In the current real estate market, owners of condo conversion properties are unable to sell their units at prices they previously enjoyed and thus are renting their unsold units. These residential condo projects are called fractured condos and present a challenge to conventional valuation thinking.

2. Fractured Condo Projects:
Highest and Best Use Determines Valuation Approach
Tim Wilmath
The statements made or opinions expressed by authors in Fair & Equitable do not necessarily represent a policy position of the
International Association of Assessing Officers.
T
he trend of converting apartment properties into projects, on the other hand, are typically assessed (and
condominiums began in Florida in 2004. The moti- appraised) on the basis of the income approach and/or
vation was to maximize profit—an individual condo sales of entire apartment projects. Typically, in apartment
unit generates a higher value than a rental apartment. projects units have a lower value than individual condo
This trend quickly became a very popular mechanism to units. For this reason, many fractured condo owners re-
generate cash flow, and hundreds of apartment projects quest their properties be assessed as apartments.
in Florida were converted to condos.
Since late 2006, however, the overall residential real es- Residential condominium projects in which a significant
tate market has declined significantly. As a result of this
decline and the oversupply of individual condo units, many portion of the units remain unsold and are being rented
condo conversion property owners (typically developers)
have been unable to sell units at the prices they had previ-
are often referred to as fractured condos; that is, they are
ously enjoyed. Renting the units became a more appealing partially owner-occupied and partially rented.
option than selling them at significantly reduced prices.
Residential condominium projects in which a significant
portion of the units remain unsold and are being rented As these fractured condos became more prevalent and
are often referred to as fractured condos; that is, they are the number of tax appeals rose, the Hillsborough County
partially owner-occupied and partially rented. Tradition- (Tampa, Florida) Property Appraiser’s office was increas-
ally, individual condo units are assessed (and appraised) ingly challenged about the proper way to value these
on the basis of sales of individual condo units. Apartment properties. Should condo projects in which most of the
Fair & Equitable • July 2012 3

3. Feature Article
units are rented be valued the same I am unaware of a provision in the law value a condominium unit as a time-
way as traditional apartment complex- which would permit unequal assessed share until the condominium unit
es? If there is a market, even a weak values for identical residential units becomes a legal timeshare under the
market, for condo units, should sales such as condominiums or subdivision law. It seems that it would be equally
of individual condo units be used to properties based solely on whether the improper for the property appraiser
determine the value? If the developer owner chooses to live in the property or to value unsold/rented condominium
of a fractured condo project seeks to rent it out. (Jeff Kielbasa 1993) units (in a project in which some units
purchase back sold units in an attempt In some cases, unsold units far out- have been sold) as if the property were
to dissolve the condominium, should number sold units in a condo proj- one rental apartment project, prior
the facility be valued as an apartment ect, particularly condo-conversions to the termination or the imminent
complex? These were the questions that were converted well into the real termination of the declaration of con-
facing the Hillsborough County Prop- estate boom and at the beginning of dominium.
erty Appraiser’s office when it was try- the downturn. Owners of these prop-
ing to forge a policy for valuing these Highest and Best Use
erties often assert that the property
properties. In reviewing all the issues related to
appraiser’s office should value the
fractured condos, the property ap-
property utilizing the income ap-
Precedents Set by Court praiser’s office realized that the real
proach, because the vast majority of
Decisions the units are being rented and most
issue in the selection of the valuation
Understandably, many condo con- approach is highest and best use.
of the property is being operated as
version property owners believe the Typically, the actions of the market
an apartment complex.
assessment of the unsold units must indicate highest and best use. When
be based on the income approach, be- a developer converts apartments to
cause the units are being rented and The determination of highest individual condo units and sells all
not marketed for sale. The courts have of them, clearly the highest and best
ruled that the method of assessment
and best use is accomplished use is individual condo ownership and
is at the discretion of the property through the traditional four-step the appropriate valuation approach
appraiser. In Bystrom v. Bal Harbour would be based on sales of individual
(1987), the court stated, process: physically possible, legally units. When a developer converts
apartments to condos and is unable to
The mere fact that that the taxpayer permissible, financially feasible, sell any units, the market is reflecting
disagrees with either the weight to be
and maximally productive. Of those that the highest and best use is prob-
accorded each factor or the method to
ably apartments. For apartments, the
be utilized in arriving at the valuation
of the property is not a sufficient reason
four steps, the most significant for appropriate valuation method would
be the income approach or sales of
to overturn the appraiser’s valuation. fractured condo projects is the last whole apartment projects.
Although the owner of a condo-
minium unit may choose to rent it, one: maximally productive. However, many projects have too
that action alone does not dictate that many sold units to be considered
it should be valued via the income ap- apartment projects. This point of no
In Schultz v. Lurie (1987), the court
proach. As the Florida Supreme Court return prevents the developer from
actually held that a condominium
noted in Bystrom v. Whitman (1986), dissolving the condo documents and
project should be valued as an apart-
resuming the original arrangement.
The core issue in any action challeng- ment project utilizing the income
There are too many sold units to go
ing a tax assessment is the amount of approach. However, in that case, the
back in time, yet a significant inven-
the assessment, not the methodology taxpayer owned all the units within the
tory of unsold/rented units remains.
utilized in arriving at the valuation.” project and could terminate the con-
These are the properties that chal-
Clearly, it would be improper to dominium at any time. Unfortunately,
lenge conventional valuation think-
value some units in a project with one in most condominium projects, a num-
ing. The determination of highest and
approach (sales) while valuing iden- ber of units have been sold and are
best use is accomplished through the
tical units with a different approach outside the control of the developer.
traditional four-step process: physi-
(income). The Florida Department of In Gilreath v. Westgate Daytona, Inc. cally possible, legally permissible, fi-
Revenue echoed this point in a June (2004), the court held that the prop- nancially feasible, and maximally
23, 1993 opinion, stating, erty appraiser is not permitted to productive. Of those four steps, the
4 Fair & Equitable • July 2012

4. most significant for fractured condo the highest and best use and the cor- In essence, the proper valuation
projects is the last one: maximally responding approach appropriate for approach hinges on the determina-
productive. Which use would produce fractured condos, as follows: tion of highest and best use. These
the highest value—apartment rental five guidelines assist the assessor in
1. If a developer owns every unit
or sales to individual owners? making that determination. If the
in the condo project and is op-
When sales of condo units slow highest and best use is deemed to be
erating the property as a rental
down, many developers choose to rent individual condo ownership, then
apartment property, then the in-
the units because the price at which the valuation approach is the sales
come approach should be used
they would sell is unacceptable. Often comparison approach using sales of
with sales of apartment projects
these properties have a mortgage bal- individual units. If the highest and
as the basis for valuation.
ance greater than the current market best use is deemed to be apartments,
2. If a developer has sold only then the valuation approach is the
value; this is often referred to as being
a very few units but is trying to income approach using sales of apart-
upside down on a property. Rather than
reverse the condo conversion ment projects.
sell the unit at a loss, in the interim
by buying back sold units, then
many owners choose to rent, wait- Method of Valuation
the highest and best use is prob-
ing until the market improves. Many Once the highest and best use has
ably apartments and the income
even discontinue sales and marketing been established, the appropriate
approach should be used with
efforts during this interim period. valuation approach is determined.
sales of apartment projects as
Although the prices at which units Although the property appraiser’s
the basis for valuation.
could sell are below the debt amount, office may be confident about the
they are above the values per unit as 3. If the developer has reached
valuation approach, the property
an apartment property. This indicates the point of no return, that is,
owner is often still convinced the
that the highest and best use remains there are too many sold units
property should be treated as an
condos—with an interim use as rent- to make repurchase feasible,
apartment complex. In seeking an
als until the market provides a price then the highest and best use is
assessment reduction, the owner or
acceptable to the owner and above the probably condo ownership, not
the owner’s representative sometimes
debt amount. rental, and the sales comparison
utilizes methods inappropriate for
approach should be used with
assessment purposes.
individual units as the basis for
The determination of highest and valuation. Many appraisals for financing pur-
poses utilize the discounted cash flow
best use ultimately dictates the 4. If the project is still marketing
approach. Financial institutions are
units for sale, then the highest
valuation approach to be used. typically interested in the discounted
and best use is likely individual
value of the unsold units with con-
condo ownership, not rental,
sideration of an absorption period,
and the sales comparison ap-
selling expenses, and holding period.
Sometimes developers convert proach should be used with
However, this approach has been
apartments to condos and are unable individual units as the basis for
rejected for assessment purposes.
to sell them at price typical for simi- valuation.
In Palm Beach Development v. Walker
larly sized condo units. This clearly 5. If a developer has temporarily (1985), the court stated,
indicates that the highest and best use discontinued marketing units
is reversion to apartment use. Often because of the declining market Implementation of the owners’ dis-
this is accomplished through dissolu- but sales in competing projects count sellout theory would result in
tion of the condominium documents. indicate units would sell for more lower valuations on owners’ property
than they would as a rental prop- than exist on adjacent similar property
Determining the Valuation erty, then the highest and best owned by others.
Approach use is probably condo ownership, Another technique used by apprais-
The determination of highest and best use not rental, and the sales com- ers in valuing condo conversions is
ultimately dictates the valuation approach parison approach should be used sales of entire apartment projects
to be used. In that light, the prop- with individual units as the basis instead of individual condominium
erty appraiser’s office has developed for valuation (with consideration units. In essence, they are valuing the
guidelines to assist in determining for the declining market). sale of the units in bulk. The courts
Fair & Equitable • July 2012 5

5. Feature Article
have rejected this approach, as illus- Arbitrary adjustments to sales were ad- the highest and best use is deemed to be
trated in Edward Rose Building Company dressed in Walters v. State Road Depart- apartments, then the income approach
v. Independence Township (1990), in ment (1970), in which the court said, coupled with sales of apartment projects
which the court opined, One of the basic rules of evidence in should be used for valuation.
It was not appropriate to apply a ‘whole- this state and other jurisdictions is that References
sale discount’ to reflect the difference testimony that is essentially speculative Bystrom v. Bal Harbour 101 Condo-
between the prices the developer would and conjectural is inadmissible to minium Association, Inc., 502 So. 2d
have received if it sold the lots on an prove the value of property. 1312 (Fla. 3d DCA 1987).
individual basis [versus selling them]
Summary Bystrom v. Whitman, 488 So. 2d 520
‘en masse.’ Use of a wholesale discount
In the current real estate market, (Fla. 1986).
would violate the constitutional require-
owners of condo conversion proper-
ment of uniformity of taxation. Edward Rose Building Company v. In-
ties are unable to sell their units at
dependence Township, 462 N.W.2d 325
Assessment Appeals prices they previously enjoyed and
(Mich 1990).
In some appeals of condo conversion thus are renting their unsold units.
valuations, property owners point to These residential condo projects are Gilreath v. Westgate Daytona, Inc., 871
certain expenses in closing statements, called fractured condos and present a So.2d 961 (Fla. 5th DCA 2004).
asserting that discounts to the buyer challenge to conventional valuation Jeff Kielbasa, Assistant General Coun-
at closing were not reflected in the re- thinking. Typically, units in apartment sel, State of Florida Department of
corded sale price. Adjusting sale prices projects have a lower value than those Revenue to John C. Dent, Jr., Dent,
based on closing fees is inappropriate. in condo projects; thus condo conver- Cook & Weber, June 23, 1993, Talla-
In Southern Bell Telephone and Telegraph sion property owners request their hassee, Florida.
Company v. Dade County (1973), the properties be assessed as apartments.
court said, Palm Beach Development v. Walker, 478
With a variety of court rulings on this So. 2d 1122 (Fla 1985).
Therefore, in this context the price at issue and questions about the valuation
which property is sold as indicated approach most suitable for fractured Schultz v. Lurie, 512 So.2d 1003 (Fla.
by the documentary stamps on the condos, the Hillsborough County Prop- 2d DCA 1987).
instrument is prima facie evidence of erty Appraiser’s office recognized that Southern Bell Telephone and Telegraph
its value. determination of the highest and best Company v. Dade County 275 So. 2d 4
Tax appeals for some condo con- use ultimately dictates the appropriate (Fla. 1973).
versions are based on analyses that valuation approach. If the highest and Turner v. Tokai Financial Services, Inc.,
included extraordinary cost-of-sale ad- best use is deemed to be individual con- 767 So. 2d 494 (Fla. 2d DCA 2000).
justments. It is improper to apply a cost- do ownership, then the sales compari-
son approach with sales of individual Walters v. State Road Department, 239 So.
of-sale adjustment outside of the mass
units should be used for valuation. If 2d 878 (Fla. 1970).
appraisal approach. The court com-
mented on the cost of sale in Turner
v. Tokai Financial Services, Inc. (2000): Tim Wilmath, MAI, is the Director of Valua-
tion for the Hillsborough County Property Ap-
To allow a blanket deduction for costs praiser’s Office in Tampa, Florida. He has been
of sale gives a windfall to the seller who involved in appraising for over 25 years and ad
has already accounted for them in his valorem assessments for 15 years. Tim oversees
sales price. Property appraisers can the valuation for all property types in Hillsbor-
make a cost of sale adjustment when ough County, a jurisdiction of 500,000 parcels.
the circumstances warrant it, but no Tim earned a Bachelor of Science Degree in
such deduction is required by 193.011. Business Administration from the University of
Some tax appeals for condo conver- South Florida and currently holds the MAI and
sion valuations propose significant SRA Designations from the Appraisal Institute.
downward adjustments to recent Tim was the recipient of the IAAO Bernard L. Barnard Outstanding Tech-
sales. Often these adjustments are nical Essay Award for “Mass Appraisal of Hotels” in 2006.
not supported by any empirical data.
6 Fair & Equitable • July 2012