The Value of Property Appraisals Mark T. Hessel, Vice President Hirons & Associates Tuesday, June 26, 2012 Break-out Sessions 217-INT and 222-INT

Hirons & Associates Introduction Firm Hirons Background In business of valuing assets for 25 + years; Specializing with Public Entities, Educational Clients; Experience with individual entities, insurers and pools nationally Hessel 26+ years in the business of appraising all varieties of property; Has appraised literally thousands of public sector facilities; Extensive experience in appraising water/wastewater facilities; Dedicated Packer fan; and, Feel free to contact directly with questions: [email protected] 414.906.1921 (direct)

I. UNDERSTANDING THE BASICS A. Objectives of an Insurance Appraisal B. Definitions of Value; INS. vs. ACCTNG C. Appraisal Frequency/Updating Values D. Methodology Inventory/Inspection E. Methodology Valuation F. Break !!!

Common Goals of Appraisals: Insurance Placement (typically Insureds objective) Improve rating Solid fiscal management (Job security?) Satisfying Requirements/Requests Broker / Agent request Insurer/reinsurer requirement Pool Board policy Clean up the SOV Correct suspect values Identify missing property or improvements/additions Stay current with recent cost changes (annual updates)

Goals of Appraisals (cont.): Underwriting Objectives: Accurately value property (ITV issues) Correct premium? Margin clause issues Equitable distribution of premiums (pools) Insurers can validate offering terms (i.e. agreed amount, blanket) Verify the condition of the specific property Verify separation (distance)of property issues Verify separation (distance) of property issues Provide reinsurance carriers accurate values, other underwriting data (C.O.P.E. ~ follows later)

Reinsurance Issues/Goals: Source: National Underwriter P&C; NU Online News Service, Aug. 26, 2008 Breaking News Data Quality Big Issue For Property Re, E&Y Finds Poor quality data translates to increased rate to primary co. cedants: 90% apply surcharges (70% of these, est. 20-25% premium penalty!) 92% said strong data controls could mean 5-15% premium credits! Quote 1: When asked which data items they consider most problematic, reinsurers pointed to insured values, complete inventory of locations and secondary characteristics. Quote 2: supplying better data would benefit the primary insurers underwriting process as well. She said critical information, such as location and number of buildings, could be better gathered with specific data fields.

Definitions Of Value: How does Replacement Cost differ from other values (Original, Market, Reproduction, etc)? Replacement Cost - is defined as the cost to repair, rebuild or replace on the same site with new materials of like size, kind and quality, or with similar property intended to perform the same function when replacement with identical property is impossible or unnecessary. Why is the basis of value important? Fundamental starting point for any appraisal; Defines your limit in the event of a loss.

Definitions Of Value (cont.): When do I use Reproduction Cost? You may / may not have a choice Typically employed for Historic property Review policy language, involve broker/consultant Reproduction Cost - is defined as the cost to repair, rebuild or replace with material of like, kind and quality compatible to those originally used, including the cost of skilled labor and/or authentic materials necessary to restore the property as nearly as possible to its original condition. When do I use Actual Cash Value (ACV)? Again, you may / may not have a choice Common for physically/functionally obsolete or vacant property Review policy language, involve broker/consultant when determining Actual Cash Value - is defined as Replacement Cost less accrued depreciation.

Sample Report: Reproduction Cost On National Register Ornate construction components; Unique design; Significant variance from standard RC value (> 50%, in this case)

Sample Report: Actual Cash Value Built 1925; replaced 1950s Originally Orphanage 95% vacant Could not operate as Juvenile Det. Center (needs major renov.)

Appraisal Frequency - Benchmarks: Individual entities vary considerations include: Time since last appraisal; Growth/addition of new properties; Transfer of assets between properties; Geographic location and impact of local cost changes; and Internal policies or external (insurer) requirements. Hirons clients tend to rotate over 37 yrs (samples): LMCIT; NIRMA; LARM National Hotel Chain Major City in NC; County in MD

Appraisal Updating: Desktop review (service bureau) Changes in property submitted annually to appraiser; Trend factors applied to unchanged Sites; Revised reports sent back to insured; typically timed w/renewal Common solution for smaller entities or those w/few changes Onsite Update Service Incorporates above PLUS an onsite component for new/changed locations; Good solution for larger entities or those who are growing rapidly w/many property transactions Phased-in Reappraisal Schedules (combining above)

RC Trend Factor Sources: 1.Marshall & Swift Valuation Service subscription Regional focus; & State/Local focus by specific Class 2.Engineering News Record (ENR) subscription Building Cost & Construction Cost Indexes (BCI & CCI) 3.Handy Whitman Index for Public Utilities 4.Producer Price Index (PPI/US Bureau of Labor Statistics) http://www.bls.gov/PPI/ http://www.bls.gov/PPI/ 5.Insurers Zurich NA - http://www.zurichna.com/zna/onlineservices/online_agent/cost_trends.htm http://www.zurichna.com/zna/onlineservices/online_agent/cost_trends.htm 6.Major construction companies Example: Turner Const. http://www.turnerconstruction.com/cost-index http://www.turnerconstruction.com/cost-index Critical to distinguish between RC and Market Value! CPI

Trend Factor Examples: Example: Turner Const. published rates for > 75 years http://www.turnerconstruction.com/cost-index http://www.turnerconstruction.com/cost-index WOW!

Trend Factor Examples: Example: M&S Regional Marshall Valuation Service; April, 2012

Trend Factor Examples: Example: M&S Local/City Marshall Valuation Service; April, 2012 Ex: B increased 3% in NOLA in the last year

Trend Factors Cost Drivers Source: ENR 2Q Cost Report; June 16, 2008

Appraisal Methodology - Fieldwork: BUILDINGS: Begin with thorough inspection Begin with thorough inspection Review available plans/blueprints (as-built)Review available plans/blueprints (as-built) Measure each structure for GSFA; P by floor/levelMeasure each structure for GSFA; P by floor/level Record major building componentsRecord major building components FrameFrame Exterior WallsExterior Walls ThicknessThickness Story HeightStory Height Roof Construction & SlopeRoof Construction & Slope Building Service Systems (HVAC, Plumbing, Electrical)Building Service Systems (HVAC, Plumbing, Electrical) Interior Finishes (Flooring, Ceiling, Partitions)Interior Finishes (Flooring, Ceiling, Partitions) Life Safety/Protection Components (Sprinklers, Alarms, Emergency Power)Life Safety/Protection Components (Sprinklers, Alarms, Emergency Power) Special Building Features (mezzanines, balconies, overhangs, special add-ons)Special Building Features (mezzanines, balconies, overhangs, special add-ons) Create sketch of building footprint for support, valuation phaseCreate sketch of building footprint for support, valuation phase Separate basement, other major sectionsSeparate basement, other major sections Take photographs and collect GPS readingTake photographs and collect GPS reading Conduct building walk-throughConduct building walk-through

Appraisal Methodology - Contents: Detailed Physical Inventory (This Is Your World!) Full, wall-to-wall inventory of major assets; level of detail set at specific dollar threshold (by client) Information collected typically includes: Full description of asset Specific Location within Building (i.e. room, department) Asset Classification for subsequent sorting/reporting Manufacturer, Model, Serial Number where applicable Benefit: Proof-of-loss determination, class schedules Downside: Most costly approach; requires more time Tally Approach Not as widely used, but still cost-effective option Depending on how it is performed, may lose Proof-of-loss detail Modeling Approach Widely used with pools; developed in the industry mid-1980s Great potential for error if not reviewed/adjusted during walk-through % of Building Value Approach Widely used by some insurers virtually no cost Often blind application of value; potential for error significant

Appraisal Methodology - Contents: REVIEW OF EXISTING FA SCHEDULES Recent FL Hospital ExampleRecent FL Hospital Example Two relatively current Inventory SchedulesTwo relatively current Inventory Schedules Capital Asset ScheduleCapital Asset Schedule Property Control / Asset Management ScheduleProperty Control / Asset Management Schedule Recent Manufacturing ExampleRecent Manufacturing Example Current Inventory / Reconciliation ProjectCurrent Inventory / Reconciliation Project Utilized their final inventory AND our walk-through to estimate RCUtilized their final inventory AND our walk-through to estimate RC Which Approach Is Right For You? Budget usually dictates

Appraisal Methodology - Valuation: BUILDINGS Tools of the Trade: Marshall & Swift MSB System (subscription-based)Marshall & Swift MSB System (subscription-based) Originally E. H. Boeckh programOriginally E. H. Boeckh program Web-enabled valuation toolWeb-enabled valuation tool Widely accepted in insurance industryWidely accepted in insurance industry Allows for more detailed input of componentsAllows for more detailed input of components Marshall & Swift Marshall Valuation Service (subscription)Marshall & Swift Marshall Valuation Service (subscription) Book version offers two valuation approachesBook version offers two valuation approaches Calculator ApproachCalculator Approach Segregated Cost ApproachSegregated Cost Approach PC-based version = Commercial Estimator 7/Agricultural EstimatorPC-based version = Commercial Estimator 7/Agricultural Estimator More detailed than Calculator; less detailed than SegregatedMore detailed than Calculator; less detailed than Segregated Other/Newer Releases mostly online/web-enabled solutionsOther/Newer Releases mostly online/web-enabled solutions RS Means CostWorksRS Means CostWorks e2Value Suitee2Value Suite Xactware Xactimate programXactware Xactimate program OthersOthers All require proper training & experience! All require proper training & experience!

Appraisal Methodology Valuation (cont.): BUILDINGS Other Subscription-Based Sources (units-in-place)Other Subscription-Based Sources (units-in-place) Sweets Unit Costs Guide (BNI)Sweets Unit Costs Guide (BNI) RS Means ( http://www.rsmeans.com/)RS Means ( http://www.rsmeans.com/) http://www.rsmeans.com/ ENR Square Foot Costbook ( http://www.bnibooks.com/)ENR Square Foot Costbook ( http://www.bnibooks.com/) http://www.bnibooks.com/ Proprietary valuation solutionsProprietary valuation solutions Primarily developed for unique, complex constructionPrimarily developed for unique, complex construction Water/wastewaterWater/wastewater Electric UtilityElectric Utility Gas UtilityGas Utility Require extensive updating and researchRequire extensive updating and research Old-fashioned, manual approach to pricingOld-fashioned, manual approach to pricing All are valuable when applied correctly! All are valuable when applied correctly! User MUST understand what models contain!User MUST understand what models contain!

Sample Screen Shot - MSB Highlights: Dozens of Bldg models Component entry Calculates Exclusions Ability to adjust by % of material Perimeter Story Height Allows for Quality adjustments Applies local costs by Zip code

Sample Screen Shot M&S Calculator Highlights: Dozens of Bldg models Selection by Class, Quality for base Cost per SF Manual Calculations Ability to adjust for Perimeter Story Height Diminished ability to adjust for components, especially interior finish Applies local costs by Region/City

Appraisal Methodology Exclusions: What are they????? (DONT ask the appraiser this) Review your policy or ask your broker/agent/pool/insurerReview your policy or ask your broker/agent/pool/insurer Underwriting issue; not valuationUnderwriting issue; not valuation Policy language should clearly spell out what IS included vs. what is NOT included in coverage.Policy language should clearly spell out what IS included vs. what is NOT included in coverage. Typical ExclusionsTypical Exclusions Foundations & Footings (below lowest level of slab)Foundations & Footings (below lowest level of slab) Site Prep & ExcavationSite Prep & Excavation Underground Portions of PlumbingUnderground Portions of Plumbing Are these costs material? Are these costs material? Variables include:Variables include: Geographic region (higher N; lower S)Geographic region (higher N; lower S) Building Characteristics (# stories, perimeter, etc)Building Characteristics (# stories, perimeter, etc)

Methodology RC vs. Contractor Cost: But we paid $$$.00! (Steps for analyzing contract cost) Ask questions regarding the bid process:Ask questions regarding the bid process: Unusual circumstances in the bidding / timing of the work?Unusual circumstances in the bidding / timing of the work? Contractor bids reasonably spread?Contractor bids reasonably spread? How low was the lowest bid?How low was the lowest bid? Obtain final (or last monthly) progress pay request (AIA document)Obtain final (or last monthly) progress pay request (AIA document) Assemble applicable soft costs (generally not in contractor costs)Assemble applicable soft costs (generally not in contractor costs) Engineering, designEngineering, design LegalLegal CM feesCM fees Other (non-bond related) costsOther (non-bond related) costs Remove interest/bond costsRemove interest/bond costs Identify allocable hard costs from detail, and set aside (mobilization or start-up)Identify allocable hard costs from detail, and set aside (mobilization or start-up) REMOVE all land costs and related land improvements (paving, utilities, curb/gutter, etc)REMOVE all land costs and related land improvements (paving, utilities, curb/gutter, etc)

Appraisal Methodology Original Cost: Example: City of Raleigh Booster Pump Station 1) Total Project Cost - $1,273,000 (with estimated soft costs) 2) Estimated Building - $330,700 3) Estimated Contents - $598,400 Total Insured Amt - $929,100 (73% of total project) When to use (or NOT to use) Great analysis forGreat analysis for Utility projectsUtility projects Major projects with significant improvementsMajor projects with significant improvements This should NOT be a substitute for an appraisal of new propertyThis should NOT be a substitute for an appraisal of new property Not so great for additions which include renovationsNot so great for additions which include renovations Really not so great for renovation workReally not so great for renovation work The older the project, the less reliable the results (trend factors)The older the project, the less reliable the results (trend factors)

Results (drum roll, please): 3 POTENTIAL SCENARIOS Little or no change??? Overvalued Property: Property has been incorrectly adjusted for renovations;Property has been incorrectly adjusted for renovations; Additions have been incorrectly added to values;Additions have been incorrectly added to values; Over-inflation of trend valuesOver-inflation of trend values Undervalued Property: Lack of annual adjustments to Replacement Cost;Lack of annual adjustments to Replacement Cost; Incorrect valuationsIncorrect valuations Wrong SFA calculations;Wrong SFA calculations; Wrong model assumptions;Wrong model assumptions; Incorrect component determinations;Incorrect component determinations; Poor valuation assumptions & judgments.Poor valuation assumptions & judgments. Missing property new items not on SOVMissing property new items not on SOV

II. VALUING UNIQUE PROPERTY A. Water & Wastewater Utility Property B. Manufacturing Concern C. Historic Property D. Educational Structures E. Seeing Green

Water/Wastewater Valuation VALUATION CHALLENGES: Complexity of Construction ~ No dedicated valuation tools for specific values Technical process equipment Recent advancements in controls systems Technological variances for treatment styles Significant Increases in Cost of Materials Unique, One-of-a-kind Design Facilities generally not cookie-cutter Fees are often overlooked/underestimated

Water/Wastewater Valuation (example) $450m TIV $138m M&E (31%) $312m Bldg (69%) 26 individual buildings/structures Rated / designed capacity = 54 MGD

Manufacturing/Industrial Property Valuation Challenges Manufacturing Higher Ratio of M&E to Building Value Highly Technical Machinery Ex: $175m TIV; $71m = B (40%) / $104m = C (60%)

Historic Property Valuation VALUATION CHALLENGES: Complexity of Construction ~ Limited valuation tools for specific values Reproduction vs. Replacement Models PLUS Additional Features Appraiser must specifically identify inclusions/excl. Significant Costs to Reproduce/Replace Materials Unique, One-of-a-kind Design (and Materials) Facilities definitely not cookie-cutter Extra fees often overlooked/underestimated

Historic Property Valuation (example) Historic Register 25 Stone walls Solid brick walls Copper cupola 48 Seth Thomas clock Rotunda w/ Stained glass Detailed plaster Painted ceiling Vaults dbl door, solid brick part. walls

Educational Property Valuation Valuation Challenges Higher Ed Space/Campus Restrictions Models PLUS Additional Features Labs/Research Buildings Other Unique Architecture Valuation Challenges K-12 Life Safety Considerations Perimeter Area Ratios Need to Carefully Assess/Select Models

Higher Ed Property Valuation (example) Research Facility Admin Offices Clinical Research Labs Connected to Teaching Hospital Standard Models??

K-12 Property Valuation (example) Originally four (4) separate buildings Admin Offices Shops Classroom wing Gymnasium Addition/new gym tied all sections together New gym featured green components

Which LEEDs me to our next topic Certification Process (old) US Green Building Council (USGBC) LEED Ratings: Certified (26-32 of 69 total points) Silver (33-38) Gold (39-51) Platinum (52-69) LEED = Leadership in Energy & Environmental Design How to Score Points: 1.Sustainable Sites (14 Points / 20%) 2.Water Efficiency (5 Points / 7%) 3.Energy & Atmosphere (17 Points / 25%) 4.Material & Resources (13 Points / 19%) 5.Indoor Environmental Quality (15 Points / 22%) 6.Innovation & Design Process (5 Points / 7%) Source: http://www.usgbc.orghttp://www.usgbc.org

LEED Continued 2009 Update (v3): US Green Building Council (USGBC) LEED Ratings: Certified (40-49 of 100 total points) Silver (50-59) Gold (60-79) Platinum (80+) How to Score Points: Commercial School 1.Sustainable Sites 2624 2.Water Efficiency 1011 3.Energy & Atmosphere 3533 4.Material & Resources 1413 5.Indoor Environmental Quality 1519 6.Innovation & Design Process 66 7.(new) Regional Priority44 Source: http://www.usgbc.orghttp://www.usgbc.org

Seeing Green ($$$?) Valuation Issues Green Buildings Separating out uninsurable factors (land improvements; brownfield redevelopment; site development) Often unique design, materials soft costs may be relatively higher Proliferation has helped reduce costs in recent years Increased costs? Early estimates range from approximately 2 10% compared to non-green buildings; however, there are extreme cases

Did I mention proliferation??? Source: http://www.usgbc.orghttp://www.usgbc.org Update: 5/2012 US Only C = 9,749 R = 21,185 Update: 5/2012 LA Only C = 32 R = 190 400% increase!

Seeing Green (Sample 1) https://www.usgbc.org/ShowFile.aspx?DocumentID=3940 https://www.usgbc.org/ShowFile.aspx?DocumentID=3940

Seeing Green (Sample 2) https://www.usgbc.org/ShowFile.aspx?DocumentID=3943 https://www.usgbc.org/ShowFile.aspx?DocumentID=3943 $386/SF Project Total (2006) Trended ~ $475/SF (2012 est.) Platinum Rating (57/69) Renovation/Addition project Notice (some obvious) features: Windows (natural light in passive solar design) Minimal finish using recycled and rapidly recyclable materials Extensive use of recycled materials on exterior all added to costs.

III. INSURER ISSUES: A. Current Trends/Concerns CAT B. Underwriting Data COPEing with much change C. Changes in Coverage

Trends/Concerns: RMS - http://www.rms.com/Publications/Cat_Risk_Maps.asp http://www.rms.com/Publications/Cat_Risk_Maps.asp

Trends/Concerns: Source: AIR Currents December, 2011 US Insured Cat Losses ($billions)

Trends/Concerns - 2011: Source: Munich Re January 4, 2012 US Insured Cat Losses ($billions): Source: Swiss Re News Release, December 15, 2011 2011 ranked second only to 2005 for total US Insured Losses; $35.9.B Global Ins. Losses - $108B

Trends/CAT: Increased Technology Cat Modeling Data/Research Coastal considerations (wind/hurricane); Flood; Quake; Hail; other Emphasis on viewing the total exposure, predicting PML Sample Risk Assessment / Modeling Tools (not all-inclusive): 1.Risk Management Solutions multiple tools; v.11 RMS Hurricane Model 2.AIR Worldwide CLASIC/2 (individual risks); CATRADER (reins.) 3.EQECAT, Inc. - RQE software; Solvency II Model 4.CoreLogic GIS Portal / CATUM software All vary, but offer comprehensive, location specific reports

Trends/CAT: Source: CoreLogic CATUM Useful for documentation of other data, including: Flood Zone Elevation Specific GPS Coordinates

COPE - What is it? COPE definition *: An acronym that stands for the four property risk characteristics an underwriter reviews when evaluating a submission for property insurance: construction (e.g., frame, brick, masonry, masonry veneer); occupancy (how the building is being used); protection (e.g., quality of the responding fire department, adequacy of water pressure and water supply in the community, the presence or absence of smoke alarms, etc.); and exposure (risks of loss posed by neighboring property or the surrounding area, taking into consideration what is located near the property, such as an office building, a subdivision, or a fireworks factory). * - International Risk Management Institute, Inc. (IRMI) - Glossary of Insurance & RM Terms (www.IRMI.com) www.IRMI.com

Trends Data Collection for Insurers: Standard Data pre-RMS v.11 Typical COPE data, including: Typical COPE data, including: Specific Address Specific Address All Relative Values All Relative Values Full Building Narrative Desc. Full Building Narrative Desc. GPS Coordinates GPS Coordinates Elevation Elevation In all, ~ 40 fields of data In all, ~ 40 fields of data Revised Data post-RMS v.11 Typical pre-v.11 data, PLUS info like: Typical pre-v.11 data, PLUS info like: Wind Tier/Hazard Zone Wind Tier/Hazard Zone Quake Seismic Zone Quake Seismic Zone Construction Quality Construction Quality Roof Sheathing Attachment Roof Sheathing Attachment Roof Anchor Type Roof Anchor Type Opening Protection Opening Protection Roof Age; Roof Condition Roof Age; Roof Condition Roof Geometry Roof Geometry Frame Foundation Connection Frame Foundation Connection In all, > 90 fields of data In all, > 90 fields of data

Trends/Concerns - Insurers: Coverage Changes Shift in focus geographic concentration of exposures (specific location becomes critical) Heartland vs. Coastal pricing The disappearing blanket Higher deductibles Implementation of Margin Clauses Multiyear deals Expansion of coverage for green issues Geothermal heat/cooling; Roofing systems (i.e. vegetation)

Final Thoughts/Questions? Thank You! Trivia question: January 2, 2012 last regular season game Which Packer QB set franchise records with 480 passing yards & 6 TDs in our 45-41 win over the Lions?

Documents

The Value of Property Appraisals Mark T. Hessel, Vice President Hirons & Associates Tuesday, June 26, 2012 Break-out Sessions 217-INT and 222-INT