Both Financial Expert and Real Property Appraiser Challenged for Sharing Valuation Metrics
By Sherrye Henry, Esq., Sr. Legal Editor, Business Valuation Update
Sugar Hill, LLC. v. United States, 2012 U.S. Claims. LEXIS 930 (August 1, 2012)
In this unusual case, the real estate appraiser relied on components of value, including occupancy and market rental rates, calculated by the financial expert.
Plaintiff finds advantage in disaster. After Hurricane Katrina in 2005, the plaintiff company purchased undeveloped land to create a mobile home park for displaced persons. The plaintiff paid just about $240,000 for the parcel and spent $1.5 million developing it. In April 2006, it leased all of its 161 trailer pads to FEMA (Federal Emergency Management Agency) at almost double the then-prevailing rate ($675 to $800 per pad per month). At the time, the plaintiff’s owner had no definitive plans for the park after the FEMA lease expired, but “wanted to stay flexible.”
In April 2008, FEMA terminated the lease and surrendered the property. By that time, the plaintiff had distributed roughly $1.8 million in retained earnings to its owners and retained $1.2 million in equity. Nevertheless, the plaintiff certified a claim to FEMA for $3.6 million in damages, alleging not only the cost incurred in repairing and converting the premises to an RV park, but also the lost profits related to FEMA’s “extensive and unconscionable” injuries that left large parts of the park “unleasable.” FEMA denied all but $4,800 in costs, and the plaintiff filed suit in the U.S. Court of Federal Claims, reasserting its $3.6 million claim.
To prove its case, the plaintiff relied on reports from a financial expert, as well as a real estate appraiser. In particular, the financial expert reviewed “tally sheets” from a nearby RV park to project occupancy rates for the plaintiff’s park, and also assumed that a large oil refining project’s need for temporary employee housing would drive demand. From this data, he projected a 90% occupancy rate into perpetuity, discounted to present value. (The court does not specify the expert’s discount rate or his monthly rental rates.)
To value the plaintiff’s property at two distinct points in time, its real estate expert relied on the occupancy, rental, and discount rates derived by the financial expert in a discounted cash flow analysis. Importantly, he did so on the instruction of plaintiff’s counsel without independently verifying the rates, but qualified them as “extraordinary assumptions” under USPAP (Uniform Standards of Professional Appraisal Practice). He later conceded that he did not analyze the actual market demand for the plaintiff’s park, including the oil company’s need for employee housing. He also would have preferred to spend at least 40 hours on a “best and highest use” analysis rather than the five to eight he actually spent. In the end, he concluded the park’s best and highest use was as undeveloped land.
Financial expert didn’t know USPAP. In reviewing the experts’ reports, the Federal Court of Claims found they were both qualified within their respective areas of expertise. However, the financial expert “did not use his accounting expertise” to derive the projected occupancy rates for the plaintiff’s mobile home park, which were critical to his lost profit calculations. As “a CPA by trade,” he was not licensed to appraise real estate and performed no regular work according to USPAP. The court said, “and did not even know” if his report complied with USPAP.
Further, he simply used the tally sheets of the nearby RV park to identify whether anyone rented its pads for more than 30 days; he did not break down its occupancy by day or month or interview anyone who rented a pad. He also failed to assess what impact its use as a public-events facility (rather than a private RV park) might have on rents. The expert had “never operated or managed an RV park,” the court noted, and thus had “limited knowledge” of the business. As for relying on the oil project to drive rental demand, the expert conceded its need for employee housing began prior to the termination of the FEMA lease and that he failed to account for the cost and inconvenience of relocating the workers to the plaintiff’s park.
“Finally, yet significantly,” the court said, the financial expert was unaware that prior to trial, the parties had stipulated to occupancy rates that directly contradicted and often exceeded his projected rates. He did not even base his projections on actual occupancy rates for the plaintiff’s park during the post-breach period, which averaged approximately 77%.
To further undermine his report, the government’s rebuttal expert, a state-certified real estate appraiser with 25 years of experience valuing commercial properties, including mobile home parks, levied three major criticisms:
- By projecting a 90% occupancy rate into perpetuity, the plaintiff’s financial expert effectively increased the local population by 7%--something that had never happened in the past 30 or 40 years; indeed, the local community had experience little to no growth over the prior half-century.
- The rebuttal expert could find nothing in the financial expert’s report that “would be to the standards that USPAP or any reasonable peer or reader would want to use to justify the conclusions.”
- His conclusions regarding market rent, occupancy rates, and a discount rate “had no support at all” for application to a real estate appraisal.
The rebuttal expert also criticized the plaintiff’s real estate appraisal for relying on the rates derived by the financial expert without any independent verification. “If you’re going to use someone else’s report,” he said, “you need to at least use some test of reasonableness.”
You could have just had a mathematician do the . . . calculations. I think he [the real estate appraiser] abdicated his responsibility…
Importantly, at trial the plaintiff did not cross-examine the government’s rebuttal expert, leading the court to conclude that his testimony was uncontroverted and “highly credible.” Accordingly, the court “drew the unmistakable” conclusion that the appraisal by the plaintiff’s real estate expert was unreliable and irrelevant under Rule 702 of the Federal Rules of Evidence. (It also noted his conclusion regarding the best and highest use for the property as undeveloped land was “remarkable.”)
Similarly, the plaintiff’s financial expert was “unqualified” to derive the occupancy rates used in his report and relied on an unsound appraisal methodology, the court held, and excluded his conclusions. Since the remaining evidence demonstrated that the plaintiff had specifically developed the park for leasing to FEMA—for which it received “premium” rents and substantial earnings—its losses were not foreseeable and the court dismissed the plaintiff’s claims.