, so
valuable to potential investorsor buyers.
So Marcus, in one case may be aproperty owner Would say that
they don't want to provide,maybe, their 2019 financials, as
they received a Substantialincome that year and don't want
to show that.
How would you handle that?
Marcus Espinoza (06:51):
That's actually a real life question and that
happens in real life is what Imean.
So, so they don't want toprovide their 2019.
So I mean, if they're providingtheir 18, their night, they
don't want to provide their 19,20, 21, 22.
Then it kind of lookssuspicious.
It looks like why are you notincluding that inside of your
(07:12):
appraisal report?
Now, can I not include itbecause there was an anomaly
Income stream that year?
Yes, I mean, I could.
It doesn't.
It doesn't help our valuationbecause it might not have any
weight to what our conclusionwould be, because it was not an
anomaly year.
But we actually see it theother way.
(07:32):
Where there's not a lot ofincome, I see it more when
there's not a lot of income in2019.
2019 was before COVID, so IWouldn't, that wouldn't be a
reason to not include it, but Iwould encourage the client, I
would encourage the propertycontact to include it and we can
just, you know, we would justsay that you know this was an
(07:54):
anomaly year.
Yeah, maybe, maybe it doesn'treflect what this, what the
subject property is, performance.
So we would, we would, we justit all.
It all depends on on where thatnumber is at.
I mean, if it's double 2018, ifit's double 2020, 2021-22, then
(08:16):
we might elect to give it lessweight and we'll take any
consideration, but we'llprobably like elect to give it
less weight.
John D. Penner (08:21):
Yeah, yeah, you hate to say it, but you know
Property owners are biasedtowards what they want and they
usually want to hire Valley.
Sometimes they want lower value, but that's not our job and Our
job is to come up with what areasonable buyer Would pay for a
property and a usually sellerwould sell it for.
So you know, if you're gonnalook at expenses, this is where
(08:44):
they tend to buffalo you.
Yeah, this is where they, youknow you and you got to think
that and know that, going in,you got to really kind of have
an idea of what's going on, orthey may be able to pull the
wool over your eyes, right?
Ari Petronelli (08:57):
Right, because usually appraisers request maybe
three to five years offinancials and you know a lot of
property owners don't want tonecessarily divulge that
information.
John D. Penner (09:07):
Yeah, sometimes they think it's kind of
ridiculous or just too much orwhatever, but they're really
kind of holding back and well,and sometimes they don't keep
very good records.
Ari Petronelli (09:16):
You know mom and pop and so yeah, so also
expenses in rank and, I'm sorry,expenses in RSO.
And rank Expenses haveincreased over the past several
years, both due to inflation andhigher usage from residents,
whether they're working fromhome or just being home in
general.
(09:37):
Conversely, rents have notreally increased the last few
years.
So how does that operatingResults?
You know, should a return tonormal expense ratios before a
cast?
Marcus Espinoza (09:49):
Right.
So what, it should be normal.
And when I say normal, I meanit should be normal with your
data set.
Your data set.
If you're appraising an RSOproperty with the restrictions,
with rent controls and a rentcontrol area, your data that you
extract, you want to get yourrent comparables, you want to
(10:10):
get your sales comparables, yourexpense comparables.
You want to generate all thatinformation from a rent
controlled environment.
Otherwise, you're not analyzingthe correct data.
So it should be normal.
Yes, expenses, historically,have gone up.
Trash has gone up, water hasgone up, insurance has gone up
(10:32):
and rent has not gone up.
And rent hasn't gone up, notbecause of the market, it just
hasn't gone up because of theRSO restrictions.
Covid-19 put a freeze onincreasing rents.
We're supposed to allow ourlandlords to increase their
rents this February at 7%, whichis a very high number.
John D. Penner (10:52):
You're talking about apartments.
Marcus Espinoza (10:53):
Apartments, yes .
So yeah, rent control is a bigissue.
Rso properties are easy toappraise, as long as you know
what that is, as long as you'rebringing the correct data to the
table.
So the expense restrictionsshould be normal.
Ari Petronelli (11:16):
All right.
So, John, reserves andreplacements are another expense
that I see appraisers use andothers don't use.
What is the correct way ofanalyzing reserves and
replacements?
John D. Penner (11:26):
Well, you have to have the Pinner Expense Guide
.
Ari Petronelli (11:28):
I mean number one.
John D. Penner (11:32):
I think that we're talking about.
You've got some expenses thatare related to long life items
that the building has that areyour structure.
That's not going to, that'sgoing to depreciate over time
when it's done, your building'sdone.
But there's short-lived itemsalso and that's really what
we're talking about the roof,the floor covering the parking
(11:56):
lot, things like that.
If you're doing an apartment,we're talking about all the
appliances and things of thatnature your air conditioner,
your oven, your refrigerator,your washer dryer.
So we're looking at those andwe're looking at the life
they're going to be, which isshorter than the life of the
building, and so we're trying tocome up with what would that
maintenance be?
So it's kind of an add-on tothe repairs and maintenance
(12:18):
expense, but it needs to bereflected because sometimes your
repairs and maintenance thatare normally happening aren't
reflecting that, because maybeyour building's 10 years old but
these things are going to last10, 15, 20 years, and so you
don't really have a number forthat.
But you have to factor it inbecause it's going to happen
over time and your income streamestimate, when you're all said
and done, is going to reflectthe value of your property into
(12:42):
perpetuity, for the life of thatbuilding for the life of that
investment, and so it needs toreflect those expenses.
Ari Petronelli (12:49):
Another big topic these days is insurance,
and insurance is a big issuewith property owners.
Since insurance has increasedmore than historical norms in
the recent years, do you use ahigher conclusion than the
current insurance premium?
Marcus Espinoza (13:06):
So our conclusions are based on the
theory of anticipation.
That means that we'reprojecting how the property's
going to perform that next year.
And so if we have historicalsaying that they're at 20 cents
a square foot and it's 25 centsa square foot, 30 cents a square
(13:29):
foot, or let's say all of themwere 30, I have seen insurance
go up as much as 30% compared tolast year.
So that right there would haveto be taken in consideration for
your projected expense lineitem.
(13:50):
And us, as appraisers, we takethat in consideration.
We look at their history.
We look at something like theexpense guy line from John
Penner.
We also look at expensecomparables and so we group all
that information together and wesay, ok, well, what makes sense
and what's going on in themarket today?
If the market today, if all ourdata, is saying it's all 30
(14:12):
cents a square foot, but we knowthat the next year will be
there's an increase in 30%because we've seen it, then we
would take that in consideration.
John D. Penner (14:23):
Marcus, what do you think about earthquake
insurance?
How do you handle that?
Marcus Espinoza (14:27):
We tend to leave that out because it's not
a required expense.
Some landlords elect to pick upthat expense.
But the reason why we don'tinclude it include it because
it's not underwritten that waywith other properties.
It's not underwritten.
If you don't underwrite it,investors don't underwrite it.
(14:48):
So if investors are notunderwriting in the sale, number
one and two don't underwrite it, then it just mixes.
John D. Penner (14:55):
Yeah, and the expense can be doubled.
Marcus Espinoza (14:57):
Right and the expense which of all?
John D. Penner (14:58):
your expenses are, it's kind of crazy high
here in California.
Yeah, that's true.
Oh, yeah, yeah flood insuranceis another, but if the property
is required to have floodinsurance, then we'll include
that Right.
Ari Petronelli (15:11):
John, I wanted to talk about Prop 13.
I've noticed that someappraisers use Prop 13 for the
real estate tax conclusion,using the value conclusion.
In other cases I see appraisersnot deduct taxes and add the
tax rate to the cap rate.
What is the correct way inhandling this expense line item?
John D. Penner (15:30):
Well, I think it's the first way, but I did
have an attorney just this lastweek argue with me a lot because
I'm doing a tax appeal andstate law has a different
definition of market value fortax appeal.
So the assessors are looking forus to load the cap rate with
the tax rate.
However, it does result in alower value, which is what the
(15:52):
client wants, but that's statelaw also.
So I'm including and I'mloading the cap rate, but other
than tax appeal, I never usethat method.
I always use just using the caprate times the value.
Ari Petronelli (16:06):
So, marcus, if using Prop 13, which value
should be used, the finalconclusion, the purchase
contract price or the lowestvalue conclusion by the approach
is used?
Marcus Espinoza (16:16):
That's interesting.
I see that done in differentways, but if you're asking me, I
would be using the purchaseprice.
However the purchase price canbe, there could be a big delta
between purchase price, becausethat's an market value.
I mean, I actually myselfpersonally bought a property
(16:40):
back in 2020, and on paper webought it for 600,000.
But the property was neverworth 600,000.
It was clear that it wasn'tworth 600,000.
So the assessor turned on theradar for the assessor.
The assessor said, hey, thisproperty is not worth 600,000.
We're gonna do our ownassessment.
So they did their ownassessment.
So when they did their ownassessment, they came out at 950
(17:02):
.
Now, was it worth 950?
That's the question.
Well, what does the assessor use?
They use market rents, they useaverage condition, and that's
what they did.
And so when doing that, they'renot considering the other
things.
They don't know what the actualrent is, they don't know what
the condition of the property is.
(17:23):
So, was it worth 950?
No, it wasn't worth 950.
It was worth something south ofthat number.
But then that's when you have togo do a tax appeal and say, hey
, listen, it's not worth 950,and here's why.
And so then here's why it comesup.
And then the assessor appraiserlays low on it.
(17:43):
But in most cases we use thepurchase price because if our
valuation is off, say 5% or 10%,the assessor is still going to
use purchase price.
So that's what they would use.
That's what I would use.
I do see it used where they saythat the income approaches are
(18:06):
self-contained approach, solet's use that number.
I also see other people use thesales comparison approach
because that's going to be thefinal conclusion of the report.
So I see it done different ways, but I tend to veer on the
purchase price.
John D. Penner (18:24):
Yeah, I think I like to look at how court really
looks at things, becauseultimately if something is in
dispute it ends up there notthat often, but that's really
the arbitrator of what, reallythe final arbitrator?
And so you have to get back tobasics and what they're really
looking for is sales.
It's really hard to disagreewith the sale because, like Mark
(18:45):
Roos was saying, the purchaseprice is the purchase price.
Somebody actually agreed to buyit for that and sell it for
that, and so as long as thatsale goes along with other sales
in the market, it's really hardto disagree with that.
So I think the other approachesare strong also in certain
instances.
But that's probably thestrongest indication.
Ari Petronelli (19:03):
I was always curious about this, but do you
find that there are significantcost savings if a property owner
has more than one building, forexample, lower repairs and
maintenance, and what otherexpenses could have cost savings
?
Marcus Espinoza (19:17):
That's actually a good question.
And the reason why that isbecause when you're doing, when
we're doing, portfolioassignments, we do see a lax
amount for repairs andmaintenance.
And the reason why is becauseif you own a portfolio of
property say 25 buildings, andthey're multi-tenant then you're
(19:37):
gonna have ongoing repairs andmaintenance, like it's just
gonna be reoccurring like on adaily.
So you can actually hire ahandyman and just hire him for
40 hours a week and you justinclude him in your payroll and
it might.
It turns out that it could beless expensive than hiring the
(19:59):
subcontractor coming out andvetting him and it just yeah,
and then they're charging youfor that one-time appearance.
If you have a subcontractorcoming out and they're coming
out 15 times a month, thenthey're gonna be more relaxed on
what they charge you.
Also, a property management.
(20:19):
If I went to you and said, hey,ari, I got a four-unit retail
building that I would like foryou to manage and you'll be like
, okay, cool, I'll manage it.
And then if I bring 15 of thoseto you, you might be, okay,
well, I'm gonna, I'm bringingmore revenue to your business
and you might cut me some slackon the percentage.
So, yeah, so that's what I seewhen I'm working with portfolio.
Ari Petronelli (20:45):
I also see that a lot of buildings are managed
by the property owner.
John, why would you deduct amanagement expense when
analyzing a property?
John D. Penner (20:54):
Well, you're gonna have to manage it, no
matter what.
So you are doing something Now,whether you want to.
If you don't charge amanagement fee, then that means
you make more income.
Okay, so you're gonna pay a taxon that.
If you are the manager and youmake money, that well, then
you're gonna pay that as incometo you and you're gonna pay
taxes on that also.
So it's just a matter of whatthey're gonna do.
But basically, you know,everybody's gonna have to have
(21:15):
management for a property and ifyou're a buyer, then you're
gonna have to assume that that'sgonna be a cost, absolutely.
So you have to account for that.
Somebody has to do the work,yeah.
Ari Petronelli (21:25):
So how should owners handle capital repairs
and improvements, John, Likewater heaters, roof replacement
you know painting and when canthey deduct them?
In the year incurred, versusamortizing them?
John D. Penner (21:38):
Yeah, that's a good question.
Just to kind of go back alittle deeper, sometimes there's
capital expenses and maybethat's a major tenant
improvement for the property orsomething, and that's not
something that's going to bededucted as an everyday
operating expense.
So we do not include that inour everyday expenses.
That's going to be dealt withseparately down below the NOI
(22:02):
line, the net operating incomeline.
So but aside from that thenwe're just kind of looking at
the expenses and some ownersdeduct them every year all the
time, and then others you knowaccount form over a time period.
We're not really looking asappraisers, we're not looking,
we're not an accountant, we'renot going to, we're not going to
utilize depreciation and thingsof that nature.
(22:25):
We're going to try to accountfor what is typical for this
property and arrive at a numberat that and probably prepares a
maintenance Probably the hardestnumber to come up with in your
appraisal as far as expenses go.
Ari Petronelli (22:37):
So where do you see expenses in the next year
then?
John D. Penner (22:41):
You know I think that Mark has touched on
insurance that's got to be thebiggest rising one, whether it's
worried about fires or allsorts of different liability, so
that's probably the biggest onethat's really jumping right now
.
There's no question, when Icome up with my numbers next
year I know that's going to behigher utilities.
Utilities are just crazy rightnow.
(23:01):
I mean whether it's water orelectric, and they're putting
all this infrastructure in inCalifornia for climate change.
Well, we're going to end upfooting the bill, so the
utilities are really probablygoing to go up too.
I think maintenance actually iskind of staying stable because
the supply chain problems we hadduring COVID are not there
(23:22):
anymore.
There's not as muchconstruction going on right now,
so the cost of different itemsisn't as high.
I think that is kind of leveledoff.
But the insurance and utilitiesare probably the biggest area.
Ari Petronelli (23:33):
Yeah, I feel it Absolutely.
Marcus Espinoza (23:36):
With repairs and maintenance.
I've seen contractors thatwould contact me and they would
actually, you know, hey, youknow.
I mean, can I do some work?
When they're calling youbecause they need work, that's
when you know that there's goingto be some relaxed numbers.
So, yeah, stable, stable, even,probably even decrease with
repairs Possibly.
John D. Penner (23:54):
Yeah, because I hate to say that.
Marcus Espinoza (23:56):
Because labor is available, insurance, you
know, like gosh, you know StateFarm just left California, yeah,
yeah.
So I mean it's just the onlyone.
Yeah, they're not the only one.
So I mean, if you have a policywith State Farm, they're not
renewing you.
So it's a very interesting timefor a lot of you.
John D. Penner (24:16):
Try to get car insurance.
Crazy yeah.
Ari Petronelli (24:20):
Also, what are the hardest expenses to analyze?
John D. Penner (24:23):
Yeah, I'd have to go back to repairs and
maintenance.
Yeah, really the most difficult, because you're really kind of
having to assess the quality ofthe building, the age of the
building, the components of it,what's going on.
Have they really done anymaintenance in the past?
You know what condition is thebuilding in, so you're going in
there and you're looking at thatand if we're going back to, you
know management, professionalmanagement is on it.
(24:45):
They're looking at it all thetime.
They're maintaining theirproperties and then all of a
sudden there's one owner that'smom and pop, that only own one
property and they kind of tendto let things go and then all of
a sudden they you know theywonder why their property is
being hit with some extra costand losses in the value,
deferred maintenance.
But there can be a lot ofdeferred maintenance that creeps
up.
Ari Petronelli (25:05):
Well, before I wrap this up, I just want to
know, John, where can we findthe Penner expense guide?
John D. Penner (25:10):
Well, it's on the internet.
Just a quick.
Ari Petronelli (25:12):
Google search of .
John D. Penner (25:14):
At penner-associatescom.
Ari Petronelli (25:17):
Okay, awesome.
Well, thank you so much to ourguests, john and Marcus, who
have certainly added a new layerof understanding for myself and
, I'm sure, our listeners aswell.
Until next time, remember thatknowledge is power and the real
estate shop is here to empoweryou in the real estate world.
Marcus Espinoza (25:33):
Thank you.
John D. Penner (25:33):
Great, thank you .
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