Ari Petronelli: 0:03

Hi, hello everyone, and thank you for tuning in to the Real Estate Shop educational platform, the go-to destination for expert insights into the dynamic world of real estate. I'm Ari Petronelli and a real estate agent based in sunny Southern California. Whether you're a seasoned investor or a first time home buyer, or simply just curious about the intricacies of property appraisal, you are in for a treat today. Our experts are here to answer your burning questions and share invaluable insights. So sit back, relax and let's embark on a journey of real estate wisdom with the Real Estate Shop. Today, we are going to delve into the intricate realm of property valuation. Joining us are two highly esteemed appraisers with a wealth of knowledge and experience. Please welcome John Penner and Marcus Espinoza, whose expertise spans the diverse landscapes of the ins and outs of appraisals. Thank you, guys, for being here.

John D. Penner: 0:57

Yeah, hi Ari.

Ari Petronelli: 0:58

Hi, thanks, hi. So John Penner has over 40 years of experience in appraisal and consulting services for all types of properties, specializing in medical office, industrial, retail, development, fractional interests and eminent domain. In addition, he publishes the widely cited Penner expense guide, which uses actual expense data from properties throughout Southern California. Mr Penner has qualified as an expert witness in bankruptcy in Superior Court for Orange, la and San Diego counties. He is a member of the appraisal institute with an MAI designation and certificate in litigation. John, again, thank you for being here.

John D. Penner: 1:36

Hey, great, that was a great introduction. Sound more experienced than I am, maybe.

Ari Petronelli: 1:42

No, sounds pretty impressive.

John D. Penner: 1:44

But I have been in for a long time and I consider myself really fortunate to be in a field that I really enjoy for this long and I hope to be in it longer, so for another 10, 15 years. So your question was about the MAI designation.

Ari Petronelli: 2:00

Yes, what is an MAI?

John D. Penner: 2:02

MAI stands for the member of the appraisal institute, which is the largest organization in the country for appraisal, and it's the longest standing. It goes back to the 1930s and it was created after the banking crisis that created Great Depression. So it's a very rigorous educational thing that we have to take a number of classes and show our experience and pass a demonstration report and also a comprehensive exam to get this after having a four-year degree. So it's pretty extensive and usually it takes at least 10 years in your career before you reach that point.

Ari Petronelli: 2:41

So it's almost like having a master's or PhD.

John D. Penner: 2:43

Yes, very much so.

Ari Petronelli: 2:44

And appraisals. That's really interesting. So Marcus Espinosa is a certified real estate appraiser who holds an MAI, sri, asa and CCIM designations with his own company, accurate Appraisers, with over 23 years of real estate appraisal and consulting experience. Marcus, what exactly is a SRA, asa and CCIM?

Marcus Espinoza: 3:10

Thank you. Thank you, ari, just like John Penner just mentioned, the SRA is also another designation that you obtain by the Appraisal Institute. Like John Penner just mentioned, the Institute has been around for several 1930s and it stands for Senior Residential Appraiser and the Senior Residential Appraiser RSRA I would say the last I check about, maybe 1% of all appraisers holds that designation. The ASA is another Institute that has been around for a long time as well and that stands for accredited senior appraiser, and the ASA is more of a multi-discipline organization where they focus on business valuation. They focus on personal property valuation, real estate valuation, and the reason why I picked that one up was because of the going concern valuations that we do in our field. And the CCIM is more geared towards brokers and that stands for certified commercial investment member.

Marcus Espinoza: 4:26

And, just like John said, you have to. You know rigorous, you know program, you know you have to do a lot to get it, so you know. So, yeah, it's like getting your master's or your PhD. You know those designations, so they're not easy to get, they're hard to get, but you know we do it because we want our clients to feel comfortable and who they're selecting as their next appraiser, and so it's very important to them, so it's very important to us.

Ari Petronelli: 4:51

I think that's really incredible that you guys have done that.

John D. Penner: 4:55

Yeah, I wish I would have done some things Marcus did.

Ari Petronelli: 4:59

John, I was curious about your expense guide and why you created the expense guide for other real estate professionals or investors. I've had the privilege of reading it and it is. It's incredible. It's really interesting with the amount of information that you have in there.

John D. Penner: 5:16

Yeah, thanks, when I was starting out appraising and I'm also a broker you start to look into investment properties and you know you have a rent. You know, let's say, the property is fully leased, you have a rent. You have a pretty good idea of what the rent is because you have a rent for your property. If it's fully leased, then you pretty much know what your vacancy is. You probably have an idea of a cap rate. These are all the things that go into coming up with an income approach, analysis of your property and come up with a value.

John D. Penner: 5:46

The real question is the expenses. It's hard to know what they are and if you don't itemize them especially here in California with Proposition 13, then you're just never really going to. You're not going to be able to just say, oh well, it's $10 a square foot or it's eight or it's this percentage or something. That is just isn't going to work. So you have to really itemize them. And so I began to look at that. And you know, when you look at expenses and you itemize them, sometimes you don't get that good information. And so if you don't have an expense guide or something to look at, what is the market really doing here? All you have is what the owner provides to you, and you may not get it right if you assume that's correct.

Ari Petronelli: 6:29

No, that information is, I mean, so valuable to potential investors or buyers. So Marcus, in one case may be a property owner Would say that they don't want to provide, maybe, their 2019 financials, as they received a Substantial income that year and don't want to show that. How would you handle that?

Marcus Espinoza: 6:51

That's actually a real life question and that happens in real life is what I mean. So, so they don't want to provide their 2019. So I mean, if they're providing their 18, their night, they don't want to provide their 19, 20, 21, 22. Then it kind of looks suspicious. It looks like why are you not including that inside of your appraisal report? Now, can I not include it because there was an anomaly Income stream that year? Yes, I mean, I could. It doesn't. It doesn't help our valuation because it might not have any weight to what our conclusion would be, because it was not an anomaly year. But we actually see it the other way. Where there's not a lot of income, I see it more when there's not a lot of income in 2019.

Marcus Espinoza: 7:39

2019 was before COVID, so I Wouldn't, that wouldn't be a reason to not include it, but I would encourage the client, I would encourage the property contact to include it and we can just, you know, we would just say that you know this was an anomaly year. Yeah, maybe, maybe it doesn't reflect what this, what the subject property is, performance. So we would, we would, we just it all. It all depends on on where that number is at. I mean, if it's double 2018, if it's double 2020, 2021-22, then we might elect to give it less weight and we'll take any consideration, but we'll probably like elect to give it less weight.

John D. Penner: 8:21

Yeah, yeah, you hate to say it, but you know Property owners are biased towards 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 a reasonable buyer Would pay for a property and a usually seller would sell it for. So you know, if you're gonna look at expenses, this is where they tend to buffalo you. Yeah, this is where they, you know 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, or they may be able to pull the wool over your eyes, right?

Ari Petronelli: 8:57

Right, because usually appraisers request maybe three to five years of financials and you know a lot of property owners don't want to necessarily divulge that information.

John D. Penner: 9:07

Yeah, sometimes they think it's kind of ridiculous or just too much or whatever, but they're really kind of holding back and well, and sometimes they don't keep very good records.

Ari Petronelli: 9:16

You know mom and pop and so yeah, so also expenses in rank and, I'm sorry, expenses in RSO. And rank Expenses have increased over the past several years, both due to inflation and higher usage from residents, whether they're working from home or just being home in general. Conversely, rents have not really increased the last few years. So how does that operating Results? You know, should a return to normal expense ratios before a cast?

Marcus Espinoza: 9:49

Right. So what, it should be normal. And when I say normal, I mean it should be normal with your data set. Your data set. If you're appraising an RSO property with the restrictions, with rent controls and a rent control area, your data that you extract, you want to get your rent comparables, you want to get your sales comparables, your expense comparables. You want to generate all that information from a rent controlled environment. Otherwise, you're not analyzing the correct data. So it should be normal. Yes, expenses, historically, have gone up. Trash has gone up, water has gone up, insurance has gone up and rent has not gone up. And rent hasn't gone up, not because of the market, it just hasn't gone up because of the RSO restrictions. Covid-19 put a freeze on increasing rents. We're supposed to allow our landlords to increase their rents this February at 7%, which is 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 big issue. Rso properties are easy to appraise, as long as you know what that is, as long as you're bringing the correct data to the table. So the expense restrictions should be normal.

Ari Petronelli: 11:16

All right. So, John, reserves and replacements are another expense that I see appraisers use and others don't use. What is the correct way of analyzing 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 that are related to long life items that the building has that are your structure. That's not going to, that's going to depreciate over time when it's done, your building's done. But there's short-lived items also and that's really what we're talking about the roof, the floor covering the parking lot, things like that.

John D. Penner: 11:58

If you're doing an apartment, we're talking about all the appliances and things of that nature your air conditioner, your oven, your refrigerator, your washer dryer. So we're looking at those and we're looking at the life they're going to be, which is shorter than the life of the building, and so we're trying to come up with what would that maintenance be? So it's kind of an add-on to the repairs and maintenance expense, but it needs to be reflected because sometimes your repairs and maintenance that are normally happening aren't reflecting that, because maybe your building's 10 years old but these things are going to last 10, 15, 20 years, and so you don't really have a number for that. But you have to factor it in because it's going to happen over time and your income stream estimate, when you're all said and done, is going to reflect the value of your property into perpetuity, for the life of that building for the life of that investment, and so it needs to reflect those expenses.

Ari Petronelli: 12:49

Another big topic these days is insurance, and insurance is a big issue with property owners. Since insurance has increased more than historical norms in the recent years, do you use a higher conclusion than the current insurance premium?

Marcus Espinoza: 13:06

So our conclusions are based on the theory of anticipation. That means that we're projecting how the property's going to perform that next year. And so if we have historical saying that they're at 20 cents a square foot and it's 25 cents a square foot, 30 cents a square foot, or let's say all of them were 30, I have seen insurance go up as much as 30% compared to last year. So that right there would have to be taken in consideration for your projected expense line item. And us, as appraisers, we take that in consideration. We look at their history. We look at something like the expense guy line from John Penner. We also look at expense comparables and so we group all that information together and we say, ok, well, what makes sense and what's going on in the market today? If the market today, if all our data, is saying it's all 30 cents a square foot, but we know that 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 up that expense. But the reason why we don't include it include it because it's not underwritten that way with other properties. It's not underwritten. If you don't underwrite it, investors don't underwrite it. So if investors are not underwriting 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 insurance is another, but if the property is required to have flood insurance, then we'll include that Right.

Ari Petronelli: 15:11

John, I wanted to talk about Prop 13. I've noticed that some appraisers use Prop 13 for the real estate tax conclusion, using the value conclusion. In other cases I see appraisers not deduct taxes and add the tax rate to the cap rate. What is the correct way in handling 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 last week argue with me a lot because I'm doing a tax appeal and state law has a different definition of market value for tax appeal.

John D. Penner: 15:43

So the assessors are looking for us to load the cap rate with the tax rate. However, it does result in a lower value, which is what the client wants, but that's state law also. So I'm including and I'm loading the cap rate, but other than tax appeal, I never use that method. I always use just using the cap rate times the value.

Ari Petronelli: 16:06

So, marcus, if using Prop 13, which value should be used, the final conclusion, the purchase contract price or the lowest value conclusion by the approach is used?

Marcus Espinoza: 16:16

That's interesting. I see that done in different ways, but if you're asking me, I would be using the purchase price. However the purchase price can be, there could be a big delta between purchase price, because that's an market value. I mean, I actually myself personally bought a property back in 2020, and on paper we bought it for 600,000. But the property was never worth 600,000. It was clear that it wasn't worth 600,000.

Marcus Espinoza: 16:50

So the assessor turned on the radar for the assessor. The assessor said, hey, this property is not worth 600,000. We're gonna do our own assessment. So they did their own assessment. So when they did their own assessment, they came out at 950. Now, was it worth 950? That's the question.

Marcus Espinoza: 17:06

Well, what does the assessor use? They use market rents, they use average condition, and that's what they did. And so when doing that, they're not considering the other things. They don't know what the actual rent is, they don't know what the condition of the property is. So, was it worth 950? No, it wasn't worth 950. It was worth something south of that number.

Marcus Espinoza: 17:31

But then that's when you have to go do a tax appeal and say, hey, listen, it's not worth 950, and here's why. And so then here's why it comes up. And then the assessor appraiser lays low on it. But in most cases we use the purchase 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 say that the income approaches are self-contained approach, so let's use that number. I also see other people use the sales comparison approach because that's going to be the final 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, because ultimately if something is in dispute it ends up there not that often, but that's really the arbitrator of what, really the final arbitrator? And so you have to get back to basics and what they're really looking for is sales. It's really hard to disagree with the sale because, like Mark Roos was saying, the purchase price is the purchase price. Somebody actually agreed to buy it for that and sell it for that, and so as long as that sale goes along with other sales in the market, it's really hard to disagree with that. So I think the other approaches are strong also in certain instances. But that's probably the strongest indication.

Ari Petronelli: 19:03

I was always curious about this, but do you find that there are significant cost savings if a property owner has more than one building, for example, lower repairs and maintenance, and what other expenses could have cost savings?

Marcus Espinoza: 19:17

That's actually a good question. And the reason why that is because when you're doing, when we're doing, portfolio assignments, we do see a lax amount for repairs and maintenance. And the reason why is because if you own a portfolio of property say 25 buildings, and they're multi-tenant then you're gonna have ongoing repairs and maintenance, like it's just gonna be reoccurring like on a daily. So you can actually hire a handyman and just hire him for 40 hours a week and you just include him in your payroll and it might. It turns out that it could be less expensive than hiring the subcontractor coming out and vetting him and it just yeah, and then they're charging you for that one-time appearance. If you have a subcontractor coming out and they're coming out 15 times a month, then they're gonna be more relaxed on what they charge you.

Marcus Espinoza: 20:18

Also, a property management. If I went to you and said, hey, ari, I got a four-unit retail building that I would like for you to manage and you'll be like, okay, cool, I'll manage it. And then if I bring 15 of those to you, you might be, okay, well, I'm gonna, I'm bringing more revenue to your business and you might cut me some slack on the percentage. So, yeah, so that's what I see when 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 a management 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 a management fee, then that means you make more income. Okay, so you're gonna pay a tax on that. If you are the manager and you make money, that well, then you're gonna pay that as income to you and you're gonna pay taxes on that also. So it's just a matter of what they're gonna do. But basically, you know, everybody's gonna have to have management for a property and if you're a buyer, then you're gonna have to assume that that's gonna 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, Like water heaters, roof replacement you know painting and when can they deduct them? In the year incurred, versus amortizing them?

John D. Penner: 21:38

Yeah, that's a good question. Just to kind of go back a little deeper, sometimes there's capital expenses and maybe that's a major tenant improvement for the property or something, and that's not something that's going to be deducted as an everyday operating expense. So we do not include that in our everyday expenses. That's going to be dealt with separately down below the NOI line, the net operating income line. So but aside from that then we're just kind of looking at the expenses and some owners deduct them every year all the time, and then others you know account form over a time period. We're not really looking as appraisers, we're not looking, we're not an accountant, we're not going to, we're not going to utilize depreciation and things of that nature. We're going to try to account for what is typical for this property and arrive at a number at that and probably prepares a maintenance Probably the hardest number 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 the biggest rising one, whether it's worried about fires or all sorts of different liability, so that's probably the biggest one that's really jumping right now. There's no question, when I come up with my numbers next year I know that's going to be higher utilities. Utilities are just crazy right now. I mean whether it's water or electric, and they're putting all this infrastructure in in California for climate change. Well, we're going to end up footing the bill, so the utilities are really probably going to go up too. I think maintenance actually is kind of staying stable because the supply chain problems we had during COVID are not there anymore. There's not as much construction going on right now, so the cost of different items isn't as high. I think that is kind of leveled off. But the insurance and utilities are 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 that would contact me and they would actually, you know, hey, you know. I mean, can I do some work? When they're calling you because they need work, that's when you know that there's going to 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 State Farm just left California, yeah, yeah. So I mean it's just the only one. Yeah, they're not the only one. So I mean, if you have a policy with State Farm, they're not renewing you. So it's a very interesting time for 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 of the building, the age of the building, the components of it, what's going on. Have they really done any maintenance in the past? You know what condition is the building in, so you're going in there and you're looking at that and if we're going back to, you know management, professional management is on it. They're looking at it all the time. They're maintaining their properties and then all of a sudden there's one owner that's mom and pop, that only own one property and they kind of tend to let things go and then all of a sudden they you know they wonder why their property is being hit with some extra cost and losses in the value, deferred maintenance. But there can be a lot of deferred maintenance that creeps up.

Ari Petronelli: 25:05

Well, before I wrap this up, I just want to know, John, where can we find the 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 our guests, john and Marcus, who have certainly added a new layer of understanding for myself and, I'm sure, our listeners as well. Until next time, remember that knowledge is power and the real estate shop is here to empower you in the real estate world.

Marcus Espinoza: 25:33

Thank you.

John D. Penner: 25:33

Great, thank you.